Bitcoin || How Cryptocurrencies Work

 Say there's a coin that's currently worth hundreds of U.S. dollars but it's not made of gold or platinum or any precious metal. In fact, it's not the kind of coin you can hold in your hand or stick in a piggy bank. It's a digital currency which means it only exists electronically. I'm talking about Bitcoin bitcoin doesn't work like most money it isn't attached to a state or government so it doesn't have a central issuing authority or regulatory body. Basically, that means there's no organization deciding when to make more bitcoins figuring out how many to produce keeping track of where they are or investigating fraud. So how does Bitcoin work as a currency or have any value at all? 

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Well bitcoin wouldn't exist without a whole network of people and a little thing called cryptography. In fact, it's sometimes described as the world's first cryptocurrency. And here's how it works. Bitcoin is a fully digital currency and you can exchange Bitcoins between computers in a worldwide peer to peer network. The whole point of most peer to peer networks is sharing stuff like letting people make copies of super legal music or movies to download. If bitcoin is a digital currency what's stopping you from making a bunch of counterfeit copies and becoming fabulously wealthy. Well unlike an MP 3 or a video file a bitcoin isn't a string of data that can be duplicated. Bitcoin is actually an entry on a huge global Ledger called the blockchain for reasons we'll get to in a minute.

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 The blockchain records every bitcoin transaction that has ever happened and as of late 2016, the complete Ledger is about 107 gigabytes of data. So when you send someone bitcoins it's not like you're sending them a bunch of files. Instead, you're basically writing the exchange down on that big. Something like Michael sends Hank 5 bitcoins. Now maybe you're thinking but wait you said that bitcoin doesn't have a central authority to keep track of everything even though the blockchain has a central record. 

 

There's no official group of people who update the ledger and keep track of everybody's money like a bank does. It's decentralized. In fact, anybody can volunteer to keep the blockchain up to date with all the new transactions and a ton of people do it all works because there are lots of people keeping track of the same thing to make sure all transactions are accurate. Like, imagine you're playing a game of poker with some pals but none of you have poker chips and you left your cash at home. There's no money on the table so a few of you get out some notebooks and start writing down who bets how much who wins and who loses. You don't completely trust anyone else. So everyone keeps their ledgers separately. At the end of every hand, you all compare what you've written down that way. If someone makes a mistake or tries to cheat and snag some extra money for themselves that discrepancy is caught after a couple of hands you might fill up a page of your notebook with notes about the money movement.

 You can think of each page as a block of transactions. Eventually, your notebook will have pages and pages of information. A chain of those blocks hence blockchain. Now if thousands of people are separately maintaining the bitcoin blockchain how are all the ledgers kept in sync. To stick with our poker analogy think of the entire bitcoin peer to peer network as a really huge poker table with millions of people. Some are just exchanging money but lots of volunteers are keeping ledgers so when you want to send or receive the money you have to announce it to everyone at the table. So the people keeping track can update their ledgers so for every transaction, you're announcing a couple of things to the bitcoin network. 

Your account number the account number of the person you're sending bitcoins to and how many bitcoins you want to send. And all of the users who are keeping copies of the blockchain will add your transaction to the current block. Having a bunch of people keep track of transactions seems like a pretty good security measure but if all it takes to send bitcoins is a couple of account numbers that seems like it might be a security problem. It's a huge problem with regular money. Just think of all the ways criminals try to steal other people's credit card information and with bitcoin, there's no central bank to notice anything weird going on to shut down fraud like if it looked like suddenly you spent your entire life savings on beef jerky.

 So what's stopping Hank from pretending he's me and just sending himself all of my bitcoins are kept pretty safe thanks to cryptography which is why it's considered a cryptocurrency specifically bitcoin stays secure because of keys which are basically chunks of information that can be used to make mathematical guarantees about messages like hey this is really from me. When you create an account on the bitcoin network which you might have heard called a wallet that account is linked to two unique keys a private key and a public key. In this case, the private key can take some data and basically the market. Also known as signing it so that other people can verify those signatures later if they want. So let's say I want to send a message to the network that says Michael sends three bitcoins to Olivia. I sign that message using my private key which only I have access to and nobody else can replicate. Then I send that signed message out to the bitcoin network and everyone can use my public key to make sure my signature checks out. That way everyone keeping track of all the bitcoin trading knows to add my transaction to their copy of the blockchain. In other words, if the public key works that's proof that the message was signed by my private key and is something I wanted to send, unlike a handwritten signature or a credit card number.

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