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How bitcoin works under the hood

Bitcoin has been causing waves in the world of finance since the mysterious Satoshi Nakamoto introduced this digital cryptocurrency in 2008. If you are interested in this game-changing cryptocurrency and how it works under the hood, stick till the end as in this blog, I will cover the bitcoin working under the hood. 

Bitcoin: The introduction

At the most basic level, bitcoin is a digital currency that does not need printing before using it. It is a digital file called a ledger that consists of lists of all the accounts and money. Every person on the bitcoin network has a copy of this ledger which gets updated with each transaction of the bitcoins. 

This ledger system sounds similar to a bank maintaining ledger, but here are some key differences:

  • A banking ledger is a centralized authority with certain people maintaining the ledger, while bitcoin is a decentralized system with groups of computers maintaining the ledger. 
  • In banking, you only have information regarding your transaction, but you can know about every transaction happening in bitcoin. 
  • In the banking system, you can trust the institution and sue them if something goes wrong, but in bitcoin, you have to be cautious while trusting as you deal with strangers. 

How does the transaction work in the bitcoin network?

Bitcoin transaction message has three parts, input transaction: sending address, output transaction: receiving address, and amount of transaction. Every time you send or receive bitcoins, a transaction message is generated and this transaction is added to the list available to all nodes called “block chain”. This helps all the nodes update their ledgers and not spend the money they don’t own.

When you send bitcoin, let’s say 5 BTC, the money in your account will go down by -5 BTC while the receiver’s money will go up by +5 BTC. Once a transaction is made, it is applied to a copy of the ledger, and then this transaction message is transferred to all the nodes present on the network.

But wait, this is isn’t that simple. Every bitcoin transaction requires a digital signature. This signature proves that the transaction message is authentic. A new digital signature is generated for each transaction and utilizes two keys;

  1. Private key: Used to create digital signatures
  2. Public key: Used to verify the digital signatures

Private keys are like real passwords as they allow you to spend your bitcoins, so you have to keep it a secret. While the Public keys are like ‘send to’ address on which the receiver receives the money. 

The digital signature uses both private key and transaction message to authenticate the transaction. This helps the bitcoin achieve following goals. 

  • Makes sure the sender is the true owner of the private key.
  • The transaction amounts remain unchanged after the message has been sent.  

How does Bitcoin mining works?

Now that you know, bitcoin transactions are made possible through digital signatures, but the question here is that where do these coins come from?

So every block in the bitcoin chain is associated with a complex mathematical puzzle. Whoever solves the puzzle block first will get a reward. In other words, this is called mining, and this also process verifies the transaction’s authenticity. 

This system is called proof of work in which all the nodes compete to solve a single puzzle. Solving the puzzle is called hashing and a lot of resources and powerful computers. Therefore the people with better equipment get the bitcoins as a reward. 

Conclusion

In simple words, bitcoin is a digital currency that works mathematically and is maintained by a group of people. Unlike a traditional financial system, Bitcoin offers various advantages like the provision of anonymity, a decentralized system, and fewer transaction fees. Thus this digital currency has changed the dynamics of the financial world. 

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