bitcoin has gained much popularity over the decade; but there are still people who dont understand what it is and how it works; this article intends to be an introductory text which hopefully makes it easier to answer these questions;

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what is bitcoin

bitcoin is a decentralized crypto-currency; bitcoin is a completely digital money maintained and transacted on a peer-to-peer network without a central authority;

from a user perspective, bitcoin is like digital cash;

how bitcoin works

before we describe relevant technology, we recommend downloading bitcoin core, the reference implementation of bitcoin, and keeping its source code at hand for reference; we also recommend reading the original bitcoin paper;

core data structures

bitcoin uses the blockchain technology; the core data structures are:

  • a blockchain is a chain of blocks;

    • a block contains a block header and a list of transactions;

      • a block header (doc, source) is a 80-byte structure containing these fields:

        • block version number;

        • hash of the previous block header;

        • hash of the merkle root of transactions (aka: txs) included in this block;

        • timestamp;

        • proof-of-work requirement (nbits);

        • nonce;

        this is block header class in the bitcoin core implementation:

        class CBlockHeader
            // header
            int32_t nVersion;
            uint256 hashPrevBlock;
            uint256 hashMerkleRoot;
            uint32_t nTime;
            uint32_t nBits;
            uint32_t nNonce;
      • a transaction contains a list of inputs and a list of outputs;

a graph may make it easier to visualize the blockchain:


bitcoin protocol: a node perspective

in this section, we analyze bitcoin protocol as an individual node in the bitcoin network;

with the data structures in mind, the job of a bitcoin node is easy to explain:

  • create a valid block meeting proof-of-work requirement;

  • broadcast the block to the full network;

  • hope the block is accepted by other nodes as the next block in the main chain;

easy, but still some questions with this explanation:

  • what is proof-of-work requirement?

  • what is main chain?


  • proof-of-work requirement is a target threshold for a block header hash; specifically, a block header hash must be less than or equal to its target threshold; the target threshold is encoded as a block header field nbits;

    the point of using a proof-of-work is to ensure generation of a new block takes a reasonable amount of time;

  • main chain is the longest chain among all well-formed block chains;

    the point of using a main chain is to have a public ledger recording all past transactions, so that every cash flow and every account balance are publicly available and verifiable;

bitcoin protocol: a user perspective

in this section, we analyze bitcoin protocol as a user;

as a digital currency, bitcoin must solve some basic problems about its usage:

  • how to issue new bitcoins?

  • how to pay with bitcoins?

  • how to store bitcoins safely?

how to issue new bitcoins

new bitcoins are issued via a process called mining, and the person called a miner; recall from above: mining is about creating a valid block meeting proof-of-work requirement; in fact, the proof-of-work requirement is adjusted by the network; thus a miner cant freely change it; instead, a miner has these freedoms over the block it generates:

  • determine the previous block;

    this is usually the current head of the main chain; but if a miner wishes, it can branch off an earlier block; however, this would require more computation because it has to generate more blocks to catch up;

  • determine which transactions to include in this block;

    this will change hash of the merkle root of transactions;

  • determine the block timestamp;

    the freedom on block timestamp is limited by a range;

  • determine nonce;

    this is the value on which a miner has the most freedom; including this value has no purpose other than rolling a different block header hash; the mining work is largely about trying different nonces until one works (which means the block header hash satisfies proof-of-work requirement);

a miner earns two types of rewards on a successful mining:

  • a block subsidy, whose amount varies over time;

    originally block subsidies are paid at 50 btc/blk, but halving every 210,000 blocks; a geometric series calculates the upper limit of all bitcoins as:

    210000 * 50 + 210000 * 50 / 2 + 210000 * 50 / 4 + ... = 21000000

    so there will ever be at most 21 million bitcoins;

  • transaction fees;

    each transaction may have one or more inputs and outputs, the sum of which dont have to be the same; for each transaction included in this block, the difference between its outputs and inputs, termed transaction fee, becomes the income of the miner; this is to reward the miner for its hard work in making this transaction possible;


    in fact, many miners are self-interested and will priorize including transactions with higher fees; this is an incentive by design;

the block subsidy and transaction fees are collected via a special coinbase transaction , which is always the first transaction in a block; every block must have a coinbase transaction (ref);

how to pay with bitcoins

paying with bitcoins is about making a transaction and finding a miner to incorporate your transaction into the main chain;

to send or receive bitcoins, you need one or more bitcoin addresses; think these addresses like bitcoin accounts;

recall from above: a transaction contains a list of inputs and a list of outputs;

  • an input has 3 fields:

    • an outpoint, which references a previous output (which transaction and which output in that transaction);

      basically, this tells you where the money comes from;

    • a signature script, which satisfies the pubkey script in the referenced output;

      basically, this is the key to unlock the money;

    • a sequence number, which is currently not being used;

  • an output has 2 fields:

    • a value field, which indicates how much money to send to this output;

    • a pubkey script, which indicates what conditions must be fulfilled for those money to be actually sent;

      basically, this is the lock on the money;

each bitcoin address is identified and protected by a pubkey script; to spend money stored in this bitcoin address, one must provide a signature script to satisfy this pubkey script (ie: unlock the money); this is similar to public key cryptography; and if thinking with scripts sounds too complicated, you may view pubkey script as public key, and signature script as secret key;

in real life, you dont have to deal with scripts or keys; you only need bitcoin addresses, and a bitcoin wallet can help you manage those addresses and do transactions;

how to store bitcoins safely

bitcoin uses the elliptic curve digital signature algorithm (ecdsa) with the secp256k1 curve; secp256k1 private keys are 256 bits of random data; to store bitcoins safely, dont disclose your signature script to others; practically, it is impossible to spend the money without a valid signature script;

when you decide to spend the money, list the address (more precisely, the outputs in transactions where this address received its money) with its signature script as an input in a transaction; if there is any change, deposit to another bitcoin address; bitcoin requires each output of a particular transaction can only be used as an input once in the block chain;

bitcoin protocol: a system perspective

in this section, we analyze bitcoin protocol as an overall system;

the bitcoin system is designed for electronic transactions without central authority; ownership of money is protected by digital signatures; double spending is prevented by running a consensus protocol across the p2p network to maintain a longest block chain as a public ledger recording all transactions; the chaining of blocks makes adversary work harder; nodes express their acceptance of valid blocks by extending them and rejection of invalid blocks by not extending them; nodes vote with their computing power so that it is impossible to disrupt the network if honest nodes control a majority of computing power (and thus control the longest block chain);


because a block can branch off any other block on the blockchain, the blockchain sometimes grows into one or more side branches; this is called forking;


because different miners may produce new blocks at roughly the same time, forkings happen occasionally; this is absolutely normal; usually, forks are short-term; as mining continues, with a few more blocks, one of the branches will excel and become the main chain and others will die natually; sometimes, several branches grow at similar speed and may produce long-term forks;

due to the existence of forks, a transaction confirmed on the main chain by 1-2 more blocks are not considered safe; there is a risk that a side branch may later grow longer and supersede the current main chain; this will render the current main chain stale, forfeiting all transactions on it; the current recommendation is to wait for 6 confirmations before assuring the transaction has been fully checked in;

consensus rule changes

forks happen occasionally when all nodes are running under the same consensus rules; when the consensus rules are changed, however, nodes may be upgraded at different times; for a period of time, non-upgraded nodes will follow old rules and upgraded nodes will follow new rules; then a fork will almost always happen;

depending on whether new rules are looser or tighter than old rules, 2 types of forks can happen:

  • a soft fork happens when rules become tighter; this means, a block may be rejected by upgraded nodes but accepted by non-upgraded nodes; this means, upgraded nodes accept a subset of blocks accepted by non-upgraded nodes;


    this is called soft fork because the diverge is temporary: as more and more nodes are upgraded, the hash rate of upgraded nodes will finally outgrow non-upgraded nodes; this means upgraded nodes grow their main chain faster than non-upgraded nodes; because all blocks accepted by upgraded nodes are also accepted by non-upgraded nodes, the upgraded main chain will finally grow longer than non-upgraded main chain, and also become non-upgraded main chain;

  • a hard fork happens when rules become looser; this means, a block may be rejected by non-upgraded nodes but accepted by upgraded nodes; this means, upgraded nodes accept a superset of blocks accepted by non-upgraded nodes;


    this is called hard fork because the diverge is permanent (unless all nodes are upgraded); as more and more nodes are upgraded, upgraded main chain will grow faster than non-upgraded main chain; but non-upgraded nodes will not accept blocks which only qualify the new rules and thus will not accept the upgraded main chain as their main chain; this creates a permanent diverge;

    the most famous hard fork happened in mid-2017 which created a fork of bitcoin itself, named bitcoin cash;


who designed bitcoin? satoshi nakamoto!

who is satoshi nakamoto? sorry, i dont know…