Bitcoin.org quotes Bitcoin as “an innovative payment network and a new kind of money.” But what really is a Bitcoin and how does it work? – Let us get started with this Bitcoin explained tutorial.
What is a Bitcoin?
On 31 October 2008, an unknown person or a group under the name Satoshi Nakamoto published a whitepaper titled Bitcoin: A Peer-to-Peer Electronic Cash System. The paper talked about how a decentralized peer-to-peer digital currency network would be made possible through the use of cryptography.
Bitcoin clubs the words ‘Bit’ and ‘Coin’ together. BitTorrent, a peer-to-peer decentralized file sharing network seems to be the source of inspiration.
The first block, genesis block, was mined for a reward of 50 bitcoins and consequently, it gave birth to the digital currency in January 2009.
Bitcoin explained in brief
Bitcoin serves as a decentralized digital currency. It uses a peer-to-peer network technology called the blockchain to work. The blockchain keeps a record of the transactions and serves as a public distributed ledger in the case of Bitcoin.
A Bitcoin is a unit of value on the Bitcoin network. The blockchain is a digital ledger that keeps a record of this value/Bitcoins. The smallest unit of the bitcoin currency is 1 Satoshi. 1 Satoshi is one hundred millionth of a single bitcoin (0.00000001 Bitcoin/BTC).
Bitcoin is an open source application which means that the code of the application is open for everyone to inspect and improve upon. There is no central authority or bank that controls it. Bitcoin uses the cryptographic hash functions and the concept of the blockchain to ensure the security of its system.
How Bitcoin works?
Bitcoin wallets make it easy for individuals to make transactions. Wallets are lighter versions of nodes. The wallet forwards the signed transaction details through a full node. Wallets keep a record of the spendable balance.
Bitcoins are transacted by the use of Bitcoin addresses and private keys. Private keys are used to sign transactions. They provide a mathematical proof that the owner of the wallet intended for this transition to happen. A signed transaction cannot be altered in any way. These validated transactions get pooled into blocks.
- Choose your wallet here
How do wallets work?
- You can buy Bitcoin here (You can earn Bitcoin as mining rewards too)
- Some places where you can spend Bitcoin here
After a transaction is signed it is broadcast into the network. Consequently, these transactions are pooled in 1MB size blocks. Miners stitch these blocks together by performing computational work. The computational work is adjusted in such a way that it roughly takes 10 minutes for a block to get added to the blockchain.
All transactions that are recorded on the blockchain can be viewed publicly. Each full node maintains the complete copy of the blockchain. Whenever a new block is added to the blockchain, a certain number of bitcoins are created and awarded to the miner who has enabled the block to get validated and attached it to the blockchain. All the transactions in the block are deemed to be confirmed after this, though it is highly recommended to wait for 6 or more blocks to get added on top of them to have a satisfactory level of confirmation. The total number of Bitcoins capable of being produced ever is currently limited to 21 million units.
Mining makes it possible for the ordering of the transactions and also secures the blockchain. It is a distributed consensus system that confirms the waiting transactions (signed by the sender) in order to include them in the blockchain.
Mining serves as an incentive system to keep the blockchain running. It also keeps it secure as to alter the details recorded in the blockchain, the attacker requires using more than 51% of the combined computing power being used by the miners.
As there is no central authority that exists to keep the network secure and to issue new Bitcoins, mining also server as a system to bring in new Bitcoins into the system. In exchange for computational power put in by the miners to successfully attach blocks to the blockchain, miners are rewarded with a determined number of Bitcoins. This is called a block reward.
Apart from the block rewards, the transaction fees attached to the transaction that make up the blocks are also taken by the successful miner. These incentives encourage individuals to mine more blocks.
The network will automatically adjust the difficulty of mining a block to 10 minutes. When a block is mined quickly the difficulty level is increased. When more people bring in computational power to mine blocks, the difficulty level keeps increasing. Miners often share resources and participate in mining pools in order to mine the blocks.
A detailed visual explanation of how Bitcoin works
Things you need to know before using Bitcoin
Bitcoin is easy to use thanks to the efforts of many in bringing out user-friendly wallets. But, it does not remove the need for you to have a clear idea of the important aspects of Bitcoin. Bitcoin, after all, is as important as money.
Securing your wallet
Wallet must be kept secured by keeping the private keys secure. Retain the control of the private keys with yourself and do not store them on third-party systems or online servers.
Bitcoin price is volatile
Bitcoin price can unpredictably increase or decrease over a short period of time. As awareness about Bitcoin is increasing and the regulatory environment is unclear in some cases, the volatility is here to remain. Caution is advised and it is not recommended to store your saving in Bitcoins.
Bitcoin payments are irreversible
A transaction signed and broadcasted to the network cannot be reversed. The person or the entity receiving the funds can possibly return you back. Now if the wrong address is used, it becomes nearly impossible to get the Bitcoins back. It is always recommended to double check the address entered before the transaction is signed.
Bitcoin is not anonymous
All Bitcoin transactions are stored publicly on the blockchain. They are permanently recorded. This means that anyone can see the balance and transactions of any Bitcoin address. Although the identity of the person to an address is not recorded on the blockchain, it can be traced in certain cases. It is hence not recommended to use Bitcoin addresses more than once.
Unconfirmed transactions aren’t secure
Each transaction takes an average of 10 minutes to get its first confirmation. If the transaction fees are set too low, the first confirmation itself can take much longer. Check the below table to get an understanding of the required number of transactions for safe transactions.
|Confirmations||Lightweight wallets||Bitcoin Core|
|0||Only safe if you trust the person paying you|
|1||Somewhat reliable||Mostly reliable|
|3||Mostly reliable||Highly reliable|
|6||Minimum recommendation for high-value bitcoin transfers|
|30||Recommendation during emergencies to allow human intervention|
Bitcoin is still experimental
Bitcoin is still in active development. It is still in an experimental phase as a new currency system. The direction that Bitcoin would take in the future would be impossible to predict. Invest in Bitcoin with caution.
Government taxes and regulations
Bitcoin is not under any centralized or official entity. It is not an official currency. Aspects related to income tax, capital gains taxes and legality of Bitcoin vary from jurisdiction to jurisdiction. Ensure that you are not breaking any laws. Some jurisdictions ban the use of Bitcoin as legal tender. Check the legality of Bitcoin in your country here.