Bitcoin – how does it work?

Bitcoin and Blockchain  – these terms seem to be going around a lot lately. Got curious to get to the bottom of it, as much as I could, anyway. Here’s a summary of what I understood.

Bitcoin is digital currency that is decentralized (reminded me of Internet, DNS, etc.). It is anonymous – like paying through cash. Anybody can use it – directly or through service providers. It appears there are about 8% of folks who do not have a bank account, time for them to transact using bitcoins.

Every transaction is represented digitally by referring to all previous transactions that led the spender to receive money – proof that the spender owns a certain amount of money. In addition, carries the receiver identity (public key) in the bitcoin system, plus the transaction amount. Plus, a digital signature of the afore mentioned data using the spender’s private key. This is transmitted to the receiver (payee) and on to the bitcoin network of computers. The signature is verified using the spender’s public key and proves the payment is from the spender.

Miners on the bitcoin network gather the unverified transactions, put them together into a block and append to existing chain of verified blocks to make the transactions legit. To do this, miners need to solve a “proof of work” mathematical puzzle that requires considerable computing power to solve. Whoever solves it faster will get to add the block to the block chain and be rewarded. Blockchain is the equivalent of a ledger.

There is this case of double spending fraud – paying a number of people with same money. This is harder to do as the double spender will have to create new blocks before others to remove the first transaction from becoming legit – this is hard to do for one person as many blocks would have formed in the mean time (decentralized helps here as many are solving the proof of work puzzle that is different for every miner), that needs to be computed, solved and substituted by the double spender.

The incentive for the miners includes transaction fees and rewards for aggregating transactions into blocks and adding them to the blockchain.




Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s