How Bitcoin Works
Bitcoin is a digital payment system. It is a cryptocurrency. Meaning it is a digital asset designed to work as a medium of exchange.
It is like a digital file or a ledger that contains names and balances. Participants exchange money by exchanging this file.
It was invented by an unknown programmer, or a group of programmers, under the name Satoshi Nakamoto.
One goal of Bitcoin is to avoid any centralised control so that every participant maintains their own copy of the ledger. Everyone participating can see everyone else’s balances, although the real system uses account numbers and names so there is some level of anonymity.
How are all ledgers kept in sync as money is transferred?
When you want to send money, you tell everyone else by broadcasting a message with your account number, the receivers and the amount. Every other Bitcoin user across the entire world then updates their ledger.
If sending money is a simple as sending message with some account numbers, what can stop someone from spending another person’s money by using their account number? Bitcoin has a system like a pen and paper signature check. It requires a kind of signature to prove that the sender is the real owner of an account. This system is based on math rather than handwriting. When a new account number is created, it comes along with the private key mathematically linked to that account number.
Unlike the pen and paper signature version the Bitcoin signatures cannot be copied. They are unique to every transaction.
When the transaction was sent is problematic. In a traditional banking system if the account owner say Alice in this case, wrote 2 cheques, but only had enough money to cover one of them, the bank would pay the first person attempting to cash a cheque but refuse the second. This is because Alice account is empty. So the order these cheques get banked is critical because it determines who should get paid first. In Bitcoin unfortunately the order is much harder to determine.
To solve this issue, Bitcoin provides a way for the entire world to decide on transaction order. New transactions are put in a pool of pending transactions. From that pool, they are sorted into a giant chain that locks in their order. To select which transactions is next a mathematical lottery is held called Cryptographic Hash. This is a function which takes an input (or ‘message’) and returns a fixed-size alphanumeric string called digital fingerprint. This digital fingerprint is irreversible.
The mathematical lottery provides a way for the entire world to decide which transaction is next but the math behind it also helps ensure everyone agrees about past transactions.
How to Send
To send bitcoins, you need two things: a bitcoin address and a private key. A bitcoin address is generated randomly, and is simply a sequence of letters and numbers. The private key is another sequence of letters and numbers, but unlike your bitcoin address, this is kept secret.
The analogy here is 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.
As of this writing 1 Bitcoin is equal to $2,355.544. Surely this is the way forward.