Someone asked me today how Bitcoin works (important update on my personal ownership of bitcoin coming in the next few days—keep those clicking fingers ready). And because I learned everything I know about Bitcoin from its Wikipedia page and personal experience, here’s the best I can explain it, per my own understanding. I’m sure this isn’t a perfect explanation. I’d guess there are things about it that people more educated than I would explain differently. But my impression is that this is an adequate middle ground of understanding that allows one to understand Bitcoin well enough to use it in their own lives.
There are two ways to get bitcoin. The first is mining it, which we’ll cover later, because it’s a little more confusing. The second is receiving it from someone else, whether as a purchase, in exchange for goods/services, or as a gift.
When receiving bitcoin either way, the transaction is added to the blockchain. To explain what that means, let’s use an example of the latter way of receiving it: receiving your bitcoin from someone else.
Say that I have .0025 Bitcoin, and I want to give it to my friend Joe for his birthday. When I send it to Joe, it’s recorded on the blockchain, which is basically a ledger. Somewhere further back on it, there would be a record of how I came to possess this bitcoin, but here, sending it to Joe, it would simply say: Stu now has .0025 less bitcoin; Joe now has .0025 more bitcoin, and that would be it. That would be the entire transaction. Nothing physical would transfer between the two of us. Nothing electronic would transfer between the two of us. The blockchain would simply now have noted that Joe’s supply of bitcoin had increased by .0025 and mine had decreased by .0025. In this way, in effect, Bitcoin runs on one giant notebook saying who has how much of it.
Obviously, it’s more complicated than this. Someone (or something) has to interact with the blockchain to make this “note” (nowadays, one would go through apps). It isn’t literally a note. Our names aren’t on there (instead, we each basically have a code that designates us on the blockchain itself), which is where the anonymity of it all comes in. But for all intents and purposes, this, I believe (and again, it’s quite possible I’m missing nuance here or am misunderstanding something) is the idea.
Now, mining: how Bitcoin enters into the system in the first place.
When Bitcoin was set up and began to exist, the amount of it that would be in circulation at any given time was mapped out. Less and less is released to miners each year, until eventually, around 2140, there will be no more mining, and 21 million bitcoins will be in circulation—the supply for all eternity. This is what gives bitcoin its value: it is, in a way, the scarcest resource in the world. We know exactly how much there will be at all times, and we know there is no way for us to generate it outside of its predesigned system.
Mining, then, consists of a “miner” setting up their computer to generate complicated numbers and send them to the blockchain, in what’s easiest to understand as a guessing game. When the right number is guessed (again, this isn’t literally how it works, but conceptually, this is how I understand it), the miner gets a little bit of bitcoin. Meaning, if I successfully mined .000001 bitcoin, the blockchain would add a note that says “Stu now has .000001 more bitcoin” (this isn’t the exact amount of bitcoin that’s released to a miner at a time, and again, this is an oversimplification for the purposes of making it understandable). The system makes sure it’s releasing the correct amount of bitcoin to miners by adjusting how difficult it is to guess the number. No one runs this system. Someone(s) started it. Now it’s self-sufficient.
Hopefully that helps. If you know what you’re talking about and you have better ways to explain it to someone who doesn’t understand bitcoin, fire away in the comments or contact me directly. I’ll update this post if it’s helpful to do so.
