How and Why Does Bitcoin Work?

Disclaimer: The following content is for educational purposes only and is not financial advice. I am not a financial advisor.

If you have been exposed to recent news regarding Bitcoin and its skyrocketing price, you are probably wondering what Bitcoin is and why everyone is talking about it. In the next few minutes, you will learn the basics of how Bitcoin works, common terminology, and what this new crypto frenzy is all about.

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Bitcoin is a cryptocurrency, a digital asset that is used as a medium of exchange. There are many types of cryptocurrencies, however, Bitcoin is the largest one with a market cap of around $1.1 Trillion. The basics of Bitcoin can be summarized into 4 elements: virtual currency, decentralized, distributed ledger, secured by cryptography.

Virtual Currency

A virtual currency is an unregulated digital currency that is not associated with any banks or central authority. Since Bitcoin is unregulated, the only real force behind its recent price increases is consumer sentiment. For example, when Tesla bought $1.5 Billion in Bitcoin, there was positive sentiment for Bitcoin and its future. Therefore the price of Bitcoin increased tremendously.


Bitcoin works in a peer-to-peer network where there is no need for intermediaries, this allows Bitcoin to be truly decentralized. A completely decentralized system, like Bitcoin, removes the trust factor issue since power is evenly distributed and everyone is contributing to the system allowing it to function.

Distributed Ledger

A distributed ledger system is similar to a spreadsheet, where everyone has their own copy. Any transaction made is recorded onto this ledger and can be viewed publicly. A distributed ledger is helpful to reduce fraud since there is no single point of failure. To validate transactions, Bitcoin miners use their computing power to solve mathematical processes that help verify a single block. From there, verified blocks are added to a public record, the blockchain. When miners add new blocks to the blockchain, they are compensated with Bitcoin.

Most companies and organizations use what is called a centralized ledger. The reason Bitcoin uses a distributed ledger is that centralized ledgers are prone to cyber-attacks and are more vulnerable because they have a single point of control.

Secured by Cryptography

For Bitcoin, to receive and sign transactions, you need a private key and a public key. The public key is unique to each individual and is derived from the private key. When someone wants to spend their Bitcoin, they need to present their public key and their signature(the private key is used to create this signature). With their signature and public key, the transaction can be verified.

This system works because it’s secure, there is no way to figure out someone else’s private key.

More About Bitcoin Mining

As discussed before, Bitcoin miners use their computing power to solve mathematical puzzles or hash puzzles and this process is necessary to create more Bitcoin. The hash rate is a metric that represents the number of blocks being mined in a given amount of time.

What Is a Bitcoin Wallet

Just like your wallet in real life, a Bitcoin wallet is used to store vital information like your private key. The Bitcoin wallet is useful because it allows you to spend Bitcoin(s).

Bitcoin Terminology

  1. Multi-Signature: A Bitcoin transaction that requires multiple keys.
  2. Confirmations: Once a Bitcoin transaction has been included in a block on the blockchain, it has one confirmation. The transaction is confirmed once more each time additional blocks are added to the blockchain.
  3. SHA-256: The hash function that is used as the Proof of Work algorithm in mining processes.
  4. Blockchain: A record that keeps track of all Bitcoin transactions including the very first one.
  5. Hash Rate: A metric that represents the number of blocks being mined in a given amount of time.
  6. Mining Pool: A group of Bitcoin miners that work together and combine their computing power to increase the probability of finding a block. The reward obtained is distributed among the pool miners.
  7. Private Key: Similar to a password, a private key allows you to spend Bitcoin through a cryptographic signature.

More terminology can be found here.

Articles Relating to Bitcoin

  • Tesla buys $1.5 billion in bitcoin, plans to accept it as payment
  • How Elon Musk Moves The Price Of Bitcoin With His Twitter Activity
  • Bitcoin Was Supposed to Be a Way Around Corporate Gatekeepers. Now Big Companies Are Hopping On Board.
  • Bitcoin surpasses $60,000 in record high as rally accelerates

Videos Relating to Bitcoin

If you learned something from this article and want to help someone else, please share. Feel free to leave a comment down below and contact me on Twitter.

How and Why Does Bitcoin Work? was originally published in DataDrivenInvestor on Medium, where people are continuing the conversation by highlighting and responding to this story.