How Bitcoin works
Let's make one thing clear... it's not essential for you to understand precisely how the Bitcoin network operates, any more than you need to understand the backend operating system of your mobile phone. We use a variety of technologies every day with only a vague idea of how they operate, ranging from the internet to cars, email, cloud computing, and aeroplanes. The average person has no clue how these technologies function, nor do they particularly care, as long as they work and provide solutions. Naturally, the market reflects the solutions that society values, as evidenced by the growing demand for the relevant goods and services. I believe that this era is also dawning for Bitcoin, where every person will use it, oblivious to what's under the bonnet.
However, for now, Bitcoin is a new technology, so much of the back-end work is still the responsibility of the average Bitcoin holder (such as you and me), rather than third-party organisations. This chapter aims to alleviate some fears, uncertainties, and doubts (FUD) by breaking down the basic elements of Bitcoin, what it is, and how it works.
One of the main functions, but by no means the only one, is that Bitcoin is a technology for preserving your generational wealth and projecting your value into the future, safeguarding your hard-earned money from inflation. Even a basic understanding of the underlying operation of the Bitcoin network can help build conviction and consequently, confidence.
Unfortunately, because Bitcoin is such a new and revolutionary technology, there is nothing in existence to which it can be directly compared. All comparisons would be inadequate and lead to incorrect conclusions. I will attempt to explain these points from a macro perspective.
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This page will focus on:
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Blockchain.
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Nodes.
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New coin creation & the halving.
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Mining and difficulty adjustment.
Before we start, it's important to note that several key innovations by early cypherpunks preceded the creation of Bitcoin. These developments laid the groundwork and made the launch of Bitcoin possible. Satoshi Nakamoto completed the incentive!
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The blockchain is a string of digital blocks that are added to preceding blocks approximately every 10 minutes, continuously forming a chain. The Blockchain can also be described as a "time chain", functioning like a clock that marks time by adding new blocks every 10 minutes.
Tick-tock, next block.
The Blockchain
Each block contains a specified amount of "digital space" or "data", which is utilised to record transactions, thus creating a digital "ledger". This ledger lists ownership by detailing addresses in the blocks and the amount of bitcoin associated with each address. These addresses can be likened to "bank account details". However, unlike traditional bank account details, these addresses are not linked to personal identities.
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This digital ledger maintains a record of every transaction ever conducted since the launch of Bitcoin's. Once a new block joins the chain, it becomes permanently fixed, unalterable, incorruptible, and utterly immutable.
Contrasting with traditional banking ledgers, the blockchain is decentralised, meaning it does not reside in a single central location.
It's worth taking a moment to reflect on the significance of this: an entirely open-source, transparent monetary system with a limited, fixed supply.
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Bitcoin is protected by a network of computers known as "nodes". These nodes are distributed globally, reflecting the decentralised nature of Bitcoin. Anyone can opt to run a node and join this network simply by downloading Bitcoin Core.
Nodes
This program connects to other computers or nodes worldwide and downloads a copy of the blockchain. Once a node is fully synchronised with the network, it collaborates with the other nodes in a symphony of robust security, continuously verifying and auditing the validity of each block added to the chain every 10 minutes. If a block presented for verification by the network of nodes contains anything malignant, it is deemed invalid and rejected by the network. Imagine auditing banks with this level of transparency!
Note: Only the blockchain is copied, not the bitcoins themselves! There will only ever be 21 million coins.
Each node that joins the network contributes to its security. Nodes can enter and exit the network at will; upon rejoining, they simply catch up to the latest block.
To shut down Bitcoin, every single node would need to be individually located, turned off, or destroyed. This task would require an extraordinary amount of time, energy, and manpower and is, to say the least, unfeasible. As nodes could reappear faster than they could be shut down, it would result in a large scale game of whack a mole.
Nodes are akin to guardians of Bitcoin!
As of this writing, the estimated number of nodes in operation, according to bitnodes.oi, is 56,461.
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For every new block presented to the network of nodes and added to the blockchain, a specific amount of Bitcoin is awarded to the "miner" who has won that block. This is achieved through a process known as "proof of work."
The Bitcoin protocol commenced on 3 January 2009. The "Genesis block" was the first block mined, with a block reward of 50 Bitcoin. Every 210,000 blocks, or approximately every four years, the block reward for any given winning miner is halved. This event, commonly referred to as the "halving," was programmed into the Bitcoin protocol from the beginning. It ensures a steady issuance of Bitcoins into the system in a deflationary manner.
New coin creation & "The Halving"
At present, the reward for any given block is 6.25 Bitcoin (900 BTC per day). As of this writing, we are on the cusp of the fourth halving, where the block reward will be reduced to 3.125 Bitcoin (450 BTC per day), thus lowering the supply into the market. With increasing demand, this naturally drives the value of bitcoin higher.
The last bitcoin is expected to be mined in the year 2140. To date, there are approximately 19,644,906 Bitcoin in existence, with about 1,355,093 Bitcoin left to be mined. Many of the coins already in existence are held by long term holders, or have been lost forever, making scarcity even higher.
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Understanding the intricacies of mining isn't essential to grasp Bitcoin basics, so let's keep it simple.
Miners constantly vie to "mine" the next block. This competition involves expending vast computing energy to solve a complex problem, akin to a "guessing game." This process is typically known as "Proof of Work." It necessitates a very specific computer, notably one with a Sha-256 processor, designed specifically for this task.
Mining
Once a miner successfully guesses or solves the problem, they earn the block reward. All other miners immediately start competing for the subsequent block. The winning miner then broadcasts the block to the network of nodes for verification and incorporation into the chain.
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The Bitcoin protocol, every 2016 blocks (or roughly two weeks), adjusts the mining challenge through the "Difficulty Adjustment." This assessment of the total computing power dedicated to mining determines the challenge level. If there's a higher amount of computing power, the difficulty increases; if it's lower, the difficulty decreases. This balance ensures the mining time for a block remains consistent, irrespective of the number of miners or their equipment's capability.
Without this mechanism, an influx of miners or advancements in mining technology could lead to blocks being mined too rapidly. Conversely, if miners exit the network, block mining could slow down excessively. The difficulty adjustment effectively addresses these potential issues.
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The Bitcoin blockchain operates as a distributed ledger, recording who owns which bitcoins. Nodes around the world hold a copy of this ledger, ensuring complete transparency. Approximately every ten minutes, new blocks are proposed to the consensus network of nodes through a process known as mining. These blocks, composed of digital data, direct the movement of bitcoin transactions to specific addresses. Additionally, each new block generates new bitcoins, awarded to the miner who successfully solves a complex problem. Once the consensus network of nodes verifies that a new block is valid, it will be added to the chain. This process repeats in a cyclical fashion.
