10 Simple Explanation of How Bitcoin (BTC) Works
In my current post, i will explain how bitcoin works. I will give multiple explanations about bitcoin. Hopefully you will understand.
Explanation – 1
This is a simple, but very challenging, question. Unlike the other answers already presented here I am going to go off on a tangent and try to describe it as a process a ten year old child can understand.
(I might get heat for the over-simplification. But it is somewhere to start off from.)
So here goes.
Take a $10 or €10 note from your wallet. Actually, take any paper money note from any country and look at it. Hold it in your hand. Ok? You have that ready? Now look at it carefully while you hold it in your hand. You are doing this now. Right?
After you have taken a close look at the note you should find a long number. Sometimes a long number with letters. It is called a serial number. I am looking at a €20 Euro note right now. At the back of the note, on the top right hand corner, there is always a serial number. For example, like this: UD2033379612. This number is registered at the European Central Bank and it is designated as a serial number representing the storage of value amounting to 20 Euros.
(Now make sure you have completed the step above. You need to identify the serial number of the bank note you have in front of you. If you don’t do that you won’t understand what I am going to allude to next when I speak about Bitcoin.)
Now, if you have followed along you might have noticed that the serial number is always different on every other bank note. That is, if you take another $10 or €10 note from your wallet you will see that the paper notes are always identical EXCEPT for the serial number. Right? Yes, we all can find out and most of us know it is is correct anyway. This is something you can check over and over again repeatedly against any other bank note of the same denomination.
Now that you understand each bank note has a different serial number we can go onto the next step. The next step is a thought experiment.
Think about this idea. What if, instead of presenting the paper money, we just present the serial number of that note at the cashier at the supermarket. After all, each paper bill has a unique serial number. Then the cashier can just type in the serial number and check it is valid and use that instead of the paper money to accept payment for your goods. That is how bitcoin works. You basically announce your serial number of your bank note and the cashier checks to see if it is a valid serial number – that is, if it corresponds to the value of money you are representing.
(I know, I know, for the people in the know, this is a gross over simplification. But hey, like I said, I want this to be the way I inform a 10 year old on how bitcoin works.)
So basically that is how bitcoin works. You own a serial number that represents a certain amount of value which you present at the cashier to pay. You don’t have to present the paper money. You see?
Ok. When you have understood this then one day we could go on to explain why it becomes “cryptographic”. That is, why we secure the serial number – in a secure scrambled up way – so that nobody else can use your serial number. I will not go any further explaining the method of securing the serial number cryptographically because the above mentioned material is just enough for you to get the most basic idea of what bitcoin is.
Remember, the only advantage of paper money is that you have to actually have the paper money to store the serial number on it. In bitcoin , you store the serial number in a password protected manner. The cryptographic encoding that is used to allow two parties to exchange value (move money between themselves).
The nice thing about bitcoin is that the serial number can now represent $10 or $1000000 Dollars. You can change the amount it represents too. You don’t have to carry many pieces of paper money in your wallet to pay for something anymore. If you have a smartphone you can do it digitally too.
This is how I explained bitcoin to my 80 year old grand mother. And it worked. She understood that the piece of paper was just that: a piece of paper. All we needed to do was work out a way where we could still store value, but this time only on the serial number, and then do it in a secure, cryptographic (password protected) way.
You don’t want to go further down the rabbit hole for now if you are still not sure about the process I explained before.
Explanation – 2
To better understand this, let’s refer to the time when banks didn’t have computer systems. They used to have a ledger to keep track of money transfer. It contained details of what account sent or received what money. Ordinarily, people trusted the bank not to deduct money from their accounts. The bank kept its promise and only they could update the ledger.
In this case, the Bitcoin network is the bank. The money is the bitcoin, normally denoted as BTC. Only this time, a bitcoin is not physical money but electronic money. You cannot touch it or carry it with you in your pockets. It is a digital currency and it has value. (Yes, people do exchange bitcoins and receive goods and services, or even other currencies.) You may ask, ‘where then do I get to keep my bitcoins?’
Bitcoins are stored in a ‘bank account’ known as a digital wallet. Just like your bank account, the digital wallet will have a private key and an address associated with it. Any person with this private key can access and send bitcoins from the digital wallet. You should therefore take appropriate steps to secure your wallet.
Perhaps what’s great about Bitcoin is that you can send and receive bitcoins without anybody knowing you have. Well, not exactly, but at least no one will know the exact person who sent or received the bitcoins. This is called pseudo-anonymity. You’ll not have to reveal your real identity; no names, tax IDs or social security numbers required to effect a transaction.
Another good feature is that Bitcoin is decentralized. Bitcoin has no single entity that controls it. How is that? Bitcoin is governed by a set of rules that are agreed upon by the entire network, which is comprised of millions of computers around the world.
With Bitcoin there is no double-spend. If I send to you a bitcoin, I can’t send the same to someone else. Remember that ledger in the bank and how only the bank could update its details? Well, with Bitcoin, everybody in the network has a copy of the ledger. So when a transaction happens, it must be verified and validated by the entire network before being updated on the global ‘ledger’. So when you try to repeat or fake a transaction, the system will check it out and you will be busted.
Anyone can join this network too, and verify and update the ledger. People who do this are called bitcoin miners. They compete to validate all transactions that happen every 10 minutes. The first miner to do that receives of 25 bitcoins (currently) and can send them to any account of their choosing. This is how new bitcoins enter into circulation. The total number of bitcoins that will ever be in circulation, however, was set at 21 million.
That explanation is as simple as it can get. There is more to what revolves around Bitcoin and other cryptocurrencies that you need to know before deciding to invest and buy any cryptocurrency.
Explanation – 3
I have tried to explain this concept in a very simple language. Do read till the end and you will get a good idea about what is Bitcoin and how it works.
Bitcoin was first launched in 2009 by Satoshi Nakamoto to eliminate the interference of third parties (generally banks).
Whenever you transfer the funds from one account to other , bank or third party checks if you have the sufficient funds and then transfers the money into the other account.But Bitcoin is a decentralised currency which works without the help of banks i.e third party.There is no Bitcoin works on peer to peer network where the trade is done between the buyer and seller.
You first need to create a Bitcoin wallet to buy Bitcoins .This is done with the help of wallet providers like Zebpay,Unocoin etc.Each Bitcoin wallet has its address just like an account number in bank which you can share to transfer the Bitcoins.Each wallet has a public and a private key.For each Bitcoin transaction, digital signature is generated. A digital signature helps to verify a transaction by nodes(Systems connected to the Bitcoin network).
Bitcoin uses the Blockchainis a public ledger which keeps the record of all the transactions.A Blockchain is made up of different blocks which stores the transaction details. Each block has a limited size of 1MB and once a block is full, another one is created which is linked with other blocks through a chain. Every new block has a reference of the previous block and this is how they are connected.Bitcoin has details of all the transactions done till date ( from the first transaction in 2009).
Now the question is who adds the transactions in Blockchain? It is done by miners.Note that Bitcoin miners don’t mine the Bitcoins. Their work is to maintain the Blockchain or PublicLieu of this, they are rewarded with the Bitcoins. These are the new Bitcoins which are introduced in the system.This is how Bitcoins enter the market through miners. This is the only way for Bitcoins to enter the market.
After adding the transactions in block, miner has to seal that block so that no one can edit those transactions.For this, a miner has to solve a difficult puzzle with the help of a mining software.After the puzzle is solved, nodes verify the blocks and it gets added in Blockchain.Only the miner who solves the puzzle first, gets the reward in the form of 12.5 Bitcoins plus the transaction fees for the transactions present in that particular block. This reward is reduced to half after every four years (It started with 50 Bitcoins reward in 2009, reduced to 25 in 2013).
Bitcoin concept is designed in a way that only 21million Bitcoins will be issued.After that new Bitcoins will stop coming in the market (around the year 2140)
To summarise, below is the process flow:
1. When you do a Bitcoin transaction, it goes to the Bitcoin network and the transaction is verified by the nodes with the help of digital signature
2.When a miner solves the puzzle (block gets sealed), the block goes to the Bitcoin network and after verification from nodes,it gets added to the Blockchain.
3.Now all the users can see all the transactions in Blockchain.