What is Bitcoin and how Does it Actually Work?

 

What is bitcoin? Bitcoin is a set of concepts and technologies that form the backbone of the digital currency ecosystem. A currency called bitcoin is used to store and transfer value between participants in the bitcoin network.

Bitcoin users primarily communicate with each other over the Internet using the Bitcoin protocol, although other transport networks can be used. Available as open source software, the Bitcoin protocol stack can run on a variety of computing devices, including laptops and smartphones, making this technology readily available.

Users can transfer bitcoins over the network to do anything they can do with regular currencies, including buying and selling goods, sending money or lending to individuals or organizations. Bitcoins can be bought, sold and exchanged for other currencies on specialized currency exchanges. Bitcoin is in a sense the ideal form of money for the internet because it is fast, secure and unlimited.

Unlike traditional currencies, bitcoin is completely virtual. There are no physical coins or even digital coins. Coins are used in transactions that transfer value from sender to receiver. Bitcoin users have a key that allows them to prove ownership of bitcoins on the bitcoin network. With this key, they can sign transactions and transfer them to the new owner to unlock and spend the value.

Keys are usually stored in digital wallets on each user's computer or smartphone. Having a key that can sign transactions is the only requirement for spending bitcoin and gives every user full control.

Bitcoin is a distributed peer-to-peer system. So there is no "centralized" server or checkpoint. Bitcoins are created through a process called "mining", which involves competing for solutions to mathematical problems while processing Bitcoin transactions.

Any member of the Bitcoin network (i.e. anyone using a device with the full bitcoin protocol stack) can work as a miner, using their computer's computing power to verify and record transactions. On average, every 10 minutes, bitcoin miners can verify the last 10 minutes of transactions and receive new bitcoins. Essentially, bitcoin mining decentralizes a central bank's issuance and clearing functions and replaces the need for any central bank.

The Bitcoin protocol includes a built-in algorithm that controls the mining functions of the network. The difficulty of the processing tasks that miners must perform is dynamically adjusted so that, on average, one person succeeds every 10 minutes, no matter how many miners (and how many transactions) compete each time.

The protocol also halves the rate at which new bitcoins are created every 4 years, limiting the total amount of bitcoins created to a fixed amount of just under 21 million coins.

As a result, the number of bitcoins in circulation follows a predictable curve, approaching 21 million by 2140. As the bitcoin issuance rate decreases, the bitcoin currency experiences deflation in the long run.

Additionally, bitcoin cannot be inflated beyond the expected supply rate by "printing" new money. Behind the scenes, bitcoin is also the name of a protocol, peer-to-peer network, and innovation in distributed computing.

Bitcoin currency is actually only the first application of this invention. Bitcoin represents the culmination of decades of research in cryptography and distributed systems and includes four major innovations combined in a unique and powerful combination. Bitcoins consist of:

• Decentralized peer-to-peer network (bitcoin protocol)
• Public ledger of transactions (blockchain)
• A set of rules (reconciliation rules) to independently verify transactions and issue currency
• Mechanism to reach global decentralized consensus on real blockchain (Proof of Work algorithm).

As a developer, I see bitcoin as the internet of money, a network for maintaining ownership of digital assets and spreading value through distributed computing. There are many more bitcoins than meets the eye.