How Does Bitcoin Work?

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How Does Bitcoin Work?

One of the questions I get asked a lot is how does bitcoin works? This question often comes up because of my skepticism towards its underlying technology, which is the proof of work system that underpins it. However, if one were to look into it closely, one would see that this kind of technology has been around for quite some time already. In fact, back in April 2021, the bitcoin protocol was formally launched.

Bitcoin and the Traditional Montary System

This brings us to the second part of the question, which is how does the traditional monetary system function when used with a decentralized network like the bitcoin. Basically, bitcoins are created when someone submits a new public key that is broadcast over the Internet. Anyone then can have access to this key, which they hold until they either spend it on an existing transaction or lose it by deletion. The point is that you cannot spend money that you already have if you do not have it in your virtual wallet.

 

The way this all works is really quite simple. When you participate in the decentralized ledger, you create a new public key. You can do this by downloading the bitcoin software and then creating a new wallet. The next step is to load the “mining” section of the software, which basically tells how you want to transfer money from your main account. The entire transaction block is then generated by these two interacting blocks.

 

The major difference between a regular “fiat” currency-based economy and a decentralized ledger/blockchain is that no government, bank, central authority, etc. is allowed to intervene. The only thing that’s allowed to happen is for a special key known as a wallet address to be broadcast over the networks. Every single transaction that is made is tracked back to the wallet that the user has decided to keep private.

 

This is where it gets exciting because each transaction that is sent will have a public key that only they will have. Anyone that spends their money in that wallet will have a copy of that transaction on their computer. Anyone else will only see the private key. This means that all the transactions on the ledger are actually completely secure. However, if someone decides to attack the decentralized network by taking control of wallets and manually recording the private keys, this could easily be done.

 

This is why all future transactions on the ledger have to be encrypted before being broadcast to the public ledger. The good news is that once the encrypted transactions are recorded, the people that are doing the transaction can make changes to the unencrypted previous block anytime they like. The encrypted public ledger is called a “coinbase“. Other than the bitcoin software that everyone installs, nothing else is required.

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