How does Bitcoin work?

The Basics

As a new user, you can get started with Bitcoin without understanding the technical details. Once you have installed a Bitcoin wallet on your computer or mobile phone, it will generate your first Bitcoin address and you can create more whenever you need one. You can disclose your addresses to your friends so that they can pay you or vice versa. In fact, this is pretty similar to how email works, except that Bitcoin addresses should only be used once.

bitcoin-how-it-works

 

Balances – blockchain

The blockchain is a shared public ledger on which the entire Bitcoin network relies. All confirmed transactions are included in the blockchain. This way, Bitcoin wallets can calculate their spendable balance and new transactions can be verified to be spending bitcoins that are actually owned by the spender. The integrity and the chronological order of the blockchain are enforced with cryptography.

Transactions – private keys

A transaction is a transfer of value between Bitcoin wallets that gets included in the blockchain. Bitcoin wallets keep a secret piece of data called a private key or seed, which is used to sign transactions, providing a mathematical proof that they have come from the owner of the wallet. The signature also prevents the transaction from being altered by anybody once it has been issued. All transactions are broadcast between users and usually begin to be confirmed by the network in the following 10 minutes, through a process called mining.

Processing – mining

Mining is a distributed consensus system that is used to confirm waiting transactions by including them in the blockchain. It enforces a chronological order in the blockchain, protects the neutrality of the network, and allows different computers to agree on the state of the system. To be confirmed, transactions must be packed in a block that fits very strict cryptographic rules that will be verified by the network. These rules prevent previous blocks from being modified because doing so would invalidate all following blocks. Mining also creates the equivalent of a competitive lottery that prevents any individual from easily adding new blocks consecutively in the blockchain. This way, no individuals can control what is included in the blockchain or replace parts of the blockchain to roll back their own spends.

More on the Technology

This is only a very short and concise summary of the system. If you want to get into the details, you can read the original paper that describes the system’s design, read the developer documentation, and explore the Bitcoin wiki.


 

Reading Resources

HM Treausry and UK Chancellor of the Exchequer on Plans to Regulate Bitcoin

UK Government

Published 18th of March 2015

VISIT LINK

Chartered Accounts ANZ and Price Water House Cooper Paper on Digital Currencies

Chartered Accounts ANZ and Price Water House Cooper

Published 28th of January 2015

VISIT LINK

Digital Disruption – Opportunities for Innovation and Growth

Speech to the Committee for Economic Development of Australia (CEDA) Adjusting Australia Series

Sarv Girn Chief Information Officer, Reserve Bank of Australia

Published 11th of June 2014

OPEN DOCUMENT

Discussion Paper on Digital Currencies

As submitted to the RBA

Amor Sexton Digital Currency Lawyer, Adroit Lawyers

Published 7th of July 2014

OPEN DOCUMENT

FinTech Revolutions

Presentation to IFC Finance Forum, Perth

Mark Pesce Lecturer, Columnist, Technology Leader

Published 23rd of August 2014

OPEN DOCUMENT

The Future of Digital Currency: Will Bitcoin Change the World?

1st Place Winner, BTA Academic Scholarship Contest

Gareth Williams IT & Services Professional, SAS

Published 4th of February 2014

OPEN DOCUMENT

The Legal Status of Online Currencies: Are Bitcoins the Future?

Dr Rhys Bollen Senior Fellow, Monash University

Published 26th of June 2013

OPEN DOCUMENT