How Does Bitcoin Work?

How Does Bitcoin Solve the Double-Spending Problem?

Before Bitcoin, people more or less exclusively relied on trusted third parties such as banks, credit card companies, and payment companies to facilitate online transactions. These intermediaries have traditionally played a key role in transactions, whether you’re making a payment to a store or establishment, or sending money between people. Without these intermediary entities — usually centralized, for-profit companies — it was almost impossible to transact digitally.

Transacting over centralized intermediary networks can result in a highly controlled and hampered economic marketplace. The unavoidable involvement of intermediaries in online transactions has empowered them in sometimes undesirable ways. For example, financial institutions have the ability to limit how and when you spend your money. Further, billions of people around the world have historically been excluded from the online economy entirely.

From an operational perspective, the main hurdle that such intermediaries have historically served to help overcome has been determining whether the person initiating a transaction had the money to spend and, importantly, wasn’t attempting to spend their money twice. Without a bank keeping track of a person’s money, what was to stop them from copying their money and spending it twice? Amongst technologists, this is referred to as the double-spending problem. Bitcoin’s 2009 launch marked a turning point in regards to solving this conundrum.

Bitcoin’s inventor, the pseudonymous Satoshi Nakamoto, designed it as a decentralized digital currency where intermediaries were not required in order for two parties to transact value. Nakamoto achieved this feat by designing a distributed ledger (secured by cryptography) that solved the double-spending problem through reliance on a peer-to-peer (P2P) network instead of a trusted third party.

The Bitcoin Blockchain Explained

At the core of Bitcoin tech is its blockchain, a distributed ledger that records transactions and tracks ownership. The blockchain is made up of blocks of transactions that have been chronologically ordered and confirmed, and copies of the blockchain are held by computers across the Bitcoin network. The blockchain is maintained by powerful, specialized computers called miners, who compete with each other to validate and add new blocks of transactions to the chain. Together, these miners contribute to ensuring that the Bitcoin blockchain is decentralized. Because of the way the blockchain is structured, miners work to process and confirm transactions without the need for any third party to provide custody, clearing, or auditing of the process.

A Bitcoin Transaction Examined: How Does BTC Work?

Let’s imagine that you, Alice, wish to send a transaction to your friend, Bob. Here’s what that would look like:

First, you would install a Bitcoin wallet on your computer or smartphone. A wallet is a program that allows you to interact with the blockchain and transact cryptocurrencies and other digital assets like non-fungible tokens (NFTs). Your wallet generates your public and private blockchain addresses — long strings of numbers and letters that employ what is known as a public and private key. Your public address serves as your identity in the Bitcoin network. You would need to know Bob’s public address to be able to send him bitcoin (BTC). Your private address is akin to a password — it allows you to move funds in and out of your wallet. It should always be kept private.

The process of transacting itself is quite simple. To initiate a transaction to Bob, you find the “send” tab or button in your wallet and enter his address, along with the amount of BTC you would like to send. Transactions almost always require a transaction fee to be paid to the network, and on Bitcoin, that amount was initially free or very cheap. The bitcoin transaction fee tends to ebb and flow with network demand; it has exceeded USD 60 on rare occasions. In 2022, these fees tend to average around USD 2–3 per transaction.

Bitcoin Transaction Process

After sending your BTC, the transaction is announced to the broader network. The network then must confirm that you held enough BTC in your wallet to complete the transfer to Bob, and that you hadn’t yet transferred that bitcoin to anyone else. This verification procedure is carried out through a competitive, computationally intensive process that miners carry out for each block of transactions. After completing this due diligence, the winning miner packages valid transactions into a block and broadcasts their block to the network. The rest of the network accepts the block if its transactions are valid, and then the block is linked to previous blocks of transactions, therefore updating the ledger. Because transactions are linked in this way, they are functionally impossible to reverse or edit. Only after all this takes place will Bob receive his bitcoin. From start to finish, the average Bitcoin network transaction time is about ten minutes.

For their effort, the winning miner receives both a block reward (a certain amount of new bitcoin determined by the rules of the Bitcoin software) and the transaction fees included with the transactions in their block. So, that’s how the bitcoin transaction process facilitates person-to-person payments without an intermediary. It relies on a decentralized network of computers who validate transactions and secure the network by using cryptography. For Bitcoin users, however, the process is as simple as a few clicks and a few minutes spent waiting for transaction confirmation to occur.