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Warning: This tutorial isn’t for you if you’re interested in sophisticated technical terms and expressions. We have deliberately kept this simple so even a 10-year-old can understand it. This is the simplest bitcoin explanation ever.
At this point, you must have come across bitcoins. But it baffles many bitcoins and Cryptocurrency fans how the technology can be so popular yet the majority are yet to join the bandwagon. But why would anyone join when all the books, articles, and Wikipedia pages about bitcoin beat you in the head with all sorts of technical jargon never truly explained in simple terms. Reading and hearing terms like consensus algorithm, proof of work, cryptography is enough to make anyone conclude erroneously that cryptocurrency and bitcoins are for computer science graduates professors, and other technical gurus. If only there was a simple easy to comprehend explanation of the technology.
We couldn’t find any so we decided to write it.
The goal of this article is to present all the basic details about bitcoin and the technology behind it in the simplest terms possible. This is the simplest explanation of bitcoin, cryptocurrency, and blockchain technology you will find on the internet. At the end of the day Bitcoin is money, you don’t need to even understand the technology behind it to use it just as you don’t need to know the type of ink or paper used to print the money you spend. (See how to start using bitcoin today here) That doesn’t mean it isn’t fun to know the underlying technology.
Before we get started, it’s best to discuss briefly the history of money. We are only covering our basis and setting the stage to introduce bitcoins but feel free to skip this section if you already understand the history of money.
A Brief History Of Money
The concept of money started with the use of articles of value like Gold to represent money. Of course, it was difficult carrying physical Gold around. Gold could also not be easily broken down to purchase the little things. Eventually, to solve the problem, it was decided that paper certificates (called Gold certificates) be used to represent ownership of Gold. You could carry this around easily and it could also be easily denominated to buy little things. And if you wanted access to your actual gold bars stored in the banks, you could retrieve it by presenting the gold certificates at the bank. Somewhere along the line the government eventually decided to change the system again and we ended up with just paper money (called fiat currency) not backed up by Gold or any assets. What is the value of the paper? Almost nothing but paper money now has value only because the government says it does. Problems have since arisen with this system.
The government became like a middleman, a central entity between the people and their money. Heck, they even printed as many as they wanted and this resulted in inflation with money-losing its purchasing power. That meant what $10 could purchase in the year 2000 can no longer be purchased for the same amount in 2020. Since the government also controls the bank where we kept the money; they were at liberty to do whatever they wish. And as mobile banking and cashless policies became more popular the situation became more problematic. The government became the central authority over what could happen to your money. They have access to our accounts. They could even easily freeze your assets when they wanted to.
How Bitcoin Began
At this point, everyone got fed up. We all wanted to take a break from having the government be the central authority over our money. ‘Necessity is the mother of invention’. We wanted to break free from the government’s oversight and a couple of inventions later we have finally achieved that. In 2008 someone (no one knows who) who called his name, Satoshi Nakamoto anonymously presented his creation to the world. A technology that meant we could have our own money, without the government’s control or even anybody serving as middlemen or central authority. The technology he used was called blockchain technology. This was used to create cryptocurrency and bitcoin became the first cryptocurrency.
Understanding Bitcoin, Blockchain, And Cryptocurrency
To help easily get the hang of it, we’ll explain it thus:
A blockchain is a group of blocks or digital ledger linked together that contains information. An example of how technology can be used is cryptocurrency. And an example of cryptocurrency is bitcoin.
Understanding how bitcoins work can throw some insight into understanding how cryptocurrencies and blockchain work.
Let’s jump right into it.
How Bitcoins Work
First, you need to know that bitcoin is just like regular money, the only difference is that it lives on the internet.
Earlier we asked you to imagine Blockchain as a group of linked blocks with information. Now let’s explain that further. These blocks can be best described as a ledger. We all know ledgers. Before banks had computers, ledgers were manually used to record our transactions. That is exactly what bitcoins uses — a ledger. This bitcoin ledger contains names and balances. Well, not actual names. Since we are not using any technical terms, let’s describe it as a bank account. So you see bitcoin isn’t as anonymous as some would have you believe. While it doesn’t use an actual name to identify you, it gives you a unique bank account (bitcoin address) that can be traced.
Sending bitcoins from one person to another only means you were sending bitcoin files from point A to point B.
But the bitcoin ledger is special.
Remember how banks and government controls our money? We hate to remember it too.
Bitcoins ledgers however are not controlled by anyone. There is no central authority. It is decentralized. That’s a fancy term that means only one ledger is used and everyone has access to their copy of the same ledger. Everyone can see whoever (not name, only the bitcoin address) is sending files (bitcoin) to another person’s address. Users (Everyone that wants to) can also help confirm this transaction and be rewarded through a process we will discuss shortly. But remember you don’t have to be part of the people (called miners) who maintain a copy of the ledger and confirm transactions. Most people are just concerned with sending and receiving their bitcoins and that’s okay too.
Are you following our simplest bitcoin explanation?
Okay, moving on.
How Bitcoin Is Sent From One Place To Another
The process we are about to explain happens in minutes and with a few touches of the button. But here’s what happens behind your screen.
If Mr. A wanted to send $10 to Mr. B. The Sender Mr. A will let everyone (miners who have taken up the responsibility of confirming transactions) know by broadcasting his address (sender’s address), receiver’s address and the amount ($10) to be transferred.
Does that mean anyone could send money from your account without your consent just by having access to your address (account number)?
A big fat No
Just like it’s nearly impossible for someone else to withdraw money from your bank account in reality it’s the same way in the world of bitcoins.
Let’s explain
The technology behind Bitcoin prevents such from happening by using a form of a signature that indicates that the owner is the actual owner of the account he’s attempting to do transactions with. In bitcoin, several unique signatures are generated.
When you create an account on bitcoin, you’ll be assigned a wallet and a unique bitcoin address unique to you which is used to generate the special signature earlier talked about.
When you attempt to send money to another bitcoin address, a complex process that also verifies your ownership of the account(address) you’re transferring money from is initiated. The broadcasted message (sender’s address, receiver’s address, and amount) and your signature are fed into a mathematical formula. Another formula is generated to check the source of the transaction and all of these generate another signature that is specific to that $10 transaction from Mr. A to Mr. B. This signature cannot be copied and can only be used once. This is what is used to authenticate and send money from you to B.
After the money is sent everyone’s ledger around the world is automatically updated to show the new owner of that code representing $10. And everyone agrees to the new state of the ledger.
Security
Next, how does the bitcoin network prevent double-spending?
What if someone attempts to cheat the system by attempting the same transaction twice when his account balance can only cover one?
The key to solving the problem is knowing when each transaction was created and authenticating it. Only one unique transaction can be authenticated at a time so it’s impossible to send 2 at the same time.
How Confirmation Of Transactions Is Done
Remember everyone (that wants to) is in charge of confirming transactions. Also, know that several transactions happen simultaneously on the network meaning several people are attempting to send money at the same time. So how does the network select which transaction is confirmed first?
Here’s where it gets interesting
When a transaction is created, it is sent to a giant pool of other pending transactions that have arrived around the same time. To determine which transaction will be verified first, the people (in charge of verifying) will be required to solve a complex mathematical problem (called a cryptographic hash) attached to each transaction. Forget the big word we will just keep calling it complex mathematical problems. Whichever transaction’s mathematical problem is solved first will be added to another register where it is confirmed (called transaction chain). And then subsequent solved transactions are added to that queue. Transactions are picked one after the order from this register to be executed.
Further security
Every bitcoin (code) being transferred must have a transaction history and could have exchanged hands multiple times over a while. This is recorded on the ledger. It is near impossible to change this history because they are linked together and as explained everyone’s ledger is always up to date. The way the mathematical problem is structured to be solved also ensures that everyone (the people verifying) agrees with previous transactions.
If a scammer for example wants to alter a transaction, it would mean the scammer would have to resolve the complex mathematical problem. It doesn’t end there, he would also have to do the same for all the previous transactions linked to it (the entire chain). And then make sure all the people (verifying the transactions) also have the alterations updated immediately on their ledger. It gets worse for the scammer. He will also need to do it within a specific time interval and it will cost a lot of computing power and resources practically out of reach for a single individual as he is trying to alter a mathematical problem that took several different computers around the world to solve.
If you’re wondering how a scammer can get through all of these layers of security, well wonder no more. It is almost impossible to do so. And this is what makes bitcoin secure as a mode of payment.
Who compensates the people verifying transactions?
The bitcoin network or blockchain has been programmed to automatically compensate these people for verifying the transactions with their computing resources. These are called miners (bitcoin miners). When a miner solves a mathematical problem to verify and authenticate a transaction, a new bitcoin is automatically generated and added to the miners’ account.
But new bitcoins will not be generated forever. There is a limited number of bitcoins that will ever be mined and it is estimated that by the year 2140 all bitcoins will have been generated and no one will be paid for mining.
What will then happen to the miners?
These miners who use their computing resources to make bitcoin transactions possible will be around forever but instead of creating new bitcoins to compensate them, they will earn money from additional fees that will be added to each bitcoin transaction. For example, if Miss A wants to send $50 to Mr. B, she will need to add $5 to the amount to make it $55 with the miners’ fee (transaction fee) of $5 paid to the miner.
This is the summary of how the bitcoin world works.
Remember bitcoin provides a safe, cheap, and secure of transferring money (bitcoins) from one point to another pseudo anonymously (meaning your name isn’t attached to it but all transactions are traceable )
In conclusion, as earlier discussed bitcoins are an example of Cryptocurrencies which in turn are examples of how blockchain technology works.
The implication of this is: understanding the concepts presented above also means you understand how blockchain and cryptocurrency work in general. Apart from Cryptocurrencies like bitcoins, blockchains are now being deployed to disrupt (streamline processes) in different industries such as finance.
We’ve come to the end of our simplest bitcoin explanation.
