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How Bitcoin Really Works (5 minute read)

How Bitcoin Really Works (5 minute read)

Posted 12/20/21 by Tomer Strolight

Here’s a real quick, yet accurate expla­na­tion of how Bitcoin works.

Bitcoin Nodes

If you run Bitcoin node software, like Bitcoin Core, it will estab­lish a connec­tion to other, random instances of Bitcoin Core, becoming part of a world­wide network of inter­con­nected Bitcoin nodes. Anyone can do this. The software is free and its code is open source.

Every new Bitcoin Core node is seeded with the first ever piece of data in Bitcoin called the “Genesis block”. It contains the details of the first piece of data upon which all the rest of Bitcoin’s history is built. Each new node then polls the other nodes for the next block. The node then uses Bitcoin’s math based rules to check if that next block meets those rules. The rules check to see that every single Bitcoin trans­ac­tion in the block is valid and that it contains a valid proof of work (explained later) for creating that block.

It keeps retrieving new blocks until it catches up to the present. At that point it is in synchro­niza­tion with every other Bitcoin node in the whole world. Each Bitcoin node has verified the accuracy and truth of every single trans­ac­tion and block and Bitcoin’s history. They don’t just copy data — they verify every single bit of it. 

Bitcoin Transactions

A Bitcoin trans­ac­tion is a text message. To be valid it has to strictly adhere to specific rules though:

  1. It can only spend bitcoin that haven’t been spent. 
  2. It must provide a crypto­graphic signa­ture which can be used to verify that the sender is in posses­sion of the correct secret, randomly gener­ated, astro­nom­i­cally large number called a ‘private key’.
  3. It is also advis­able that the addresses of the recip­i­ents of the transaction’s funds are speci­fied. (If they’re not then the entire trans­ac­tion becomes a fee paid to miners.)

That’s it. It can include other data, like the date or time at which the trans­ac­tion will be valid (like post-dating a check), but it doesn’t have to.

There’s one other type of trans­ac­tion, called a coinbase trans­ac­tion (nothing to do with the company of that name — that company stole its name from this term). That trans­ac­tion is explained in the Bitcoin Blocks section of this article.

Bitcoin Addresses

Bitcoin addresses are weird looking strings like: 

bc1qtxsjjjgupnccn2czvwaj5x3szc4hw75nc53hm8 or  16t8xf4MG1mHoKU1AbpT5QGKDfj5UYg1W5 or  3CwT3oXQVtwYwBGnsRVd1Juj2gqBxsfNpv

But they’re not arbitrary and you don’t make them up. They are crypto­graphic finger­prints of either ‘public keys’ or of entire scripts of code. When it comes time to spend coins from those addresses the spender will have to provide the digital signa­ture associ­ated with the private key that corre­sponds to the public key or script.

Bitcoin Blocks

A bitcoin block contains a bunch of data:

  1. It contains a whole bunch of trans­ac­tions, each of which is verified to be a valid one. The first trans­ac­tion in it is called the coinbase trans­ac­tion. The coinbase trans­ac­tion rewards newly issued coins and fees paid in all the other trans­ac­tions in that block to the discov­erer of the block. People who discover blocks are referred to collo­qui­ally as ‘miners.’ All bitcoins in circu­la­tion come into circu­la­tion by being rewarded to miners. No other bitcoins exist.
  2. It also contains a verifi­able crypto­graphic finger­print or digest of all these trans­ac­tions (called a merkle root).
  3. It contains the crypto­graphic finger­print of the previous block — to prove that it was created only after the previous block was created. This is what chains this block to the previous block to create the famous “blockchain”.
  4. It contains a current date and time.
  5. It contains a couple of other small pieces of data (a version number and a target).
  6. Finally, it contains a special number called a ‘nonce’. Nonce is short for “number used once”. This nonce is used to prove that this block meets the proof-of-work require­ments at the time of its creation. Every node can run this block through the finger­printing algorithm (called SHA256) and check that the resulting number is smaller than the maximum allowed at the time (the target), thus making the block valid according to the rules of Bitcoin.

Mining

Miners work to discover nonces that satisfy the proof of work require­ments for the newest block to be added to the blockchain. This is basically just guess­work like guessing numbers in a giant lottery. The harder they try — that is, the more guesses they make — the sooner they’ll discover valid nonces to blocks and the faster they’ll produce blocks and be rewarded. However, Bitcoin is designed to keep the pace of blocks coming in at one every ten minutes on average, so roughly every two weeks (or precisely every 2,016 blocks) the diffi­culty associ­ated with finding a valid block (also known as the target) is recal­cu­lated with a precise formula, by every node, to make it harder (or sometimes easier, if neces­sary). Because every node uses the same formula on the same data, every node ends up agreeing on what the new diffi­culty target is. Miners then need to work as hard as the new diffi­culty demands to be able to earn the rewards of discov­ering new valid blocks.

That’s (just about) all folks:

With just the above mecha­nisms, Bitcoin runs.

People who have bitcoins, or fractions of them, can send them to anyone else who provides them an address. They prepare a valid trans­ac­tion and send it to any other node on the network and that node sends it out to others and it quickly ends up on every node, where each one ensures that it is in fact valid.

Miners take these new valid trans­ac­tions that haven’t been added to a block yet and try to guess the nonce to a new block containing those trans­ac­tions (and every­thing else a block must have). Sooner or later, one of them finds a valid nonce and shares the whole block with other nodes who then send it out to others and it quickly ends up on every node, where each one ensures that it is in fact valid. Every­body adds this block to their identical copy of the blockchain as soon as they verify its validity.

New coins get intro­duced into the system with the coinbase trans­ac­tion of each block, although the number of new coins per block keeps getting cut in half roughly every four years (or precisely every 210,000 blocks). This formula ensures that there will only ever be 21 million full bitcoins.

Nobody can fake anything because everyone checks every­thing all the time. Any nodes that attempt to misre­port any data are unable to get away with any decep­tion because the math behind every trans­ac­tion and block is what deter­mines the true state of things,

And that’s how Bitcoin really works.

This blog offers thoughts and opinions on Bitcoin from the Swan Bitcoin team and friends. Swan Bitcoin is the easiest way to buy Bitcoin using your bank account automatically every week or month, starting with as little as $10. Sign up or learn more here.


Tomer Strolight

Tomer Strolight thinks a lot about Bitcoin. He talks about it a lot. He writes about it a lot. He has authored the 26 article collection, “Why Bitcoin” available as a free ebook at swanbitcoin.com/whybitcoin and has many articles published on his own site at tomerstrolight.medium.com and at swanbitcoin.com. He also wrote and narrated the short film Bitcoin Is Generational Wealth, available at Swan Bitcoin’s YouTube channel.

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© 2022 Swan Bitcoin

Electric Solidus, Inc.
26565 Agoura Rd Ste 200
Calabasas, CA USA
hello@swanbitcoin.com
+1.218.379.7926

Swan Bitcoin does not provide any investment, financial, tax, legal or other professional advice. We recommend that you consult with financial and tax advisors to understand the risks and consequences of buying, selling and holding Bitcoin.