How Does Bitcoin work – The Essential Guide

So let try answering this question without blinding you with science.bitcoin-how-it-works

We do have to get a little bit technical but hang on in there, it will be worth it to really get to grips with Bitcoins potential. Bitcoins utilize the same technology that is leveraged in digital signatures, initiated by the cryptographers Martin Hellman and Whitfield Diffie in the year 1970. In 2007, some anonymous developer or group possessing the pseudonym Satoshi Nakamoto got hold of this technology and devised the software for the generation of digital currency. That is how the first cryptocurrencies started functioning.

“Complex mathematics verifies who owns the bitcoins .”

all-you-need-to-know-about-bitcoinThe complex mathematics verifies that a person spending 10 units owns them and cannot reuse the same 10 units again. To send bitcoins, you need two things: a bitcoin address and a private key. A bitcoin address isn’t like a bank account; you don’t need mountains of paperwork and ID to set one up. In fact, they are generated
randomly, and are simply sequences of letters and numbers.

The private key is another sequence of letters and numbers, but unlike your bitcoin address, this is kept secret.bitcoinDigitalPaperWallet Think of your bitcoin address as a safe deposit box with a glass front. Everyone knows what is in it, but only the private key can unlock it to take things out or put things in. When Alice wants to send bitcoins to Bob, she uses her private key to sign a message with the input (the source transaction(s) of the coins), amount, and output (Bob’s address). She then sends them from her bitcoin wallet out to the wider bitcoin network. From there, bitcoin miners verify the transaction, putting it into a transaction block and eventually solving it.

Why must I sometimes wait for my transaction to clear?
Because your transaction must be verified by miners, you are sometimes forced to wait until they have finished mining. The bitcoin protocol is set so that each block takes roughly 10 minutes to mine. Some merchants may make you wait until this block has been confirmed, meaning that you may have to make a cup of coffee and come back again in a short while before you can download the digital goods or take advantage of the service that you paid for.


On the other hand, some merchants won’t make you wait until the transaction has been confirmed. They effectively take a chance on you, assuming that you won’t try and spend the same bitcoins somewhere else before the transaction confirms. This often happens for low value transactions, where the risk of fraud isn’t as great. What if the input and output amounts don’t match? Because bitcoins exist only as records of transactions, you can end up with many different transactions tied to a particular bitcoin address. Perhaps Jane sent Alice two bitcoins, Philip sent her three bitcoins, and Eve sent her a single bitcoin, all as separate transactions at separate times. These are not automatically combined in Alice’s wallet to make one file containing six bitcoins. They simply sit there as different transaction records. bitcoin-guide-infographic
When Alice wants to send bitcoins to Bob, her wallet will try to use transaction records with different amounts that add up to the number of bitcoins that she wants to send Bob. The chances are that when Alice wants to send bitcoins to Bob, she won’t have exactly the right number of bitcoins from other transactions. Perhaps she only wants to send 1.5 bitcoins to Bob. None of the transactions that she has in her bitcoin address are for that amount, and none of them add up to that amount when combined. Alice can’t just split a transaction into smaller amounts. You can only spend the whole output of a transaction, rather than breaking it up into smaller amounts. Instead, she will have to send one of the incoming transactions, and then the rest of the bitcoins will be returned to her as change.
Alice sends the two bitcoins that she got from Jane BitcoinGuide
to Bob. Jane is the input, and Bob is the output. But the amount is only 1.5 bitcoins, because that is all she wants to send. So, her wallet automatically creates two outputs for her transaction: 1.5 bitcoins to Bob, and 0.5 bitcoins to a new address, which it created for Alice to hold her change from Bob. Are there any transaction fees? Sometimes, but not all the time. Transaction fees are calculated using various factors. Some wallets let you set transaction fees manually. Any portion of a transaction that isn’t picked up by the recipient or returned as change is considered a fee. This then goes to the miner lucky enough to solve the transaction block as an extra reward.

“Bitcoin have very low or no transaction fees”

bitcoin-mining-imageRight now, many miners process transactions for no fees. As the block reward for bitcoins decreases, this will be less likely. One of the frustrating things about transaction fees in the past was that the calculation of those fees was complex and arcane. It has been the result of several updates to the protocol, and has developed organically. Updates to the core software handling bitcoin transactions will see it change the way that it handles transaction fees, instead estimating the lowest fee that will be accepted. Can I get a receipt? Bitcoin wasn’t really meant for receipts. Although there are changes coming in version 0.9 that will alter the way payments work, making them far more user-friendly and mature. Payment processors like BitPay also provide the advanced features that you wouldn’t normally get with a native bitcoin transaction, such as receipts and order confirmation web pages.

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