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Bitcoin explained in 5 minutes



SUMMARY


You may have heard Bitcoin referred to as "digital gold" or "cash for the internet", but these descriptions don't really say much about Bitcoin. If you want to know what Bitcoin really is and how it works, you've come to the right place.



CONTENT

  • Understanding Bitcoin

  • Bitcoin nodes decentralize the network

  • How do miners verify bitcoin transactions?

  • Bitcoin mining rewards make the blockchain secure


UNDERSTANDING BITCOIN


Bitcoin is neither a physical nor a digital object. Rather, Bitcoin (BTC) is a representation of value in the form of proof of ownership in the Bitcoin blockchain. Although this may sound completely foreign to you, if you scroll down this page you will understand what Bitcoin really is and how it works.


To understand Bitcoin as a proof of ownership, you first need to understand the Bitcoin network, which consists of three things:

  • the Bitcoin blockchain,

  • Bitcoin transactions, and

  • the entities that verify and secure transactions.

The Bitcoin blockchain is simply a public record that has some very unique properties that make it incredibly secure and trustworthy. This public record exists on tens of thousands of computers around the world simultaneously, called nodes, and is updated in real-time. No one person or company controls these nodes, which makes Bitcoin decentralized.


Bitcoin transactions are just like any other financial transaction you are already familiar with: a transfer of value (e.g. dollars, real estate) from one person to another. But instead of going through a bank or other financial service provider, this transaction is validated, recorded, and secured directly on the blockchain by all nodes on the Bitcoin network. This process makes transactions on the Bitcoin blockchain secure and verifiable.



BITCOIN NODES DECENTRALIZE THE NETWORK


Every Bitcoin transaction is sent from the node where the transaction originates to all nodes on the Bitcoin network. These nodes ensure that the transaction is valid, i.e. they scan the entire blockchain to confirm that the person sending the money actually has that money and is authorized to send it. If these two conditions are met, the transaction is considered valid.


Remember that Bitcoin is decentralized, which means that thousands of Bitcoin nodes in aggregate must agree that a transaction is valid. Even if a few bad actors were to falsely confirm a transaction, thousands of other nodes would not, and the transaction would not be confirmed. This makes the likelihood of a valid transaction being recorded extremely high and the likelihood of a false transaction being recorded extremely low - making the use of Bitcoin incredibly safe and secure.


Every 10 minutes or so, the latest valid transactions are combined into a block of data, which is then sent to the entire network to be backed up in the blockchain.


Before we continue, let's briefly recap how transaction blocks are sealed, secured, and added to the blockchain.

  1. Bitcoin transactions are sent to all Bitcoin nodes.

  2. The transactions are validated and confirmed by the network.

  3. All valid transactions are combined into one data block approximately every 10 minutes.

  4. The unsecured data block is sent to the entire Bitcoin network to be added to the Bitcoin blockchain.


HOW DO MINERS VERIFY BITCOIN TRANSACTIONS?


A special subset of nodes called miners take unsecured blocks of data and do a few things to secure that block in the Bitcoin blockchain.


First, they take every transaction in the block and run it through an algorithm that takes each transaction and creates a unique identifying signature of 64 letters and numbers called a hash.


So now we have a block of transactions that have been compressed into hashes. They are then compressed further by pairing hashes together and creating a new hash for the pair. This is done until the entire block of transactions is represented by a single hash.


Then the hash of the previous block is added to the block.


So now our block has the hash that represents all the current transactions in the block and the hash that represents all the transactions in the previous block. This is how the "chain" in "blockchain" is formed. If even a single byte of data from a previous block were to change, all future blocks would be invalid because every single hash in the future would change and break the blockchain.


The last part of the block is a random number called a nonce, and this is where the miners really come in.


The nonce and the two hashes in the block must combine to make a hash that meets a set of criteria set by the software that runs the Bitcoin network. The only way to find a valid hash is to try random nonce numbers until the hash criteria are met.



BITCOIN MINING REWARDS MAKE THE BLOCKCHAIN SECURE


Miners buy or build special computers, develop algorithms and invest a lot of time and energy in the form of electricity to find the nonce that meets these criteria. The first miner to find the nonce and create the hash that meets the criteria sends the hash to the entire network.


While it is very difficult to create the hash of the block, verifying that it meets the criteria is very simple. The nodes verify that the hash of the block meets the criteria and then add the block to their copy of the blockchain.


Remember that each Bitcoin full node keeps a copy of the entire blockchain, so an invalid block can only be added to the blockchain if 51% of all nodes agree to the addition. While this is possible, it is very unlikely, which is further proof that decentralization ensures a secure and accurate record of transactions on the blockchain. Valid blocks are added to copies of the blockchain around the world and Bitcoin miners start working on the next block.


In return for their work, called Proof of Work (PoW), miners are rewarded with new Bitcoin. This is the only way to generate bitcoin.


So, again, a quick summary:

  • Transactions are converted into multiple hashes.

  • These hashes are converted into a single hash.

  • This hash is combined with the hash of the previous block.

  • These two hashes are combined with a nonce to create a unique hash for the new block.

  • The hash of the new block is verified by the network, added to all copies of the blockchain and the prospectors are paid in Bitcoin.

The way the prospectors receive their bitcoin is that each prospecting team adds a transaction to the block in their node stating that they will receive the pre-determined bitcoin for successfully prospecting that block. The team that actually succeeds receives the bitcoin because their block is added to their copy of the blockchain and then to all copies of the blockchain in the world. All the blocks from the other mining teams are discarded.


They now understand that decentralization and cryptography are the mechanisms by which the security of data and trust in the Bitcoin blockchain is established and strengthened. And that Bitcoin is simply a representation of value in the form of proof of ownership in the Bitcoin blockchain.






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