So how does bitcoin actually work?

Thursday 14 July 2016

Bitcoin is difficult in theory, and unbelievably complex in practice. This might help you get your head around just it a little bit more.

In some ways, bitcoin is simple to understand. It’s like digital cash - meaning coins and notes that you hand directly to another person, without a middleman. No intermediaries necessary.

Delve much deeper than that, and you find it’s more complicated. A lot more complicated. The Bitcoin White Paper is, of course, the first and most authoritative word on this: the scripture from which all subsequent cryptocurrency denominations have been derived. One problem is that it’s a paradigm shift in the concept of money, and that’s before you get into the details of how it works - which is a real killer. Neither did Satoshi write his white paper with the intellect of the average human in mind; it is not a document for popular consumption.


Figuring out the broad strokes of bitcoin is a headache. Really understanding it? Get the painkillers ready.

Not even 'money'

For starters, you have to grasp that the basis of money in bitcoin is not a thing - even data - being sent from one person to another, like you might send an email. It’s a ‘shared ledger’: a record of who owns what, distributed among everyone in the network. ‘Sending’ money is a process akin to recording a change of ownership. You have to have some grasp of cryptography, specifically public key cryptography, because critical to the idea is the principle that you mustn’t be able to impersonate someone else. And you have to grasp the idea that validating a transaction means tracing it all the way back to the start, to make sure that the person sending money really does have the money to send - and how you enforce that.

Michael Nielson has done an excellent job of explaining how bitcoin works. In a series of steps, he unpacks the theory behind the idea of digital currency, building up a picture in stages. It’s pretty informative, and it starts with theoretical simple versions of bitcoin (‘Infocoin’, as he calls it) that demonstrate how each element works - and why you need all of them to create a robust form of internet money.

This is bitcoin simplified, but even this isn’t for the faint hearted. It’s a lengthy post, best consumed in segments and with plenty of time to digest the last one in between. But if you’re planning to work with digital currencies on more than a superficial level, it’s well worth the effort to understand what’s actually going on when you click the send button - or submit an API call, or even start thinking about how your own platform is going to work.

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