Bitcoin

An Easy Primer for Understanding Bitcoin and Blockchain Technology

As you might expect with any cryptographic technology, understanding how bitcoin works requires a multi-layered approach. If you’ve struggled to understand bitcoin in the past, don’t worry. This guide starts with the most basic concepts of bitcoin technology, so we don’t lose anyone along the way.

We’ll begin with a general overview of bitcoin’s “purpose,” then move onto the principles that make it work. After reading this guide, you should have a good understanding of bitcoin’s use cases, how it functions – and be able to share the information with a friend. 

You can navigate this article with the following links:

  • Bitcoin’s Purpose as a Decentralized Financial Technology
  • What’s a Blockchain Ledger?
  • How Do You Send Bitcoin?
  • How Bitcoin Solves the “Double-Spend” Problem

Bitcoin’s Purpose as a Decentralized Financial Technology

The mysterious inventor of bitcoin, “Satoshi Nakamoto,” created bitcoin as the first decentralized financial technology. There were several purposes behind this decentralized cryptocurrency:

  • Cut out banking middleman: To bypass banks and their exorbitant transaction and maintenance fees.
  • Speed up money transfers: To facilitate money transfers that happen in minutes, so you don’t have to way days for a transaction to clear.
  • Stop inflation: To create a currency with a fixed supply. Bitcoin has a supply cap of 21 million coins, so only a finite amount will ever exist. No government or centralized authority can reduce the value of bitcoin by printing more of it.
  • Give currency users more control: To put more control of money into the hands of the people who are using it.
  • Better money: Many view bitcoin as “better money” because bitcoin has a permanently-capped supply, and you can transfer it across the world in minutes without incurring large bank fees.

As a “decentralized financial technology,” bitcoin doesn’t have a single authority that controls it. Instead, bitcoin has a decentralized network of thousands of computers (bitcoin miners) that manage and maintain its ledger of accounts. The owners of the bitcoin mining computers don’t know each other. Nevertheless, they organize themselves around a set of cryptographic principles called the “bitcoin protocol.” The bitcoin protocol enables anonymous miners to work in unison as they validate bitcoin transactions and update their identical copies of the ledger. 

Key takeaways: Bitcoin is a decentralized financial technology managed by a vast network of anonymous computers that organize themselves around a set of cryptographic principles called the bitcoin protocol. The result is “better money” with a permanently-capped supply that you can transfer to anyone in the world in minutes, not days, and without using a bank.

What’s a Blockchain Ledger?

At the core of bitcoin is a shared public ledger – called a blockchain ledger – that keeps track of each bitcoin account, how much bitcoin it has received, and the historical record of all bitcoin transactions. 

The easiest way to understand a blockchain ledger is to view it as a database – or Excel spreadsheet – with a very important difference. Instead of showing a simple tally of accounts, bitcoin’s blockchain ledger saves a string of sequential “snapshots” or “blocks of transactions.”  Each block on the blockchain shows a batch of confirmed transactions for a given time. These blocks are chained together, going back to the beginning of the ledger. The blockchain ledger doesn’t directly say how much bitcoin is in each account. Instead, it simply gives a record of confirmed transactions. By looking at the record, the bitcoin network can calculate how much bitcoin each account controls. 

When the computers that manage the bitcoin network validate a new block of transactions, they add it to the blockchain and update all of their individual copies of the ledger with the same information. Due to the cryptographic principles at the heart of the bitcoin protocol, the blockchain ledger is an immutable, unchangeable record that cannot be altered. 

The bitcoin blockchain ledger contains the following information:

  1. The most recent block on the blockchain: This shows you the most recent bitcoin transactions so you can determine how much bitcoin each account owns. 
  2. All previous blocks on the blockchain: These blocks go back to the birth of the blockchain.
  3. Data for all bitcoin transactions: This includes the time, date, amount, and account IDs for each bitcoin transaction going back to the first. 

A cryptographic hash for every block: Each block of the blockchain can be identified by a unique cryptographic fingerprint called a hash.

Key takeaways: The bitcoin blockchain ledger records information for all bitcoin transactions going back to the first. These transactions are batched into a sequence of blocks. By looking at the history of transactions, you can calculate how much bitcoin each account owns. The bitcoin ledger is a permanent record that can’t be changed.

How Do You Send Bitcoin?

A bitcoin user needs three pieces of information to send bitcoin to another account on the blockchain:

  1. The amount of bitcoin: This can be any number or fraction of bitcoin down to 0.00000001 BTC.
  2. The receiver’s public key: This is a public set of numbers and letters assigned to each account or “wallet” on bitcoin’s blockchain ledger. The public key – or public address – is just for receiving bitcoin, and you can share it with anyone. Here’s an example of a public key: 1J7mdg5rbQyUHENYdx39WVWK7fsLpEoXZy
  3. The sender’s private key: This is a secret set of numbers and letters assigned to each account or “wallet” on bitcoin’s blockchain ledger. The private key is used to generate a unique transaction signature, which verifies the sender as the owner of the account. Users must be careful to keep their private key secret. If a thief steals it, the thief can empty the account. Here’s an example of a private key: E9873D79C6D87DC0FB6A5778633389F4453213303DA61F20BD67FC233AA33232

The Bitcoin Sending Process

Sending bitcoin involves posting a public transaction message to the bitcoin network via the internet. This transaction message must include (1) the amount of bitcoin; (2) the receiver’s public key; and (3) the “unique transaction signature.”. 

Like the public and private keys, the “unique transaction signature” is a set of numbers and letters. It is cryptographically derived from the private key, the public key, and the amount sent. Every transaction message must have its own, unforgeable digital signature. Each private key can generate an unlimited number of unique transaction signatures for this purpose.

Bitcoin miners use a mathematical function that gives a true-or-false output to verify that the transaction signature is accurate. Bitcoin miners also check the complete history of bitcoin transactions to ensure that the sending account has received enough bitcoin to fund the transaction – and that it hasn’t already spent them.

Can You Fake a Bitcoin Transaction Signature?

It’s impossible it is to forge a bitcoin transaction signature. These signatures are 256 bits long, which means they have 2256 possible combinations. According to PrivacyCanada:

There is a one in over 115 quattuorvigintillion (that’s a 78 digit number) chance of finding a collision. This number is bigger than the number of atoms in the perceivable universe. And not by just a little bit either. Exponentially bigger. This number is so big that the human mind can’t comprehend how big it is. It’s just really big. Huge. I can not overstate this enough. This is a very big number. Your financial and cryptographic transactions are secure because of how big this is. Only a fool would attempt to brute force this many possible combinations.

Moreover, it’s equally impossible to work backward to derive a private key from the transaction signature. Therefore, you can publish a transaction message to the bitcoin network with full confidence that your private key will remain secure. 

Key takeaways: Sending bitcoin requires you to publish a transaction message with a unique transaction signature to the bitcoin network. The transaction signature is cryptographically related to the private key for the account, and it’s impossible to forge. Bitcoin miners verify the transaction signature and make sure the sending account has enough bitcoin to satisfy the transaction.

How Bitcoin Solves the “Double-Spend” Problem

To understand the rest of how bitcoin technology works, we need to talk about the “double-spend” problem, and how bitcoin’s unique proof-of-work system solved this problem to make decentralized financial networks feasible. Here’s a description of the double-spend problem:

  1. Jim has 1 bitcoin.
  2. He spends his 1 bitcoin twice – either by accident or with fraudulent intent. 
  3. Jim sends 1 bitcoin to Mary (Transaction A) and 1 bitcoin to Jane (Transaction B) at the same time.
  4. By themselves, both transaction messages appear valid. They each have valid transaction signatures, and the blockchain history shows that Jim has 1 bitcoin to spend.   
  5. Some mining computers receive Transaction A first. Others receive Transaction B first.
  6. It’s easy to fake a timestamp, so there’s no way to know which transaction came first.
  7. Some miners will receive and verify Transaction A first, and reject Transaction B as a double-spend when it arrives.
  8. Other miners will receive and verify Transaction B first, and reject Transaction A as a double-spend when it arrives. 
  9. This ultimately produces two versions of the latest block. Some miners will have a block that reflects transaction A and the other miners will have a block that reflects transaction B. 
  10. Both versions rejected one of the double-spend transactions, so technically, both add up.
  11. How do the thousands of computers on the bitcoin network reach consensus and decide which block is correct? 

Hal Finney’s Solution to the Double-Spend Problem

Long before the creation of bitcoin, developers were aware of the double-spend problem, and the way it made decentralized financial networks unfeasible. In 2004, developer Hal Finney created a “proof-of-work system” to overcome the double-spend problem. Later, this system was incorporated into the bitcoin protocol, and Finney became an early bitcoin contributor. Some even speculate that Finney was, in fact, Satoshi Nakamoto.

Finney’s Proof-of-work system requires the mining computers that comprise the bitcoin network to engage in a race to solve a complex puzzle called a “proof-of-work problem.” The computer that solves the puzzle first has its block of verified transactions added to the blockchain. This way, there’s no ambiguity about which version of the block should be the permanent record. The computers on the network can immediately verify that the block winner’s transactions are valid and that the block winner’s block will be used. The block winner also receives an award of bitcoin as an incentive for doing the work to win the race. 

Solving the proof-of-work problem requires the bitcoin mining computers to guess different numeric keys until one computer finds the correct key. This process takes a lot of electricity. According to recent estimates, the bitcoin network consumes about the same amount of energy as Chile. The promise of the block award is the motivation for bitcoin miners to pay for this energy. To make sure that their mining operation is as profitable as possible, bitcoin miners usually pool together their resources in mining pools and share the block reward when their pool wins. 

What’s “Mining Difficulty”? 

As more computers join the bitcoin network, they start solving blocks of transactions faster. That’s when the bitcoin network automatically adjusts the “mining difficulty” of the puzzle to ensure that it always takes approximately 10 minutes to solve each block. 

Why is “mining difficulty” calibrated to 10 minutes? It’s mostly about network efficiency and preventing “wasted work.” Here’s an interesting explanation from Lingyong Wang:

Ten minutes was specifically chosen by Satoshi as a tradeoff between first confirmation time and the amount of work wasted due to chain splits. After a block is mined, it takes time for other miners to find out about it, and until then they are actually competing against the new block instead of adding to it. If someone mines another new block based on the old blockchain, the network can only accept one of the two, and all the work that went into the other block gets wasted. For example, if it takes miners 1 minute on average to learn about new blocks, and new blocks come every 10 minutes, then the overall network is wasting about 10% of its work. Lengthening the time between blocks reduces this waste.

Key takeaways: The most revolutionary aspect of bitcoin technology is its ability to solve the infamous “double-spend” problem associated with decentralized financial networks. This problem can result in disagreement among bitcoin mining computers about which block of transactions is correct. Hal Finney proposed the “proof-of-work” system to overcome double-spend problems. This involves a race among bitcoin mining computers to solve a cryptographic puzzle. The random computer that wins the race will receive a reward of bitcoin and have its block of transactions added to the ledger. This achieves consensus among the miners and ensures that there is only one correct version of the ledger. 

Final Thoughts on the Bitcoin Network

You should now have a basic understanding of how the bitcoin network operates, and how bitcoins move from account to account across the network. You might even be able to explain how bitcoin works to a friend. Maybe even dabble in using Bitcoin to make payments

If you’d like to learn how easy it is to start accepting payments in bitcoin, contact the team at GBLPay now

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