So... How does Bitcoin work?

Now for the burning question. How does Bitcoin work? To start, lets talk about how normal transactions work. If I were to go into a shop and pay for something with my card, the shop takes my bank details (when I used my chip and pin or contactless payment). The shop then goes to the bank to see if I’m good for the money and do in fact have the money for the transaction. The bank will then check its records, or its ledger of customer details, to see if I do have the money in my account. If I do have the money, the bank tells the shop, the transaction is completed, and the bank will then update its ledger, taking the money out of my account into the shops. The bank will take an albeit small cut from this transaction but think of the millions of transactions that are processed everyday – the banks will make a fortune. This is what cryptocurrency wanted to stop. It was a system that wanted to remove the need for the middle man in our daily transactions. But there are still some issues with just simply removing the need for banks. First of all, where will the ledger of everyone’s account’s be kept without them being altered. Would you trust me to keep the records? Probably not, and I wouldn’t trust any of you to keep the ledger either (no offence). But we might trust every single person in the system. This is the idea behind cryptocurrency.

This is where blockchain comes in. Blockchain creates a digital ledger of everyone in the system’s account details and makes it publicly known to everyone in the system. Everyone who uses bitcoin will have access to view this ledger. This is called a peer-to-peer network and blockchain records every single bitcoin transaction that’s ever occurred in a chronological order inside a “block”.

But what is stopping someone altering this record and just giving themselves more bitcoin? Consider this example I heard once. Say you’re playing poker with your friends but none of you have any money or chips on you. So instead, every player takes out a piece of paper and records throughout the game who owes who what money. At the end of the game, you all compare what you’ve written on your pieces of paper. If someone tries to get more money and their record doesn’t match everyone else’s, this is caught and it will be forced to be changed by everyone else. This is the same idea of bitcoin. Instead of friends playing poker it is computers part of a network, who constantly compare ledgers to make sure there are no discrepancies and if there are then they change them. So instead of the bank checking the ledger is correct for a small fee, the network of computers checks all the public ledgers are correct. Every so often, a computer will be gifted a bitcoin by the system if it confirms a certain number of transactions.

Although all this information is public, there is still anonymity as everyone’s details are displayed in an encrypted way, which is called their “signature”. So all we can see is the different signatures on the ledger and how much they have or what they bought. Therefore transactions made are anonymous and irreversible as there no way of knowing who you just traded with. This leads to a lot of problems that I’ll talk about in a later blog post. 

In relation to the example given at the start, we now have a new system for transactions. Say this ledger that the bank used to be the sole owner of is now distributed around the world and every computer as part of the network records every single transaction. Now, I give my account details to the shop, the shop will go to the network of computers to confirm that I have the money. The whole network will have to agree that I have the money and if one has a discrepancy then the network will change its ledger to the correct one. The network will then get back to the shop and allow for the transaction to go through and every single computer will change their ledger to update the accounts after this transaction. This process will then produce a bitcoin for one of the computers in the network, which is called "mining". This simply means that computers are getting rewarded after completing complex problems involved in updating and maintaining this public ledger, and after a certain number of these problems are solved the network offers the computer a Bitcoin.

So, to sum up, bitcoin uses a network of computers to maintain a central ledger. This ledger is updated constantly with new transactions and the network has to agree on a change made to the central ledger in order for it to make it into the block. This means I can’t send bitcoin I don’t have as the network will see I only have a certain amount and will reject my transaction. All transactions are anonymous. Since this system is on a network of computers, no one person “owns” it or the ledger therefore no one can just give themselves bitcoins or alter the ledger themselves. To do this, an individual would have to hack essentially every single computer on the network and change all their ledgers at once which is virtually impossible. All these features are what makes bitcoin special: it is a decentralised currency (no one owns it); it cuts out the need for a middle man (the bank); it is anonymous and; hacker proof.