Bitcoin and its magic

Bitcoin is just a digital file that lists accounts and money like a ledger. A copy of this file is maintained on every computer in the Bitcoin network. You don’t have to maintain a ledger just to use Bitcoin to send and receive money, this is for people who want to help maintain the system.

To send money, you broadcast to the network that the amount on your account should go down, and the amount on a receiver’s account up. Nodes or computers, in the Bitcoin network apply that transaction to their copy of the ledger, and then pass on the transaction to other nodes. This, with some math-based security, is really all there is — a system that lets a group of computers maintain a ledger.

While this may sound similar to the way a bank maintains a ledger, the fact that the ledger is maintained by a group rather than a single entity introduces a number of important differences. For one, unlike at a bank where you only know about your own transactions, in Bitcoin, everyone knows about everyone else’s transactions. Yes, you read that right! Everyone knows. Read on, to know its beauty.

Also you can trust your bank, or can at least sue it if something goes wrong. In Bitcoin, you’re dealing with anonymous strangers, so you shouldn’t trust anyone. The Bitcoin system is amazingly designed so that no trust is needed--special mathematical functions protect every aspect of the system.

  • How sending money in Bitcoin works

At a basic level for X to send money to Y, X simply broadcasts a message with the accounts and the amount:

“Send 10.0 BTC from X to Y.”

Every node that receives it will update their copy of the ledger, and then pass along the transaction message. But how can the nodes be sure that the request is authentic, that only the rightful owner has sent the message?

Bitcoin rules require a kind of password to unlock and spend funds, and this password is what’s called a “Digital Signature.” Like a real handwritten signature, it proves the authenticity of a message, but it does so through a mathematical algorithm that prevents copying or forgery in the digital realm.

Unlike a simple static password, a completely different Digital Signature is required for every transaction. Keep in mind that in Bitcoin, you’re dealing with complete strangers, so you never want to reveal a password that could be copied and reused by someone else.

A Digital Signature works by utilizing two different (but connected) keys, a “private key” to create a signature, and a “public key” that others can use to check it. You can think of the private key as the true password, and the signature as an intermediary that proves you have the password without requiring you to reveal it. Public keys are actually the “send to” addresses in Bitcoin, so when you send someone money, you’re really sending it to their public key.

To spend money, you must prove that you’re the true owner of a public key address where money was sent, and you do that by generating a Digital Signature from a transaction message and your private key. Other nodes in the network can use that signature in a different function to verify that it corresponds with your public key.

Through the math behind the Digital Signature, they are able to verify that the sender owned a private key without actually seeing it.

Importantly, because the signature depends on the message, it will be different for every transaction, and therefore can’t be reused by someone for a different transaction. This dependence on the message also means that no one can modify the message while passing it along the network, as any changes to the message would invalidate the signature.

In summary,

Bitcoin is a mathematically protected digital currency that is maintained by a network of peers. Digital Signatures authorize individual transactions, ownership is passed via transaction chains, and the ordering of those transactions protected in the Block Chain. By requiring difficult math problems to be solved with each block, would-be attackers are pitted against the entire rest of network in a computational race they are unlikely to win.

Bitcoin promises many interesting ideas, such as insulation from government meddling, anonymity, and potentially lower transaction fees. It also has many challenges, as it is currently very difficult to exchange Bitcoins for other currencies, and it has been cited as a haven for illegal activity and tax evasion, so governments may try to ban it.

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