How does Bitcoin work?

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It would be strange if we create reviews of bitcoin casinos and do not talk about how bitcoin works. I hope in our article you will find answers to your questions.

The mechanisms behind cryptocurrencies can be difficult to understand, and how bitcoin works in practice is even more difficult. Explaining technology in simple words.

A programmatic article on the “peer-to-peer electronic payment system” now known as bitcoin was published in 2008. An unknown person or a group of people who were hiding under the pseudonym Satoshi Nakamoto published the so-called Bitcoin whitepaper when the whole world was shaking from the latest financial crisis, and fiat money was going through hard times.

The identity of the mysterious Satoshi remains unknown to this day. The documentation, which describes in technical terms how bitcoin works, was the culmination of various efforts made in cyberspace to create confidential digital payments independent of any state or institution.

In this article, we will tell you how cryptocurrency works in practice and what technologies are behind bitcoin, the price of which has jumped several thousand dollars over the past ten years and even approached the $ 20,000 mark, in simple terms.

Bitcoin principles

Bitcoin came at a particularly dramatic moment – in the midst of the 2008 crisis when people around the world lost faith in the central financial institutions of their countries.

In society, a demand has arisen for an alternative to the current payment systems, in which anonymity would be combined with the transparency of transactions and independence from financial giants. It is believed that it was based on these criteria that Bitcoin was created.

The first thing to understand is that Bitcoin is not a physical asset. The price of a currency is formed online without the participation of central authorities.

The scarcity of bitcoins is another key feature that differentiates it from fiat currency. Bitcoin has a limited supply of 21 million coins. The Bitcoin scarcity was incorporated into the Bitcoin protocol by the creator in order to preserve the value of the coin in the long term. As of the beginning of 2020, there were more than 18 million bitcoins in circulation.

Depending on the type of traffic that the blockchain network receives, the Bitcoin protocol adjusts the difficulty of mining each new block at an interval of 10 minutes. As of March 2020, the mining difficulty is 15.4 terahashes. In 2009, the complexity of mining did not exceed 1 hash.

A lot has changed since the launch of cryptocurrency in 2008. It has become much more difficult to mine coins on the Bitcoin network: mining rewards are getting smaller, the difficulty is increasing, and electricity bills are increasing. To make mining profitable, miners unite into communities – pools – and launch their farms. Most of these farms are concentrated in China.

Often, due to limited emission, bitcoin is referred to as an analog of gold and a safe asset in crisis situations. The cost of coins is determined solely by the laws of supply and demand. How intensely people interact with it determines the price of Bitcoin.

While the price of bitcoin certainly shows high volatility as the coin infiltrates the global financial system, its controlled supply is in direct contrast to the ever-increasing supply of fiat currencies that have fueled economic crises in the past.

How does blockchain work?

Every time a network participant sends bitcoins to someone, he creates a transaction attaching the recipient’s public key to it, and signs the transaction with his private key.

When a transaction enters the Bitcoin blockchain, all its participants can confirm that the new owner of the coins is the owner of the public key specified in the transaction.

A custom signature on a transaction verifies the authenticity of the transaction. The entire transaction history is kept by each member of the network, so anyone can check who is the current owner of any particular group of coins.

Hence, by the way, a big misconception is formed that bitcoin is an anonymous currency. The blockchain stores a complete record of transactions, which is a sequence of blocks.

How blockchain stores transaction history

It is impossible to understand how the blockchain works without talking about how the blockchain stores transactions. All participants in the blockchain network have a copy of the blockchain. Members of the network constantly update copies, transferring information to each other about new blocks.

Each block in the Bitcoin blockchain contains a group of transactions that were sent from the previous block. To preserve the integrity of the chain, each block confirms the integrity of the previous one, up to the very first block in history, called “genesis”.

In the bitcoin blockchain, the integrity of the blockchain is encoded using SHA256 as the underlying cryptographic hash function.

A cryptographic hash function essentially takes input data, which can be of almost any size, and changes it into an unrecognizable format of numbers and letters.

The slightest change in the input data significantly alters the hash, so no one can create a data block with different input data and have an identical hash.

What is a Bitcoin address?

A bitcoin address is a digital identifier for the place where bitcoins are stored. A Bitcoin wallet address is typically 26-35 alphanumeric characters long and usually starts with the numbers 1, 3, or the bc1 preset.

If you are an ordinary blockchain user, then you may have noticed that your bitcoin address changes during transactions. In reality, the initially generated address remains unchanged. Third-party services change it to maintain the illusion of anonymity.

What is Bitcoin mining?

How are bitcoins mined and how do they appear in circulation? Mining farms, which have special computers for mining cryptocurrencies, are constantly in some kind of computational race to process new transactions entering the network.

The winner is usually the miner who has the computing power of his equipment to verify the blocks of the bitcoin network faster than others.

As mentioned above, all bitcoin transactions are recorded in a publicly accessible log. Along the chain, this log is provided to miners, who subsequently select from many different hash combinations one correct hash that matches all new transactions and a secret key that provides the miner with a bitcoin reward.

As soon as the hash is guessed, the block with all operations is closed, and the miners begin to select the next hash, based on the following parameters:

  • the new hash must be based on the hash of the previous block;
  • the new hash consists of the sum of hashes of bitcoin operations over the last 10 minutes;
  • a random number generated by miners so that the final hash fits the blockchain requirements.

The listed conditions are the basis for determining the difficulty of finding a hash. They are updated every 2016 blocks and are automatically generated in such a way that the counting of these blocks takes 2 weeks.

Emission of bitcoins

The frequency of the release of new blocks in the Bitcoin blockchain network is fixed and is always equal to six blocks per hour. Thus, the volume of issued bitcoins in a block always decreases strictly in a geometric progression.

So, every four years there is a reduction in the reward for miners, which always decreases by 50%. In the cryptocurrency industry, this event was nicknamed ” halving ” (from the English halving – halving).

It turns out that the cryptographic algorithm is the guarantor of a strictly established limit, according to which the number of bitcoins will never overcome 21 million coins.

Some traders and analysts, for example, having data on the maximum number of offered coins, can predict the bitcoin rate in accordance with macroeconomic and geopolitical conditions.