How Does Bitcoin Work?
Bitcoin is the best known and most valuable cryptocurrency, a form of digital money. Unlike dollar bills that you can hold in your wallet or stuff in your pocket, you can’t physically touch a bitcoin. Bitcoins exist in a purely digital environment maintained by a large network of computers worldwide.
If you’re new to digital currencies, then it’s important to understand how bitcoin works and how it is created. Here’s a deeper look at the bitcoin blockchain and the bitcoin mining process.
Key Takeaways
- Bitcoin is a form of digital money available for online transactions and investments.
- The bitcoin network is maintained by a large number of computers responsible for tracking the history and ownership of every bitcoin ever created.
- The bitcoin network is considered secure, although individual bitcoin owners can face security risks.
What Is Bitcoin?
Bitcoin is a digital currency. Unlike government-backed currencies, known as fiat currencies, bitcoin isn’t backed by any central bank or government. Bitcoin’s value derives from both the security of the underlying technology, global adoption by the community of bitcoin users and the fact that its supply is capped at 21 million. Its price on the exchanges, not unlike stocks, is determined by demand and supply.
Where it’s legal, anyone with a bitcoin wallet and an internet connection can transact in bitcoin.
Bitcoin, along with other cryptocurrencies, uses blockchain technology to achieve a combination of anonymity and security that’s not possible with non-digital currencies. While bitcoin certainly is not riskless, many cryptocurrency enthusiasts see bitcoin and related currencies as the future of money.
How the Bitcoin Blockchain Works
The bitcoin blockchain is a digital ledger that tracks the creation and movement of every bitcoin. This digital ledger is decentralized and public, enabling anyone with an internet connection to view any transaction in the network’s history. The blockchain’s history is fully transparent while users’ identities remain anonymous.
The bitcoin blockchain works like this:
- Users transact in bitcoin, either buying, sending, or exchanging bitcoins. The transactions are broadcast to many computers that compete to validate blocks of transactions.
- The validation process, known as mining, is completed by cryptocurrency miners who own vast computing resources. Miners earn bitcoin for every block that they validate.
- Miners add blocks to the bitcoin blockchain. Every transaction is triple-verified by the sender, the receiver, and the rest of the bitcoin network.
- Every new block and the transaction information it contains is instantly copied worldwide to bitcoin miners’ local versions of the bitcoin blockchain, which creates consensus regarding the current state of the bitcoin blockchain.
Note
As a bitcoin user, once you send a transaction to the network, it cannot be cancelled or reversed.
How Bitcoin Mining Works
Let’s take a closer look at bitcoin mining, which is the computing process that makes the bitcoin blockchain work.
Bitcoin miners compete with each other to be the first to solve complex mathematical problems. To be the fastest, most bitcoin miners own and operate vast amounts of specialized computing hardware designed for exactly this purpose. Those who solve the math problems the fastest earn the right to validate blocks of bitcoin transactions and add new blocks to the bitcoin blockchain. The miner broadcasts to the network the addition of the newest block.
Note
Although bitcoin mining can be conducted by nearly any computer in the world, the large scale of most mining operations means that significant computing resources are required to successfully mine bitcoin.
Most bitcoin miners work together in mining pools, sharing both computing power and bitcoin rewards received. And other miners choose to mine other cryptocurrencies that are less competitive and require less computing resources.
How Secure Is Bitcoin?
Because so many computers verify every bitcoin transaction, the bitcoin blockchain is considered extremely secure and difficult, if not impossible, to modify. The entire history of the blockchain is public, creating a high level of consensus among bitcoin users about the state of the network.
But that doesn’t mean that your own bitcoins don’t face any security risks. You can minimize the likelihood of being personally scammed or hacked by choosing a bitcoin wallet—where you store your cryptocurrency keys—or combination of wallets that balances convenience and security.
Here are your basic wallet options:
- Software: Software wallets are wallets connected to the internet. They are the easiest to use and may be free to create, but come with the greatest risk of being hacked.
- Hardware: Hardware wallets are physical devices that are less convenient to use but offer the highest level of security.
Note
If you decide to buy and hold bitcoin, it’s important to follow best practices for digital security. To maintain the highest level of security, consider a hardware wallet for long-term storage.
Frequently Asked Questions (FAQs)
How does Bitcoin mining work?
Bitcoin mining uses computing power to track and validate bitcoin transitions. Bitcoin miners around the world operate hardware specially designed to track bitcoin transactions and ownership. Bitcoin miners use their computing power in a race to validate pools of transactions, which are recorded as new blocks in the bitcoin blockchain and they are rewarded for their efforts in bitcoin.
How does Bitcoin work on Cash App?
Cash App from Square enables bitcoin transactions and stores bitcoin keys for Cash App users. If you already have Cash App, you can buy and sell bitcoin directly within the app. You may be charged a fee to use your bitcoin within Cash App.
How does Bitcoin make money?
Bitcoin isn’t a business that makes money. All bitcoin mining fees are paid out to bitcoin miners, who operate the bitcoin network. As an open-source development project, bitcoin is maintained by volunteer developers.