Bitcoin For Beginners – How Bitcoin Works.
Bitcoin is a digital currency with a decentralized system which means there is no centralized authority or agency to regulate, rather than it requires multiple parties to take their own independent decisions. You can transfer bitcoins directly from one person to another person via internet without going through any bank so there are no transfer charges. Yes, you can buy almost anything today in exchange for bitcoins. “Satoshi Nakamoto” which is an alias for the unknown person or persons who invented the bitcoin in 2009 as the first decentralized P2P (peer to peer) digital currency. Today we have more than 500 digital currencies like bitcoin itself but bitcoin is famous among all as it has first-mover advantage. Bitcoin is legal and accepted in many countries now which include USA, Japan, Canada, Australia, The European Union etc.
How Bitcoin Works?
To understand how this system works let’s start with a very oversimplified explanation of the system than we will keep on going deeper and deeper into the technicalities of the system. There are several currency exchanges from where you can buy or sell bitcoins for Rupees, dollars, euros and more and then you can keep your bitcoins in your digital wallet on your system or on your mobile device, using these wallets you can send bitcoins from one person to another. It is as easy as sending an email but you must be thinking if there is no central bank or authority than who ensures security and How? Bitcoin is secured by individuals called “miners”, these miners verify the transactions and get some amount of bitcoins as a reward and that’s how new bitcoins are created in the system. Examples of some of the bitcoin wallets are Coinbase, Unocoin, Zebpay
Let’s get more technical, in reality, bitcoin is just a ledger which contains names alongside with their balances. This ledger is public means everyone who is connected with bitcoin network keeps its own copy of the ledger and when a transaction is made a message is sent across the bitcoin network which contains senders name, bitcoin amount and receiver’s name and after reading this message everybody updates the balances in their copy of ledger. This shared ledger is called the “Blockchain”.
How Transaction occurs in bitcoins.
For the sake of simplicity, we said that bitcoin is just a ledger which contains names and balances of all the people who are connected with the bitcoin network and we also said that all the people who are connected with bitcoin network, maintains its own copy of this ledger so this means that everybody could see anybody’s balances but to maintain some anonymity the real system only use account numbers (bitcoin addresses) instead of names. Now you must be thinking if everyone maintains their own ledger how these ledgers are kept in sync when money is transferred, well it is simple whenever you want to transfer money you simply broadcast a message in the bitcoin network. This message contains your account number, receivers account number and the amount of money you want to transfer so by receiving this message everybody updates their ledger across the bitcoin network.
Security Of Transactions
Well if it is as simple as broadcasting a message in the network to transfer money than how it is ensured that some thief or hacker will not use someone else’s money just by sending a message with the victim’s account number, to ensure this doesn’t happen bitcoin uses a signature-based approach. Every transaction message is signed by the user who has initiated the transaction but these signatures are not handwritten instead these are based on math(digital signatures). When a new account is created on bitcoin network, it comes along with a private key mathematically linked to that account number and using this private key and text in the message a unique signature is created which cannot be copied and other people with the help of the public key (account number of the owner) checks the transaction and make sure that it was created by the real owner and it applies to that specific transaction.
Order Of Transactions
So the digital signature on the transaction proves who sent the transaction but it can’t prove when it was sent and it can be very problematic. To ensure the order of these transactions these transactions are first collected in a pool of pending transactions and from here these transactions are sorted into a giant chain. To select which transaction is next in the chain a mathematical lottery is held where the users pick up the pending transaction of their choice and began to solve a special mathematical problem that will link the transaction to the end of the chain. The first person to solve this problem wins and their transaction is selected as next in the chain and everytime someone wins this lottery new bitcoins are created this process is called mining as this is how money enters the system and money is created but bitcoins are limited and it is estimated that somewhere around the year 2140 no more bitcoins could be created.
I hope this post helped you to understand how bitcoin works.
Have a good day!