An Introduction to How Bitcoin Works

When you send someone bitcoins, you’re not sending them a bunch of digital files.

When Bitcoin began in 2009, one bitcoin was worth less than one euro. At the time of writing this sentence, one bitcoin is worth almost €10,000. If someone bought a hundred bitcoin in 2009 and sold it now, they’d make something like a million euro. As you probably know, bitcoin isn’t made of gold or silver or, really, anything other than code. It’s a digital currency, which means it only exists electronically. So, how does it work?

There’s no organisation in charge of bitcoin. Without trying to do a deep-dive into economics here, the basic facts of pretty much every other normal currency is that there’s some organisation, usually a government or state, which acts as a central issuing authority or regulatory body. Put simply, those organisations decide when to make more money and how much money to make, keep track of where all the money is, investigates fraud, and other overseeing activities.

Bitcoin doesn’t have anything like that.

Even before bitcoin, there were global networks where people could send copies of music or movies from one computer to another, all of which was super legal. These are called peer-to-peer networks. You can exchange bitcoin on one of these networks.

An important part of this peer-to-peer network is a huge, worldwide ledger called the ‘blockchain’. Every bitcoin is just an entry on the blockchain because the blockchain records every bitcoin transaction that has ever happened. At present, that blockchain stands at 151 gigabytes. That’s huge considering it’s just a text file.

When you send someone bitcoins, you’re not sending them a bunch of digital files. If that were the case, you could just copy-and-paste yourself all the money you could ever want. Instead, you’re just writing on the blockchain. Think of it as me writing on the ledger, ‘Mark sends Barry 5 bitcoins,’ although, to be clear, I don’t have the value of €50,000 down the back of the couch.

As said above, bitcoin doesn’t have a central authority to keep track of everything. It’s decentralised. That raises some concerns as to whether it can work in the real world. In theory, it works because there are lots of people keeping track of the same thing.

Imagine a scenario where four friends are playing poker. Mark, Barry, Jane, and Anna don’t have any money or poker chips or anything. So, as an alternative, Jane gets a piece of paper and writes down who bets how much money, who wins, and who loses as the rounds play out. Nobody completely trusts everyone else so all four of us keep our own ledgers. At the end of every hand, we all compare what we’ve written down. That way, we’ll notice if Jane tries to snag an extra €50,000 for herself.

You can think of each page of that ledger as a block and a whole book of those ledgers as a chain. It’s like, I don’t know, a chain-block.

To be clear, some people who use bitcoin just send and receive money. But, a lot of people are keeping track of the blockchain.

So, every time you want to make a transaction, you must announce your account number, the number of the account you’re sending bitcoins to, and how many bitcoins you’re sending.

But, you’re announcing this to the entire bitcoin-using world. This is meant to be a security measure but it seems like it could lead to some security concerns, right? Let’s not overstate this; it’s not like someone could get into your Twitter account just by knowing your handle. But, think of regular money and all the different ways criminals try to get your credit card information. Worse yet, there’s no regulating authority to keep track of anything fishy that might be afoot.

There’s a more eloquent solution to all this than just relying on the diligence and community service of strangers. It’s safe, at least in theory, because of ‘keys,’ which are long lines of characters that are here used to make mathematical guarantees about messages. Private keys are mathematically related to all addresses generated for the wallet. Put simply, a key would say “Hey, this is really from me!” This is something which is much harder to fake than a credit card number or signature.

There are other important things, like the complicated method for keeping track of when transactions are made. But, you have the essentials of how it works.

The next and perhaps more pressing question is whether you should invest in it. Is it a bubble? That’s not really a question for this kind of article so come back this time next week to read about why investing in Bitcoin is a terrible idea.

I decided to write this article first because the internet has been quick to bash bitcoin. While I essentially agree with that, we should be cognizant of how cool and interesting an idea it is. It’s astonishing that it’s made it this far.

Hey, thanks for reading! You can find me on Twitter and throw some coins in my hat over on Patreon.

You should also know that there’s a video version of this post available here.

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