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How does Bitcoin work?

How does Bitcoin work?

Beginner

19th December 2019
Updated: 27th June 2020

3a – How are bitcoins transferred?

Imagine sending someone (e.g. your friend Sarah) an email that reads ‘1 bitcoin’. You would:

  1. Log into your email account
  2. Enter Sarah’s email address
  3. Type ‘1 bitcoin’ into the body of the email
  4. Hit send
  5. Sarah would receive a message reading ‘1 bitcoin’

A bitcoin transfer works in a similar way, but instead of email accounts you and Sarah each have ‘wallets’. If you were sending 1 bitcoin to Sarah, she would receive 1 bitcoin in her wallet, rather than an email in her inbox.

From a user’s perspective, wallets function like email accounts, but they are much more secure. Each wallet has a public address used to send and receive bitcoin (like your email address), and a ‘private key’ used to access your funds (like your password).

A bitcoin wallet public address (also known as a ‘public key’ or ‘wallet address’) is comprised of a string of 26-35 letters and numbers, starting with numbers 1 or 3. Here’s an example of a bitcoin wallet address:

1S0xjzn7AcGd7wl7AyLqmLYL2oFl

Users of the blockchain can transfer funds to your wallet by entering your public address, and if you transfer bitcoin to somewhere else it will be recorded on the blockchain as having been sent from your wallet address.

Private keys are comparable to your password. They are what enable you to access the bitcoin you have received, and send bitcoins to other wallets. But private keys are much, much more secure than email passwords. Private keys take the form of a 64 character long string of letters (A-F) and numbers (0-9). Here’s an example of one:

072DDD3DE3017A3D82CDEA29E585004AD25
F132CE36BA7D0D48B73736822353C

So, if you wanted to make a payment to Sarah, you would first need to have your wallet’s private key to gain access to your bitcoin wallet and the funds held within it. You can then choose to send funds from your wallet to Sarah’s through entering her wallet’s public address.

The transaction will then be publicly recorded on the blockchain as a transfer of one bitcoin from your wallet to Sarah’s.

3b – Can you have less than one bitcoin?

Yes you can. Bitcoins are divisible, and can be broken up into fractions of up to 8 decimal places. The smallest fraction of a bitcoin that you can store on a wallet, or to transfer to others is 0.00000001 BTC (one hundred millionth of a bitcoin), which is known as a ‘satoshi’.

The divisibility of bitcoin works just the same as regular currency. In the UK, the currency is pounds, but you can get 50p, 20p, 10p, 5p, 2p, and 1p pieces.

3c – What is Bitcoin mining?

Mining is the process that verifies the legitimacy of bitcoin transactions and adds them to the Bitcoin blockchain in the form of new blocks.

Remember the football players from the game in section 1c, who kept score of the game without the need for a referee? They are the miners: the users of the blockchain who verify transactions without a central authority calling the shots.

When it comes to bitcoin, mining involves computers competing to solve mathematical equations in a process known as ‘hashing’.

To imagine how mining works, it is best to envision a situation where multiple people are working on solving 5 by 5 rubik’s cube, where the first person to complete the cube is rewarded with £100.

With mining, instead of solving a rubik’s cube, miners are working on verifying bitcoin transactions, grouping them into blocks, and adding them to the blockchain. Once this process is complete, instead of £100, the successful miner is awarded with a set amount of bitcoins as a ‘block reward’. This reward is what encourages more people to participate in bitcoin mining, which is what keeps the blockchain decentralised.

The mathematics behind mining are complicated, and it is not necessary to understand them fully in order to use and spend bitcoin – just as you don’t have to be able to build a computer in order to use one, or understand investment banking to have a debit account.

If you’re interested in learning how to mine bitcoin, you can do so on our designated ‘Mining’ pages. For now we’re going to move on to how you can buy, store, and invest in bitcoin.

By Harry Atkins
Harry joined us in 2019 to lead our Editorial Team. Drawing on more than a decade writing, editing and managing high-profile content for blue chip companies, Harry’s considerable experience in the finance sector encompasses work for high street and investment banks, insurance companies and trading platforms.
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