How Does Bitcoin Work?

Bitcoin is a decentralized network that consists of a shared ledger (the blockchain), a system of cryptographic keys (public and private) and mining (the Proof of Work algorithm). In this article, we’ll look “under the hood” and examine the main components that power Bitcoin.

Blockchain

It is essentially a shared ledger, with each node holding a complete history of transactions. Every change in the ledger (a bitcoin transaction) is immediately sent into the entire network and all nodes must accept it. If you want to know more about blockchain, read the article What is Blockchain?

A System of Cryptographic Keys

Bitcoin transactions are based on so-called public key cryptography. Each address has a public key – think of it as an email address, which is necessary for receiving transactions from other people, and a private key – akin to an unchangeable password for the address in question – which enables us to send transactions to other people.

Bitcoin Address = your public address (share it with people who want to send you bitcoins)
Private Key = securely back this data up (the person who knows the private key can access the Bitcoins at the address)

Cryptographic keys come in the form of a hash (a string of numbers and letters). A hash can also be displayed, for instance, as a QR code (many mobile apps support this). The private key can also be encrypted into a mnemonic seed phrase. We keep the private key in secret, back it up, and do not reveal it to anyone – because the person who knows the private key can access the Bitcoins at the address.

TIP: We do not recommend holding funds on exchanges. Exchanges are typical financial intermediaries—the bitcoins that you have on your exchange account are not actually yours—the exchange can access the private keys and you only have a claim towards the funds on your account. If the exchange is hacked or goes bankrupt, you probably will probably never retrieve your Bitcoins. We are preparing an article on security in which we will explain how you can secure the private keys to your Bitcoins.

Transparent accounts

The Bitcoin blockchain is public. Anyone can view the transactions and the status of the addresses.

Try it out yourself—view this public address: 3JozN3qKXqcwDB2kfcXosZ7NyMCVmV5Afr in our Bitcoin browser.

It is the donation address for our website. In the browser, you can view how many BTCs are on our address, as well as an account statement with the date and time of all transactions. If you know our public address, you know how many BTCs we have received as donations from our supporters.

This breaks down the myth that Bitcoin is anonymous. We can partially negate this by generating multiple public addresses to one private key – essentially, we can create a new public key for each transaction that we receive. However, this does not work in reverse. We cannot retrieve the private key of a public address (which is why it is also known as asymmetric cryptography). Many modern bitcoin wallets are based on this concept.

TIP: If you want to retain a high degree of privacy, generate a new public key for each received Bitcoin transaction. It’s free and you can generate as many public addresses to your private key as you want.

Proof of Work

PoW designates the mining of Bitcoins through computational processing. It is used as proof of the miner’s “work” (their computer’s processing time) in recording a new block into the network, with all transactions and the current state of the blockchain. This ensures that changes are only made by those authorized to do so, preventing the network from being overloaded with fraudulent or incorrect information. This is why transactions are recorded into so-called blocks, which are shared with the nodes approximately once every 10 minutes.

You can find out more in our article on Bitcoin mining.

Bitcoin full nodes

Nodes (full validating nodes) are an important part of the Bitcoin network. These nodes do mine as they are not financially motivated, yet they are still important and many users operate them. These nodes run the Bitcoin software that records the entire history of Bitcoin’s blockchain. They can also approve or reject changes in the Bitcoin network’s code (if they want to accept the changes, they update their version of the software, if not, they simply refuse to do so). You can find out more about Bitcoin nodes in our article What is a Bitcoin Node?

Community

The Bitcoin ecosystem also consists of researchers and developers (who suggest and program technological improvements), exchanges (where Bitcoins can be purchased or sold), companies that accept Bitcoin as a form of payment and last, but not least, of its users—everyday people who purchase, spend, trade or invest in Bitcoin.

The global BTC community welcomes everyone

Join the Bitcoin community!