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How does Bitcoin Really work?

Updated: Mar 30

The first question we have is what is Bitcoin?

I have been in crypto for not too long and I was curious to go through the Bitcoin Whitepaper as it is supposed to be the Holy Grail in here. This article is for anyone who is new and wants to understand what makes this technology beautiful .Let's get into it!

Bitcoin is a P2P version of digital money which allows users to transact with each other without the need of a financial institution.

Sounds simple enough? It pretty much is! That's the whole point of it.

Now the obvious question is why was something like this needed? Doesn't the current system with banks work well enough?

Let me list out the disadvantages of the current system to you.

  1. Biggest one is the trust based model. You always need to put in trust in a central authority. That is the main idea behind the web3 revolution.

  2. Non reversible transactions are not possible and with this possibility, the need for trust increases and also the cost of maintaining the possibility of reversing transactions in case of non reversible services.

  3. Now since there is a mediator in the transaction the cost obviously goes up since the transaction fees is charged.

Now how does bitcoin solve these problems?

  1. Transactions on the chain are irreversible. You can of course send the money back to the payee but you would then have a record of both the transactions.

  2. Counters the double spending problem

  3. Doesn't need a mediator hence the cost incurred is less than conventional methods.

How do the transactions happen?

  1. The sender initiates the transaction by specifying the recipient's address and the amount of Bitcoin they want to send.

  2. The transaction is broadcast to the network, where it is verified by network participants called "miners." Miners check to make sure the sender has enough Bitcoin to cover the amount they are sending, and that the transaction follows the rules of the Bitcoin network.

  3. Once the transaction is verified, it is added to the public ledger of all Bitcoin transactions, called the "blockchain." The blockchain is a Decentralized, secure record of all Bitcoin transactions that have ever taken place.

  4. The recipient can then see the incoming transaction in their Bitcoin wallet, which allows them to access and use the transferred Bitcoin.

By now we have heard a lot that BTC works on PoW consensus. But what is proof of work?

  1. The proof-of-work involves scanning for a value that when hashed satisfies a particular criteria, such as with SHA-256, the hash begins with a number of zero bits. This can vary with the chain and the protocol. The average work required is exponential in the number of zero bits required and can be verified by executing a single hash.

  2. Once the block has been mined and verified by others, it cannot be changed without redoing the work and also redoing all the blocks after it. For example if you want to change 6th block in a 10 block chain, you would have to redo all the work involved in creating blocks 6 to 10.

  3. To compensate for the increasing technology and fast processors the mining difficulty increases once more number of blocks are being mined/hour.

Be it mining, the usage or where you can buy Bitcoin, everything has been covered in detail here.

Okay, now we understand the terms involved in the process, but how does it actually function? Have a look at the steps below.

  1. New transactions are broadcast to all nodes.

  2. Each node collects new transactions into a block.

  3. Each node works on finding a difficult proof-of-work for its block.

  4. When a node finds a proof-of-work, it broadcasts the block to all nodes.

  5. Nodes accept the block only if all transactions in it are valid and not already spent.

  6. Nodes express their acceptance of the block by working on creating

Now most importantly (for the node of course) what are the incentives that are involved?

The first transaction in a block is a special transaction that starts a new coin owned by the creator of the block. This Serves as the incentive for nodes to support the network, and provides a way to initially distribute coins into circulation. The incentive can also be funded with transaction fees.

You can think of this as Gold miners working hard to generate new gold in a mine. Just that in this case, the hard work is CPU power and electricity.

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The incentive encourages nodes to stay honest. However, the most amazing thing here is that, even if someone wanted to attack, they would find it more profitable to play by the rules as he would have more to gain instead of defrauding the system and creating the chain from start. Amazing isn't it?

By now you must be wondering if a block only contains a single transaction?

Although you wouldn't be entirely wrong as this is possible, but in most cases this wouldn't be the most efficient way. How it normally happens is multiple transactions are combined into one and can have multiple inputs and outputs.

By now you must have seen people rambling about the privacy bitcoin provides but if all the transactions are in public, how is the privacy maintained?

The answer to this question lies with public keys.

The way bitcoin functions is that each transaction is published on the chain making it completely transparent. However the only information someone can see is that a transaction of a particular amount happened and not who made the transaction.

The user can only be identified by their public key.

The last section mentioned in the Whitepaper are the calculations. I apologize but I was never very good with math. If you have gone through the paper please let me know on how the math works!

If you are into crypto and looking to hold up discussions, join communities and network better with traders and crypto enthusiasts from all over the globe, you should definitely check out Our Crypto Talk.

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