HOW DOES BITCOIN WORK?
Let’s start by looking at the different things you need to get a cryptocurrency working. We’ll start with the basics and then move into more specifics about what you’ll need to get started.
● The Transaction – The first thing you need to think about with a virtual currency is the transaction – the actual exchange of value from one person to another. While this may sound simple, in many ways it can be easy to forge a transaction to try to cheat the system. With physical currency, transactions are controlled by banking institutions which verify that they’re not forged and are unique.
● A Serial Number – To avoid people trying to forge transactions or reuse them with virtual currency, you need a way to tie a unique serial number to each person and each transaction as well. Bitcoin does this by using a private and public encrypted key. These hashes are used to make sure transactions aren’t duplicated in the network and there’s no way to cheat the system.
● Goodbye Banks – Currently, banks are in place to facilitate a financial transaction between two people. When Bitcoin was being set-up, it was realized that banks could be taken out of the picture entirely if a peer-to-peer network was created to verify the transactions between two entities. This decentralization of financial transactions is one of the biggest reasons so many smart people are getting excited about Bitcoin.
● Bitcoin Mining – Another piece is needed to make Bitcoin work. If it’s too easy for transactions to be validated, people could program bots to flood the network with verifications, making it difficult to actually verify the transaction. To combat this, the idea is to make it computationally difficult to verify the transaction. This helps fight against the bad guys while at the same time offering a way to reward people who give up computing power to verify the transaction. The computational puzzle has to be difficult enough to make it impossible to hack while easy enough to still allow people to solve in a reasonable amount of time.
So, when you set-up a Bitcoin Wallet – aka a Bitcoin client – you will generate a public and private key that is unique to you. This is used to transfer bitcoins to you as well as allow you to transfer bitcoins to other people in the network.
After your Bitcoin Wallet is installed and running, you can create a Bitcoin Address if you want to receive BTC from someone else on the network. At the same time, you can use another Bitcoin address generated in order to pay for goods or services.
The next step is a transaction being generated when the actual swapping of BTC occurs between a buyer and seller. This is added to the block chain where others will verify the transaction (by solving the math problem) and then publish details of the transaction publicly.