What Are Bitcoins, and How do They Really Work on the Internet?
Over the past year, words like “Bitcoin” and “cryptocurrency” have gone from being obscure tech jargon to finding their way into the vernacular. You probably know that Bitcoin is an online form of money, but what actually is it, and how does it work?
Bitcoin is the most well-known of many forms of online money, called “cryptocurrencies.”
Cryptocurrencies are virtual, meaning that transactions and trading take place online. They use what’s called decentralized control; there is no central mechanism deciding when to produce more money. There are no third parties, like banks, to hold your funds on your behalf — the user always controls his or her own money directly.
Without those sorts of institutions, which are vital to more traditional currencies, what keeps track of transactions that have taken place online? A massive digital collection of accounts and transactions called the blockchain fulfills this role and more.
Think of the blockchain as a super-logbook, one that holds every user balance and transaction that has ever taken place. But since Bitcoin is decentralized, no one person or group holds the blockchain: every Bitcoin user connected to the network has a copy, and in order for any balances to change or transactions to be made, every copy of this blockchain must be updated accordingly.
We’ll talk about Bitcoin from now on but the same principles apply to over a thousand other cryptocurrencies such as Ethereum and Litecoin.
Every user has a digital “wallet.” A Bitcoin wallet doesn’t actually hold pieces of “Bitcoin” — Bitcoins aren’t real. Instead, a Bitcoin wallet holds code about every transaction a user has made from the first time any Bitcoin was deposited into the account (the same info visible to everyone via the blockchain), and more importantly, code holding private information that allows only the owner of the account to initiate transfers of Bitcoin to other accounts.
Before any amount is transferred from one wallet to another, the request must be “validated” to make sure everyone’s copy of the blockchain confirms that the sender has enough to send the requested amount to the recipient.
Once the transaction is given the “OK” by enough members within the Bitcoin network, the transaction is ready to be made — it is included as part of a “block” and made ready to be connected to the blockchain. (The blockchain is literally a digital chain of blocks, with each block holding new transactions between users, hence the name).
Here’s where the term “Bitcoin mining” comes in to play. The only way Bitcoins are created is by special users who use the computing power of their own devices to add new blocks — full of transactions ready to be added to the blockchain — to the rest of the Bitcoin transactions in the currency’s history. Adding a new block to the network earns a Bitcoin miner a reward of 12.5 Bitcoins as of March 2018, worth more than $100,000.
However, adding a new block is an intensive process that many miners around the world compete to accomplish. Only one new block can be completed at a time, so once it has been added, miners must move on and attempt to be the first to add the subsequent block.
Adding a new block requires the completion of a special puzzle. Miners basically play a guessing game, in which their high powered computers generate guesses of a “target number.” That number is determined by information in the new block users are creating, as well as information in the most recently added block (i.e. the block users want to connect the new block to).
If a miner is the first one to arrive at a value close enough to the number created by the blockchain blocks, their balance increases by 12.5 Bitcoins.
This process eliminates the need for any company, government or other authority to control the process of making new Bitcoins — the creation of a Bitcoin sets in motion the creation of the next automatically.
The value of a full Bitcoin started rising rapidly in value in mid-2017, peaking above $17,000 per Bitcoin before tumbling to below $7,000. Currently its value stands at about $7,400. While more and more cryptocurrency transactions have been taking place over time, many people simply hold these currencies to sell them later at higher prices.
The future of cryptocurrency is still in debate — some see it as the future of currency, while others see a new fad that might make a handful of lucky techies a few bucks. Regardless of people’s sentiment on the new technology, it’s here now, and it’s making an impact.