How Does Bitcoin Work?

In case you’re wondering how Bitcoin works, here’s a high level overview to wet your appetite. At its core, Bitcoin has 4 main parts:

  • Addresses;
  • The Block Chain;
  • Transactions; and
  • Miners.

Bitcoin, like the Internet, works thanks to millions of connected computers around the world running a special Bitcoin software program. This Bitcoin program keeps track of all Bitcoin transactions, and ensures the Bitcoin network is secure and that your money is stored safely.

What are addresses?

A Bitcoin address, like a bank account number, is where your bitcoins are stored. It is also what you share publicly with people to receive money. It is represented by a series of numbers and letters:

What is the Block Chain?

The Block Chain is a public record (or “ledger”) of how much bitcoin belongs to each and every bitcoin address. Basically, it keeps track of where all the bitcoins are.

What are transactions?

A Bitcoin transaction is like any other financial transaction (like credit card purchases or Paypal money transfers): it records the movement of funds from one account to another. Specifically a Bitcoin transaction updates the Block Chain to record the movement of bitcoin from one bitcoin address to another.

What are miners?

Miners are the “auditors” or “referees” of the Block Chain – they make sure all Bitcoin transactions are valid and that no one is tampering with the Block Chain. Specifically miners are Bitcoin users who have chosen to run special software which does the auditing automatically – in return for their efforts Miners are given bitcoin.
To show how these 4 parts work together, let’s pretend that Mohamad wants to send 1 Bitcoin (“BTC”) to Ahmad. Here’s what happens:

1 Mohamad asks the Miners to send 1 BTC from his Bitcoin address (“1AcL2…”) to Ahmad’s Bitcoin address (“1Bq34…”). This “request” is actually a Bitcoin transaction.

2 The Miners audit his transaction. They check that the transaction is valid and verify that Mohamad is allowed to move the money. They do this second part by checking the Block Chain to confirm that he has enough bitcoin (btc) at his address to make the payment and that he isn’t also trying to send the same bitcoin to someone else at same time (i.e. “double-spending”)

3 Once the transaction is approved and the Block Chain is updated, Ahmad has the bitcoin. He doesn’t need to take any action to receive it, but if he were to check the Block Chain now he would see an extra bitcoin at his address.

“But Bitcoin isn’t just a digital currency, it’s revolutionary!”

Since Bitcoin is a program running on millions of independent computers around the world, it’s–more accurately–a technical innovation that has many potential applications beyond simply money.

Think of how the Internet changed the way we communicate, learn, and do business.

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