How Bitcoin Works

Mario Dian Sep 27, 2016 3 min read

In order to send bitcoins to someone else, there's a chain of reaction and every participant of the network is part of it.

Send bitcoins

Sending bitcoins on the network is done by constructing a Bitcoin transaction (TX). Every transaction (except the very first one called coinbase) is made of one or more digitally signed inputs. An input is an unspent output of a previous transaction.

Look at the following diagram to get an idea.

Let's say Bob has 50 BTC and wants to send 0.5 BTC to his friend Alice.

To construct a transaction, Bob takes the unspent output of 50 BTC and uses it as an input of the transaction. The input represents a value that is spent to certain output(s).

He then signs this input with his private key and broadcasts the transaction (TX A) on the network.

Because Bob doesn't want to spend the whole output to Alice, he spends 49.5 BTC to his change address. If he didn't do it, this amount would have gone towards transaction fees paid to miners.

Think of the change address as a change you'd get back for paying $5 worth of product with a $20 bill. You can't simply tear the bill into 2 parts. Instead, you hand over your $20 bill and get back the change of $15.

Alice has received Bob's 0.5 BTC as well as 0.1 BTC and 0.2 BTC from other people in numerous transactions. These are her unspent outputs.

Alice then decides to spend all 3 outputs at once to her employee.

Similarly, she creates one input that references these unspent outputs, signs the input with her private keys and broadcasts the new transaction (TX B).

Confirm the Transaction

Once the TX is broadcasted on the network it hangs in mempool (memory pool) for a while until it's picked up by miners.

Mempool is a place in system's memory that holds a list of all unconfirmed transactions that need to be processed by miners.

A miner is an individual or a company that competes with other miners by solving extremely difficultmathematical problems. This process is called mining and it's very resource intensive and expensive.

How Mining Works

The miner picks up transactions from the mempool based on his arbitrary rules and includes them in a new block. This data along with the header of the previous block is used to create new block's header.

A nonce (an arbitrary unique number) is then added to the block header and hashed. This process is repeated by incrementing the nonce which produces a completely new hash until it is equal or less than the mining target.

A mining target is a huge 256-bit string. The lower the value of the string is, the harder it gets to find the right hash.

Imagine you have a random number generator that generates fixed set of numbers from 0 to 100. Generating a number that is less than or equals to 100 is very simple with a probability of 100%. Any generated number would match. Lower this threshold and the probability of you meeting the requirement is way lower.

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"In a world of centralized currency, new coins go to whoever the money printer (central bank, commercial banks or the state) choses as a recipient of those coins. In a world of decentralized currency, we want the distribution to be fair, so Satoshi Nakamoto, the creator of Bitcoin, invented mining."

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Because miners come and go and the rule of the network is to mine approximately 1 block every 10 minutes, the mining target needs to be periodically adjusted. This readjustment is set to happen every 2016 blocks or ~every 2 weeks.

The first miner to find the right hash broadcasts it on the network. He also gets to keep all the feesincluded in the block as well as the block reward (currently at 12.5 BTC per block).

Verify the New Block

After the newly minted block is broadcasted on the network, it gets verified by full nodes.

A full node is a computer on the Bitcoin network that runs a Bitcoin software enforcing certain network rules, also called "consensus rules" referenced in a bitcoin-core client.

Every new block passes through full nodes which check whether included transactions and the block itself matches consensus rules. If it doesn't it absolutely get's rejected by the client.

This design makes sure miners are in check. If they don't follow the rules, their blocks will be invalid which means miners just burned a lot of electricity for no reason.

If you want to learn more about Bitcoin, read the original Bitcoin Whitepaper created by Satoshi.

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Mario Dian

I'm an Anarchist, Rothbardian, Bitcoiner and Travel Hacker. Also founder of @freedomnodecom.

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