How Bitcoin Really Works (5 minute read)

Here’s a real quick yet accurate expla­na­tion of how Bitcoin works.

Bitcoin Nodes

If you run Bitcoin node software, like Bitcoin Core, it will estab­lish a connec­tion to other, random instances of Bitcoin Core, becoming part of a world­wide network of inter­con­nected Bitcoin nodes. Anyone can do this. The software is free, and its code is open source.

Every new Bitcoin Core node is seeded with the first ever piece of data in Bitcoin called the “Genesis block.” It contains the details of the first piece of data upon which all the rest of Bitcoin’s history is built. Each new node then polls the other nodes for the next block. The node then uses Bitcoin’s math-based rules to check if that next block meets those rules. The rules check to see that every Bitcoin trans­ac­tion in the block is valid and contains a valid proof of work (explained later) for creating that block.

It keeps retrieving new blocks until it catches up to the present. At that point, it is in synchro­niza­tion with every other Bitcoin node worldwide. Each Bitcoin node has verified the accuracy and truth of every single trans­ac­tion and block and Bitcoin’s history. They don’t just copy data — they verify every single bit of it.

Bitcoin Transactions

A Bitcoin trans­ac­tion is a text message. To be valid, it has to strictly adhere to specific rules, though:

1. It can only spend Bitcoin that hasn’t been spent. 

2. It must provide a crypto­graphic signa­ture which can be used to verify that the sender is in posses­sion of the correct secret, randomly gener­ated, astro­nom­i­cally large number called a ‘private key.’

3. It is also advis­able that the addresses of the recip­i­ents of the transaction’s funds are speci­fied. (If they’re not, then the entire trans­ac­tion becomes a fee paid to miners.)

That’s it. It can include other data, like the date or time at which the trans­ac­tion will be valid (like post-dating a check), but it doesn’t have to.

There’s one other type of trans­ac­tion, called a coinbase trans­ac­tion (nothing to do with the company of that name — that company stole its name from this term). That trans­ac­tion is explained in the Bitcoin Blocks section of this article.

Bitcoin Addresses

Bitcoin addresses are weird looking strings like: 

bc1qtxsjjjgupnccn2czvwaj5×3szc4hw75nc53hm8 or  16t8xf4MG1mHoKU1AbpT5QGKDfj5UYg1W5 or  3CwT3oXQVtwYwBGnsRVd1Juj2gqBxsfNpv

But they’re not arbitrary, and you don’t make them up. They are crypto­graphic finger­prints of either ‘public keys’ or of entire code scripts. When it comes time to spend coins from those addresses, the spender will have to provide the digital signa­ture associ­ated with the private key that corre­sponds to the public key or script.

Bitcoin Blocks

A Bitcoin block contains a bunch of data:

1. It contains a whole bunch of trans­ac­tions, each of which is verified to be a valid one. The first trans­ac­tion in it is called the coinbase trans­ac­tion. The coinbase trans­ac­tion rewards newly issued coins and fees paid in all the other trans­ac­tions in that block to the discov­erer of the block. People who discover blocks are referred to collo­qui­ally as ‘miners.’ All Bitcoins in circu­la­tion come into circu­la­tion by being rewarded to miners. No other Bitcoins exist.

2. It also contains a verifi­able crypto­graphic finger­print or digest of all these trans­ac­tions (called a merkle root).

3. It contains the crypto­graphic finger­print of the previous block — to prove that it was created only after the previous block was created. This is what chains this block to the previous block to create the famous “blockchain.”

4. It contains a current date and time.

5. It contains a couple of other small pieces of data (a version number and a target).

6. Finally, it contains a special number called a ‘nonce.’ Nonce is short for “number used once.” This nonce is used to prove that this block meets the proof-of-work require­ments at the time of its creation. Every node can run this block through the finger­printing algorithm (called SHA256) and check that the resulting number is smaller than the maximum allowed at the time (the target), thus making the block valid according to the rules of Bitcoin.

Mining

Miners work to discover nonces that satisfy the proof of work require­ments for the newest block to be added to the blockchain. This is basically just guess­work like guessing numbers in a giant lottery. The harder they try — that is, the more guesses they make — the sooner they’ll discover valid nonces to blocks and the faster they’ll produce blocks and be rewarded. 

However, Bitcoin is designed to keep the pace of blocks coming in at one every ten minutes on average, so roughly every two weeks (or precisely every 2,016 blocks), the diffi­culty associ­ated with finding a valid block (also known as the target) is recal­cu­lated with a precise formula, by every node, to make it harder (or sometimes easier, if neces­sary). 

Because every node uses the same formula on the same data, every node ends up agreeing on the new diffi­culty target. Miners then need to work as hard as the new diffi­culty demands to earn the rewards of discov­ering new valid blocks.

That’s (just about) all, folks:

With just the above mecha­nisms, Bitcoin runs.

People who have bitcoins, or fractions of them, can send them to anyone else who provides them an address. They prepare a valid trans­ac­tion and send it to any other node on the network, and that node sends it out to others, and it quickly ends up on every node, where each one ensures that it is, in fact, valid.

Miners take these new valid trans­ac­tions that haven’t been added to a block yet and try to guess the nonce to a new block containing those trans­ac­tions (and every­thing else a block must have).

Sooner or later, one of them finds a valid nonce and shares the whole block with other nodes, who then send it out to others, and it quickly ends up on every node, where each one ensures that it is, in fact, valid. Every­body adds this block to their identical copy of the blockchain as soon as they verify its validity.

New coins get intro­duced into the system with the coinbase trans­ac­tion of each block. However, the number of new coins per block keeps getting cut in half roughly every four years (or precisely every 210,000 blocks). This formula ensures that there will only ever be 21 million full Bitcoins.

Nobody can fake anything because everyone checks every­thing all the time. Any nodes that attempt to misre­port any data are unable to get away with any decep­tion because the math behind every trans­ac­tion and block is what deter­mines the true state of things,

And that’s how Bitcoin really works.