What is Bitcoin and How Does It Work?

Just what is Bitcoin? Is it really money? How does Bitcoin function and what problems does it aim to solve? We explain Bitcoin clearly to you.

Wednesday, 13 Nov 2019

In October of 2008, on an anonymous mailing list called Cypherpunk, an anonymous participant using the pseudonym Satoshi Nakamoto announced the publication of a paper.

"I think I have solved a problem in computer science" - Satoshi Nakamoto

Satoshi was claiming to have found a way to create a system of electronic cash that is peer-to-peer, meaning it is direct between people. Satoshi also provided a white paper and software following its specifications.

So Bitcoin is a software application? Yes, exactly that. You run it on your computer and it connects with others around the world who are also running the application. It connects with others randomly, creating a mesh of connections, this is what we call a peer-to-peer network.

Where's the central computer? You might ask. There is no central computer, just a crowd of computers talking to each other over the network. No singular identity controls the network. The system is based off collaboration, communication and computation through cryptography - every computer running Bitcoin follows these principles.

What's actually going on here? Well, computers are exchanging transactions. These transactions are encoded in a digital format. They contain information about the transfer of value and the authorization to do so. Bitcoin transactions are packaged up into what's called a block. Chains of blocks are what make up the Bitcoin blockchain, a digital ledger of all existing transactions.

So Bitcoin is a system that transmits value. Is that not a form of money? When you look at the concept of money throughout history, it started off as trading physical goods. It then became precious metals, and transitioned into coins and paper notes that people deem valuable. But now it's something even more abstract, it's digital.

Bitcoin is a digital form of currency! It's validated independently by every computer that participates in the network. It's issued independently by a process called mining (powerful computers running Bitcoin mining software). You can imagine mining as a way to keep the network going.

Roughly, how do computers running mining software work? They solve complex cryptography puzzles which enable the creation of blocks. As mentioned earlier, a block is a series of processed transactions. Additionally, every time a new block is generated by a miner, more Bitcoins are minted into the network.

The result? Bitcoin is self-sustaining and completely decentralized. It cannot be forged, cannot be counterfeited, and cannot be censored. It can be transmitted anywhere in the world, and by anyone. Quite simply, it's money for the people.

TLDR; here's a summary of Bitcoin's key characteristics:

  • Bitcoin is easy to set up - anyone can download a Bitcoin wallet, create an address and start receiving and sending Bitcoins on the network. There are a number of Bitcoin wallets available, some download the whole blockchain onto your computer and others don't. Lightweight wallets are sufficient for transmitting Bitcoins via your mobile devices.
  • Bitcoins are mined - Bitcoins are generated through a process called mining. A process where computers on the network solve complex cryptography puzzles with scientific algorithms. This also enables the network to process transactions.
  • Bitcoin is decentralized - it's the responsibility of each computer on the Bitcoin network to track and exchange value. Because of this, the system remains operational at all times. If dozens of peers running Bitcoin were disconnected or shut down, it wouldn't affect the whole system.
  • The creator of Bitcoin is unknown - it was created by an unknown person or group of people called Satoshi Nakamoto. Nobody knows exactly who Satoshi is, or perhaps their identity is a heavily guarded secret. Today, many cryptocurrencies exist using Satoshi's model, or one that's similar. These currencies do not have a mystery creator.

Does Bitcoin sound like something you would use as a consumer? If you own a business or website might it be a form of payment you consider accepting?

If you're still curious, check out this introductory video: