A very simple explanation of how Bitcoin works

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 A very simple explanation of how Bitcoin works
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Highlights

  • Bitcoin was always envisioned as a currency with no regulators, like central banks, and no intermediaries, like commercial banks
  • Bitcoin also has a blockchain mainnet network, which records all the transactions related to BTC tokens
  • A currency is usually never a speculative investment asset; however, Bitcoin became one soon after its launch in 2009

Bitcoin -- a popular cryptocurrency created in the late 2000s by developer/s Satoshi Nakamoto -- can be complex in terms of operations. One can say Bitcoin is a digital currency that uses cryptography to record transactions. One can also say that underlying blockchain tech adds uniqueness to Bitcoin. It can also be said that Bitcoin is all about the absence of any intermediary like banks, with full control of operations in the hands of the people. The situation right now is such that even stakeholders within the cryptocurrency world lack consensus on Bitcoin.

Before one assumes anything about Bitcoin, including that it is an emerging speculative investment asset, it is important to understand how Bitcoin works. Is Bitcoin a company where staffers work in an arrangement that resembles operations of a bank? Are Bitcoin operations controlled from any headquarters? How are records of the movement of BTC tokens from one party to another maintained? Here is a simple explanation.

How Bitcoin functions

First, Bitcoin is also a blockchain network aside from being a cryptocurrency. Bitcoin’s mainnet is a distributed ledger, which means recordkeeping is not centralised but distributed over a large number of participants. Nakamoto imagined Bitcoin as ‘electronic cash’ or virtual money. Money makes sense only when records are properly maintained and there is no double-spending. The holder should have the ability to use the money once, and the subsequent right to spend should be passed on to the recipient.

Bitcoin functions in a manner that all transactions are recorded on the ledger by globally distributed peers. This process verifies the authenticity of transactions and prevents any double-spending. Elements like hashing and proof-of-work could be complicated, even for someone with a technical background. These simply contribute to the process of recordkeeping, with rewards accruing for recordkeepers, also known as nodes. It’s simple -- when two parties transact, it triggers a record-updating exercise, which is undertaken by independent nodes that are rewarded for work done.

Bitcoin price movement

Data provided by CoinMarketCap.com

Both cryptocurrency and blockchain

Many cryptocurrency enthusiasts focus predominantly on Bitcoin as a cryptocurrency. However, there is a definite and distinctive blockchain mainnet that exists. It is similar to the blockchains of Ethereum or Solana or Cardano. Notably, Bitcoin’s blockchain can support a so-called secondary framework, also dubbed Layer 2 in the blockchain world. Lightning Network is one such Layer 2 protocol that sits atop Bitcoin’s mainnet.  When a token is mined on the mainnet, it becomes the Bitcoin (BTC) cryptocurrency.

Bottom line

Bitcoin can be simple to understand -- considering it is a decentralised virtual currency -- and also complex if one considers how recordkeeping on the mainnet is managed. Intermediaries like central banks and commercial banks have no role to play in it, and the authority is distributed among participants known as nodes. Is Bitcoin a speculative investment asset? This is another debatable topic.

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