How Bitcoin works

3 min read

Unlike credit card networks like Visa and payment processors like Paypal, bitcoin is not owned by an individual or company. Bitcoin is the world’s first completely open payment network which anyone with an internet connection can participate in. Bitcoin was designed to be used on the internet, and doesn’t depend on banks or private companies to process transactions.

One of the most important elements of Bitcoin is the blockchain, which tracks who owns what, similar to how a bank tracks assets. What sets the Bitcoin blockchain apart from a bank's ledger is that it is decentralized, meaning anyone can view it and no single entity controls it.

Here are some details about how it all works:

  • Specialized computers known as ‘mining rigs’ perform the equations required to verify and record a new transaction. In the early days, a typical desktop PC was powerful enough to participate, which allowed pretty much anyone who was curious to try their hand at mining. These days the computers required are massive, specialized, and often owned by businesses or large numbers of individuals pooling their resources. (In October 2019, it required 12 trillion times more computing power to mine one bitcoin than it did when Nakamoto mined the first blocks in January 2009.)

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  • The miners’ collective computing power is used to ensure the accuracy of the ever-growing ledger. Bitcoin is inextricably tied to the blockchain; each new bitcoin is recorded on it, as is each subsequent transaction with all existing coins.

  • How does the network motivate miners to participate in the constant, essential work of maintaining the blockchain—verifying transactions? The Bitcoin network holds a continuous lottery in which all the mining rigs around the world race to be the first to solve a math problem. Every 10 min or so, a winner is found, and the winner updates the Bitcoin ledger with new valid transactions. The prize changes over time, but as of early 2020, each winner of this raffle was awarded 12.5 bitcoin.

  • At the beginning, a bitcoin was technically worthless. As of the end of 2019, it was trading at around $7,500. As bitcoin’s value has risen, its easy divisibility (the ability to buy a small fraction of one bitcoin) has become a key attribute. One bitcoin is currently divisible to eight decimal places (100 millionths of one bitcoin); the bitcoin community refers to the smallest unit as a ‘Satoshi.’

  • Nakamoto set the network up so that the number of bitcoin will never exceed 21 million, ensuring scarcity. There are currently around 3 million bitcoin still available to be mined, which will happen more and more slowly. The last blocks will theoretically be mined in 2140.

Cryptocurrencies and traditional currencies share some traits — like how you can use them to buy things or how you can transfer them electronically — but they’re also different in interesting ways. Here are a few highlights.

Other currency
Who manages it?
A network of computers running open source code
The government that issues it
How does it hold its value?
Primarily based on supply and demand
Primarily based on confidence in the government that issues it
How is it secured?
By a network of computers that verify every transaction — anyone with an internet connection can participate
By third parties like banks and governments — only a select few can participate
Are there physical bills or coins?
Can I buy things with it?
Yes, but only where merchants accept it
Yes, but typically only in the country that issues it

Bitcoin is the world’s first completely open payment network which anyone with an internet connection can participate in.

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Key question

How does bitcoin have value?

Essentially the same way a traditional currency does – because it’s proven itself to be a viable and convenient way to store value, which means it can easily be traded for goods, services, or other assets. It’s scarce, secure, portable (compared to, say, gold), and easily divisible, allowing transactions of all sizes.

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