This is the Best, Most Simple Explanation of How Bitcoin Works

Before you start buying bitcoin or downloading your first bitcoin wallet, it’s best to know how exactly the whole ecosystem works, and what bitcoin is.

What exactly is Bitcoin?

Bitcoin is one of the myriad crypto-currencies floating around the interwebs, and perhaps the most recognizable. Coins like Dogecoin exist for the memes, and Ethereum is a close second to Bitcoin. Bitcoin, however, continues to be the largest of its kind in terms of total market value. It is a peer-to-peer system, not quite unlike torrents, in that there is no centralized server, repository or administrator handling transactions. Instead, the transactions take place between users directly, without any sort of intermediary involved.

These transactions are verified by several network nodes, and are then recorded in a publicly distributed ledger, called the blockchain. The blockchain is what facilitates the magic of any crypto-currency. In the case of Bitcoin, it uses bitcoin as its unit of account.

Why Bitcoin is Immune to Inflation

All currencies, like the dollar and euro, are vulnerable to inflation, however Bitcoin was designed in a manner that specifically prevents it: they are released in controlled amounts that are continually halved, in a manner that ensures that there will only ever be 21 million coins in circulation. However, this cap will probably eventually have to be raised, as there are already 16,305,238 coins in circulation (77% of the total bitcoin value). There is also a certain amount of bitcoins that are invariably lost, either by hard drives dying, theft of devices, wallet details getting lost, or just simply by being thrown away. These factors are accounted into the bitcoin price by an online bitcoin exchange.

gold vs bitcoin last five years graph
Gold vs Bitcoin Over the Last 5 Years with Prices in Indian Rupees ($1 = ₹64)

How Are Bitcoins Secure?

If bitcoins only exist digitally, then what is to stop someone from hacking all the bitcoins to steal them, or just shutting the system down for the lulz? This is an important question. If bitcoins were even a little bit insecure, they would have no value. It’d be like asking people to invest in a pile of money that’s left out in the open, in a crowded town square.

As we now know, there is no central bitcoin server. Any and all information about bitcoins is hosted on the millions of computers that house bitcoin wallets. Now is about when you’d say “Hang on there just a second, doesn’t that just mean that it’d be even easier to hack, since the only information I’d have to change would be on my computer?”

This is where the blockchain comes into play. Every bitcoin has it’s own uniquely identifying, really long hexadecimal code (in base 16, using A-F in place of 10-15, meaning you can represent bigger values with fewer numbers). Whenever you transact with bitcoins somewhere, a broadcast is sent to everyone on the blockchain, saying that this wallet address is sending these specific bitcoins to that wallet address.

What is a Bitcoin Blockchain?

If you’ve ever tried to set up a Bitcoin wallet, and downloaded the client, you’ll have noticed that before you can do anything at all, the client starts a really really big download. This download is nothing but the blockchain, the entire ledger of every bitcoin transaction, ever. It updates on your computer every time you open the client.

Now because each computer has a copy of this huge ledger of who has how many, and more importantly, which bitcoins, at any moment in time, it knows everything is legitimate. This ensures that the ledger is both secure, and accurate, which may seem impossible without one centralized server, but that is where the real magic happens.

How ‘Hashing’ Makes Bitcoin Secure

Every few hundred transactions are bundled into blocks, which is just a big list of who sent what to whom. These blocks are sent around as part of the ledger, with an accompanying hash. Bitcoin’s entire security is based on the concept of “hashing”.

A hash is a function that takes an input and returns a predictable output, in a way such that you can’t then take that output and know for sure what the input was. A really simple hash function would be something that records the value of each byte of the input, and then returns the sum of all those values. Obviously this will return different values for the inputs “cat” and “dog”, but it would return the same value for “bat” and “tab”.

However, more sophisticated hash functions use more complex algorithms that can distinguish between input values that differ even by a single bit; the best hash algorithms are used in cryptography and will produce wildly different outputs even when the inputs only have a single bit different.

In the case of the Bitcoin blockchain, changing even one small number in a data block will COMPLETELY change the hash code.

You Can’t Cheat the Blockchain

Going back to the blocks, each one holds the hash code of the next block, along with an arbitrary number (called a nonce) added into it. Unlike the hash, this number has no relation to the actual data contained within the chain. If someone tries to play around with the system and change the info in a block to say they haven’t actually spent bitcoins A, B and C, the new resulting hash would be completely different from the one held in the previous block, and everybody on the chain would know it was a fake.

Now, what’s to stop someone from just hashing their new block and slipping the new number into the last block? Simply that the codes are very, very computationally difficult to come by. So much so, that even the creators of bitcoins can’t do it themselves, which is where bitcoin miners and the system of distribution of bitcoins come in.

So What Exactly is Bitcoin Mining?

This article won’t go into how the actual mining of bitcoins works, but it is essentially the use of the processing power of your computer to hash these blocks, so they can be added to the universal ledger. The miners are paid, per block, in brand new bitcoins.

What happens, is when a block is released (which is a regular occurrence, happening anywhere between every few minutes to every few hours), everyone who is in the mining business races to figure out what nonce will cause the hash code to come out below a certain value.

You Need Really Good Hardware to Mine Bitcoin

Why is it done this way? For maintaining control. Finding the hash itself is not that hard, in fact most computers can calculate several hundred hashes a minute. The addition of the nonce creates a sort of guess-and-check game, that typically requires billions of hashes to get right (simply because since the numbers are so incredibly long, there is a significantly higher chance for the result to come out over the target, rather than under).

Because the blockchain functions like this, it dramatically increases (over a million times), the computational power needed to mine each block. This makes it horribly impractical (and that’s an understatement), for any person or group to try to rewrite the Bitcoin ledger. It also allows those in charge of the distribution of new bitcoins to control the rate at which they’re released.

Why You’re Too Late to Start Mining Bitcoin

Whenever a person (or a group, as most mining is done in guilds, due to the huge processing power required) solves, or ‘mines’, a block, they’re paid with a certain amount of bitcoins. Ever so often, at fixed intervals, the people in charge of the distribution of bitcoins look at the number of coins paid out in the last period. If it was more than expected, they drop the target number, making it harder to mine the blocks, resulting in fewer blocks mined, and less coins being paid out. This works the other way, too, if not enough coins were released, they raise the target number, making it easier to mine the blocks.

It’s probably too late for you to get into mining at this point, however. With the decreasing payouts, and the steadily rising difficulty level, the golden era of mining bitcoins is long gone.The current difficulty level is at 521,974,519,554, with a hash rate of 4,099,214,184 GH/s.

There is no way you can compete with the many mining farms around the world with your GPU, or even with a specialized, single purpose mining computer (called and ASIC). Your chances of receiving any coins are bleak, at best, and you’d probably end up losing money on all the equipment and electricity costs, even in the long run.

Bitcoin Mining Hardware Not Enough Power

Why is Bitcoin So Secure?

To sum up, Bitcoin is secure because there is only a finite amount in circulation, preventing inflation, and because it’s really, really, really, REALLY hard to hack, to the point that it’s simply impracticable. In fact, with that kind of processing power, you’d be better off (and probably more successful) in hacking your local bank than trying to steal bitcoins. We obviously don’t recommend doing either of those.

If you have any questions over anything bitcoin related, don’t hesitate to leave a comment! The bitcoin wiki and /r/bitcoin are good places to get started if you want to dive into the depths of crypto-currency.

Written by Shivendra Shukla

Shivendra's interests mainly lie in writing about himself in the third person, being awake when he is not supposed to be, breaking the bounds of normality, and being vague. Comes with own spectacles.

Leave a Reply

Your email address will not be published. Required fields are marked *