Bitcoin and blockchain technology is introducing people to a new world of possibility and a fair amount of confusion. We’ll do our best in this post to look at it conceptually and to try and help you visualize exactly what happens when BTC is sent from one wallet to another.
Bitcoin involves some very unique attributes that make sending and receiving it secure and trustworthy.
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Let’s say that I wanted to send you some BTC.
Before you received anything, our transaction needs to be validated. This validation means it can be added to the blockchain. Before this can happen, our transaction will first be broadcast to the entire Bitcoin network to ensure that a) I have the funds available and b) I have the permissions needed to send them to you.
Here’s how a Bitcoin transaction works and what it might look like.
1 - Blocks
First, our transaction will be grouped with many other transactions into batches called blocks.
2 – Hashes
Every block of unsecured data needs to be secured via a process called mining. It involves taking every transaction in the block and running it through an algorithm which creates a unique identifying signature of 64 letters and numbers called a hash for each transaction.
3 – Combining Hashes
Once a block of transactions have been compressed into hashes, they are compressed further by pairing hashes and creating a new hash for each pair.
Finally the entire block of transactions will be represented by one single hash.
4 – Adding the Previous Hash
Now we have a hash that represents all of the current transactions, along with the hash that represents all the transactions from the previous block.
The “chain” in “blockchain” is formed by matching these two hashes.
If a single byte of data from any previous block were to change, it would invalidate all future blocks because every single hash going forward would change and break the blockchain.
5 – The Nonce
The final piece of the block is a random number called a nonce.
The nonce and the two hashes combined need to create a new hash that meets the criteria established by Bitcoin network. The only way to find a valid hash is by trying random nonce numbers until the hash criteria is met. This is what takes an enormous amount of energy and computing power.
6 – Mining
Bitcoin mining uses an energy intensive (and highly secure) consensus mechanism known as Proof-of-work.
Other cryptocurrencies like Ethereum use different consensus mechanisms. The most notable alternative is Proof-of-stake.
And there you have it. More or less.