What Is Bitcoin?

Updated: Apr 29, 2024 | Published: Apr 29, 2024
Verified Investing
By Verified Investing
What Is Bitcoin?

Bitcoin is the original cryptocurrency. It is the first real-life implementation of a decentralized peer-to-peer virtual currency system.

Bitcoin was invented as an alternative to fiat currency. Unlike “paper money” that governments can print unlimited amounts of, Bitcoin has a fixed maximum supply of 21 million bitcoins.

There is also a limit to how fast bitcoins can be created. A maximum of 144 blocks of bitcoin transactions can be mined per day. New bitcoins can only enter the system through mining blocks of transactions.

These facts make Bitcoin a deflationary currency. As demand grows faster than new bitcoins can be created, the price rises, unlike the continuous loss of purchasing power that fiat currencies see.

But what IS Bitcoin?

Bitcoin is an open-source codebase for creating and tracking digital tokens called bitcoins. Each transaction is recorded on millions of identical digital ledgers called a blockchain. These transactions are recorded and verified by millions of participants worldwide, known as “bitcoin miners.” The miners compete for the opportunity to write the next block of transactions onto the blockchain by solving extremely difficult math problems. The one who adds the new block is rewarded with a set amount of bitcoins.

The Bitcoin Software

The Bitcoin software is open-source code that implements the Bitcoin Protocol. This is the set of immutable rules that defines how everything in the Bitcoin system works. Since Bitcoin is a peer-to-peer network, there is no master server. All instances of the Bitcoin software are coequal parts (nodes) of the distributed system.

These nodes constantly communicate with each other. When a new block of transactions is appended to the blockchain, that computer broadcasts the details to other nodes, which pass along the information until every node has updated its copy of the blockchain.

The Blockchain

The blockchain is the permanent, public record of every Bitcoin transaction that has ever been made. There is no “master blockchain.” As a distributed system, every Bitcoin node carries an identical version of the blockchain. Each node on the network queries multiple other nodes to stay current with new blocks being added.

New transactions are bundled together into 1 MB “blocks” that are permanently added to the end of the blockchain once verified. These transaction blocks are generated and verified by special nodes known as Bitcoin miners.

Bitcoin Mining

Bitcoin Mining

Miners are vital to Bitcoin. They assure that each transaction is valid before it is recorded onto the blockchain. It takes massive amounts of computing power and expensive hardware to keep the Bitcoin ecosystem running. Most miners use banks of purpose-built computers called ASICs to be the first node to solve the complex mathematical problems needed to add a block of transactions to the blockchain.

In more detailed terms, every node uses the same formula to work with the same block of transactions to create a unique 64-character string called a hash. The hash has to meet the current requirements generated by the Bitcoin software.

The first party to solve the hash gets to add the block to the blockchain and earns a pre-set reward of bitcoins, but only after other nodes verify that the solution is valid. They do this by entering the same key that the original miner discovered to generate a hash on their copy of the block of transactions. If the hashes match (remember that the hash is unique) then the transactions are verified and the block can be added to the blockchain.

Bitcoin Wallets

Bitcoin wallets are programs that manage your Bitcoin account. Each account consists of a public key and a private key. The public key is the 256-bit number that identifies your account that you send to others to receive bitcoin. The private key is the secret number that in combination with your public key unlocks the encrypted message that contains the bitcoin you were sent.

Some people purchase hardware wallets that store your bitcoin wallet on a custom physical device that has to be plugged into a computer to use. Hardware wallets are far more secure than wallet apps since they are only connected to the internet long enough to complete your transactions.