To understand how Bitcoin works, we need to look at how transactions are made in our current system (if you want to skip the reading, check
Say you buy something for $10 on your debit or credit card. This is what happens:
1. A request is sent through to your bank via a third party.
2. Your bank verifies that you have enough money available.
3. The transaction is then authorised or declined.
4. If the transaction is approved, money is deducted from your account and it is sent to the account of the person or business whom you’re buying from.
All this has to occur through the banking system
- a type of centralised system that relies on trusting third parties like Mastercard, Visa, EFTPOS, and PayPal to mediate the transaction.
One of Bitcoin’s aims is to manage transactions without going through a centralised system. How does this occur? Say, for example, that I transfer you 1 Bitcoin. When this happens, a digital signature is created. This signature is secured with cryptography – hence the term cryptocurrencies.
If you then transfer this Bitcoin to someone else, another digital signature is created, but all previous signatures are kept. This record of all transactions is called a distributed ledger or, as it is more commonly known as, the blockchain. It is essentially the verification system which confirms and records every single Bitcoin transaction that has ever occurred.
Now, imagine if I had $100 in my bank account, wrote two cheques for $100 and gave them to two different people. One of them would get the money; the other would feel cheated because the cheque would bounce once they went to cash it in. This creates a ‘double spend’ of my $100.
The verification process of the blockchain is key to the Bitcoin system as it must prevent double spending. Remember: When you buy something at the shop, the bank does all the authorising to make sure you have enough money in your account. But who verifies transactions in a decentralised system like Bitcoin’s?
This is where the Bitcoin miners come in. Miners use computers to verify transactions across the network. Remember how every time there is a Bitcoin transaction, a digital signature is created? That digital signature is secured by a complex algorithm. The miners solve these complex algorithms with high-tech computers.
By confirming transactions across the network (known as ‘proof of work’), miners maintain the Bitcoin system. For their work, they are rewarded with Bitcoin.