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What bitcoin is and how it works

What bitcoin is and how it works

Learn about Bitcoin, the world's first decentralized digital currency
6 minutes
06.04.2024
Editor Satoshi`s Secrets
What bitcoin is and how it works

In Brief

Bitcoin (BTC) is the world’s first decentralized digital currency, created in 2008 by an anonymous entity known as Satoshi Nakamoto. Mining involves solving complex cryptographic puzzles to validate transactions and secure the network, rewarded with BTC and transaction fees. Total Supply: The Bitcoin network is capped at 21 million BTC, with 18.7 million already mined and the remaining expected to be mined by 2140. Value Proposition: Bitcoin is considered “digital gold” due to its deflationary model, with its value determined by market demand and supply.

A lot of people are eager to deepen their knowledge about bitcoin and its working mechanisms, especially after its price has surpassed the $70,000 mark. To better understand this issue, let’s look at the origins of the first cryptocurrency and the beginning of the cryptocurrency industry.

What is bitcoin

Bitcoin (BTC) is the first ever decentralized digital currency, created in 2008. According to information from Coindesk, it was on October 31 that the Bitcoin.org website published the document “Bitcoin: A Peer-to-Peer Electronic Payment System”, the authorship of which is attributed to an anonymous person or a group of people using the pseudonym Satoshi Nakamoto. This document describes how the system works to make payments on the Internet without the need for intermediaries such as banks or clearing centers.

Unlike traditional currencies such as the dollar or the euro, bitcoins are not made by printing. They are issued through the operation of computers around the world that use specialized software to keep the Bitcoin network running. Bitcoin owners store their funds in electronic wallets.

Each cryptocurrency wallet has a private key and a public key. The public key can be compared to a bank account number, which is used to receive transfers and is available for everyone to see. An example of a public key looks like this: “1DSsgJdB2AnWaFNgSbv4MZC2m71116JafG”.

The private key, in turn, serves as a secret password, similar to a bank card PIN, and is intended to access the funds stored in the wallet. The minimum possible part of bitcoin for transactions is called “Satoshi” and is equal to one hundred millionth of BTC.

What is mining

Understanding Bitcoin requires recognizing its dual nature: on one hand, it’s a digital currency stored in electronic wallets; on the other, it’s a decentralized network that manages and logs transactions. At the heart of Bitcoin is a distributed ledger—a database replicated across thousands of computers in the Bitcoin network. This setup ensures that every transaction is recorded on all these devices, offering a high degree of transparency and security.

Solving the Double-Spending Problem

One of Bitcoin’s groundbreaking features is its solution to the “double-spending problem” without relying on a central authority like a bank. In traditional finance, banks ensure that money isn’t spent twice by acting as the middleman. Bitcoin, however, operates without such intermediaries due to its decentralized structure.

Decentralization and Transaction Verification

In Bitcoin’s ecosystem, no single entity or bank oversees transaction verification. The system is upheld by a community of volunteers. Transactions occur directly between parties, usually with lower fees compared to traditional banking.

Ensuring Transaction Integrity with Proof of Work

Bitcoin ensures transaction integrity through a consensus mechanism called “Proof of Work.” This system involves miners solving complex cryptographic challenges using powerful computers. These miners are vital for the network’s health, verifying transactions, and ensuring the spender has sufficient funds.

The Role of Miners in the Network

To process transactions, miners perform elaborate calculations. The first miner to solve the puzzle records the transaction in the ledger and receives a reward. The network then verifies this solution; if agreed upon, the transaction is finalized and publicly recorded. Miners earn from solving these puzzles, including transaction fees specified by the sender.

Incentives and Rewards for Mining

Transactions are grouped into “blocks,” and miners who discover new blocks receive additional rewards. This setup motivates more people to join the mining process, enhancing the network’s robustness and preserving its decentralized nature. Miners can earn significant sums through fees, depending on their equipment’s efficiency. The more computing power a miner has, the faster they can solve puzzles and validate transactions.

Initially, when Bitcoin was first launched, miners were rewarded with 50 BTC for each block they mined. Following the first halving in 2012, this reward was reduced to 25 BTC and then halved again to 12.5 BTC in 2016. The latest halving in 2020 reduced the block reward further to 6.25 BTC.

What is bitcoin halving read in our article: What is bitcoin halving?

How many bitcoins are there in total

The Bitcoin network is designed to produce a maximum of 21 million BTC, with currently 18.7 million BTC already mined. It is expected that the final 11% of Bitcoin will be extracted by the year 2140. As the reward for mining each block is halved, the complexity of the network — the difficulty of the cryptographic puzzles needed to verify transactions — steadily grows. This evolution necessitates ever more powerful computing resources.

Back in 2008, a simple home computer could manage to participate in supporting the Bitcoin network. Yet, with escalating network complexity, the task of mining new blocks began to demand increasingly advanced hardware. Initially, this led to the adoption of mining-optimized graphics cards, and more recently, the transition to specialized devices known as ASICs (Application-Specific Integrated Circuits), engineered exclusively for Bitcoin mining.

Is bitcoin digital gold?

Bitcoin incorporates a deflationary model, meaning due to the limited supply of 21 million BTC, its value is theoretically expected to increase, which is why Bitcoin is often referred to as digital gold. The value of BTC is determined by market demand and supply.

Besides being an asset, Bitcoin can also serve as a means of payment. For instance, in 2010, the first physical item purchased with BTC was two pizzas by Laszlo Hanyecz for 10,000 BTC, which cost him $50 at the time, now worth around $500 million.

Overall, Bitcoin is the first cryptocurrency that initiated the rapidly developing asset class, possessing characteristics of traditional money, except they are purely digital, and ownership proof is based on cryptography. As of February 2021, the total market capitalization of cryptocurrencies exceeded $1.5 trillion, comparable to the market capitalization of the American company Amazon.

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