Bitcoin was first introduced in a 2008 paper. A person known as Satoshi Nakamoto proposed a groundbreaking idea: let’s create a currency that is not controlled by any government or central authority! This concept seemed crazy at the time—just a string of numbers with no tangible backing, no one responsible for it. How could anyone trust such a system? If you sent someone this digital money, how would they know it was real?
However, what once seemed impossible has now become a reality. Over the years, driven by a growing community of supporters around the world, the Bitcoin network became operational. More and more people and investors joined in, and the concept of Bitcoin began to spread like wildfire. In 2017, Bitcoin experienced explosive growth, rising from $1,000 at the start of the year to a peak of $20,000. The world took notice, governments started to pay attention, and ordinary people began to understand its potential. The truth is that Bitcoin has already changed the world, and it will continue to do so in the future.
Media outlets often focus on Bitcoin's price fluctuations, but they tend to ignore or fail to explain some fundamental questions:
- What is the principle behind Bitcoin?
- Why does this decentralized system work?
- How does Bitcoin trading work?
- What is the relationship between Bitcoin and blockchain?
In this article, I’ll try to answer these questions and help you better understand Bitcoin. While the technical details are important, I’ll keep things simple and easy to grasp.
One thing to note: this article only covers the technical aspects of Bitcoin and does not provide investment advice or predict price movements. Frankly, I don’t know where Bitcoin will go next. If I did, I might not be writing this blog right now.
First, asymmetric encryption.
To understand Bitcoin, it’s essential to grasp the concept of asymmetric encryption. You may have heard of it before. Asymmetric encryption uses two keys: a public key and a private key. The public key is shared openly, while the private key remains secret and belongs to the owner. Others can use your public key to encrypt messages and send them to you, and you can decrypt them using your private key. Alternatively, you can encrypt a message with your private key, and others can verify it using your public key, proving that the message came from you and hasn’t been altered. This process is known as a digital signature.
Now imagine if instead of encrypting regular information, you encrypted a small amount of money and sent it to someone. That’s essentially how Bitcoin works. You can unlock the encrypted value using your private key, and since no one else has access to it, the transaction is secure. This is the core principle of Bitcoin and other digital currencies: asymmetric encryption ensures secure transactions.
Since the funds are tied to the private key, it doesn’t matter who you are. What matters is who controls the private key. You can only spend the money that is sent to you if you have the corresponding private key. (In practice, the process is slightly different; the private key ensures that only you can spend the funds you own.)
Second, Bitcoin wallet.
With Bitcoin, you aren't sending money to a person, but to a private key. This is why Bitcoin transactions are anonymous—no one knows who owns the private key behind the address.
So, the first step in Bitcoin trading is to generate your own public and private keys. When you sign up for a Bitcoin exchange, they will help you create a Bitcoin wallet. This wallet stores your public and private keys. The software generates these keys and keeps them secure within your wallet.
The public key is typically 512 bits long, which is quite lengthy to handle. To make it easier, the protocol also generates a 160-bit "fingerprint" of the public key, called a wallet address. This address is unique and used to receive Bitcoin. For example, an address might look like: 1BvBMSEYstWetqTFn5Au4m4GFg7xJaNVN2.
When you want to receive Bitcoin, you simply share your wallet address with the sender. Since you control the private key, you are the sole owner of the funds sent to that address.
Protecting your private key is crucial. If it’s stolen, your Bitcoin is effectively lost, as others can use it to transfer your funds. Similarly, when sending Bitcoin, you must ensure the recipient's address is correct, as any mistake could result in losing your funds permanently.
Third, the transaction process.
Let’s walk through the entire process of how a Bitcoin transaction works.
A transaction involves transferring Bitcoin from one address to another. Since all Bitcoin transactions are recorded publicly on the blockchain, it's possible to see which addresses hold how many Bitcoins. This allows verification of whether a sender has enough funds to complete a transaction.
The challenge is ensuring that the transaction is legitimate and that the sender actually owns the address they’re using. For example, if someone claims to send 10 Bitcoins from Address A to Address B, how do we know it’s truly the owner of Address A making the claim?
The Bitcoin protocol requires the sender to include additional data in the transaction:
- The hash of the previous transaction (to show where the funds came from)
- The addresses involved in the transaction
- The sender’s public key
- A digital signature generated using the sender’s private key
Verification involves three steps:
1. Check the previous transaction to confirm the sender's balance.
2. Calculate the fingerprint of the sender’s public key to verify that it matches the address.
3. Use the public key to validate the digital signature, confirming that the private key is genuine.
Once these steps are completed, the transaction is considered valid.
Fourth, transaction confirmation and blockchain.
After verifying the transaction, it isn’t yet complete. The transaction data needs to be added to the blockchain, allowing the recipient to receive the funds.
Bitcoin uses a special database called the blockchain. All transaction data is sent to miners, who are responsible for packaging the transactions into blocks and adding them to the blockchain.
Each block is limited to 1MB, and each transaction is about 500 bytes, meaning a block can contain up to 2,000 transactions. Miners compete to solve a complex mathematical problem to add a new block to the blockchain. The first miner to find a valid solution gets the reward, which currently stands at 12.5 Bitcoins.
Once a transaction is written to the blockchain, it becomes permanent and cannot be reversed. It’s important to understand that Bitcoin isn’t stored in wallets or physical locations—it exists only on the blockchain. Every transaction you participate in is recorded, showing how much Bitcoin you’ve received and spent, allowing you to track your balance.
Fifth, miner rewards.
Miners play a critical role in confirming transactions. But why do people choose to mine? The Bitcoin protocol provides a reward for miners who successfully add a new block to the blockchain. Initially, the reward was 50 Bitcoins, and it halves every four years. As of 2018, the reward is 12.5 Bitcoins.
Eventually, around 2140, the last Bitcoin will be mined, and miners will no longer receive block rewards. At that point, their income will come entirely from transaction fees.
Transaction fees are paid voluntarily by users. Higher fees mean faster processing, while lower fees can result in delays. With the increase in transactions, fees have risen significantly, sometimes reaching 3–10 Bitcoins per block. If your fee is too low, your transaction might take days to be confirmed.
Sixth, block size and scaling.
The Bitcoin protocol limits each block to 1MB, allowing only about 2,000 transactions per block. At an average of one block every 10 minutes, this results in a throughput of about 3–5 transactions per second. This has become a bottleneck, especially with the increasing number of users.
To address this, several proposals have emerged. One notable fork was Bitcoin Cash (BCH), which increased the block size to 8MB, allowing for faster transactions and lower fees. Another proposal, SegWit2x, aimed to increase the block size to 2MB but was eventually abandoned due to lack of consensus.
Seventh, peer-to-peer network.
Bitcoin operates as a global, decentralized network. Anyone with a server can join the network as a node. Each node maintains a full copy of the blockchain and continuously synchronizes with other nodes.
When you make a transaction, your node broadcasts it to the network. Miners collect these transactions and package them into blocks. Once a block is added to the blockchain, all nodes update their copies to reflect the latest version, ensuring consistency across the network.
Finally, there is still a fundamental question: what is the nature of Bitcoin?
After all, Bitcoin is just a record on the blockchain. It seems to be created out of thin air. Why should it be considered money? For example, miners receive 12.5 Bitcoins as a reward, which is recorded on the blockchain. This record gives them the right to spend those coins. If the blockchain suddenly adds a record that says your address has earned 1,000 Bitcoins, you would technically own that amount. But what makes this possible? This is one of the most intriguing aspects of Bitcoin and continues to spark debate among economists and technologists alike.
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