How Bitcoin Works: A Deep Dive into Decentralized Transactions

When writing this article, Bitcoin's price had surpassed $50,000 per coin. While the financial principles behind Bitcoin remain complex, its technical underpinnings reveal a fascinating decentralized system. This article explores how Bitcoin operates without a central authority.

Understanding Transaction Recording

Imagine an ancient tribe using barter systems. To simplify trade, the chief introduces shells as currency—1 shell equals 1 egg. The chief holds 100 universally recognized shells.

Initial state:

After Trade 1 (5 shells for 5 eggs):

After Trade 2 (2 shells for 1 goose egg):

Alternative recording via transaction chains:

This demonstrates Unspent Transaction Outputs (UTXOs)—funds become spendable only when referenced as inputs in new transactions.

Anatomy of a Bitcoin Transaction

Cryptographic Foundations

• Private Key: Secret number controlling Bitcoin access
• Public Key: Derived from private key, shared publicly
• Address: Base58Check-encoded public key hash (e.g., 1A1zP1eP5QGefi2DMPTfTL5SLmv7DivfNa)

Transaction Scripts

Example transaction locking/unlocking mechanism:

{
 "vin": [{
   "txid":"7957a35...f6f18",
   "scriptSig": "<signature> <pubkey>" 
 }],
 "vout": [{
   "value": 0.015,
   "scriptPubKey": "OP_DUP OP_HASH160 ab680255...54e7 OP_EQUALVERIFY OP_CHECKSIG"
 }]
}

P2PKH (Pay-to-Public-Key-Hash) workflow:

1. Sender creates output locked to recipient's public key hash
2. Recipient unlocks with signature + public key

3. Network verifies:

   • Public key hashes match
   • Signature validates transaction authenticity

Blockchain Architecture

Simplified block structure:

+---------------------+
| Block Header        |
| - Version           |
| - Previous Hash     |
| - Merkle Root       |
| - Timestamp         |
| - Difficulty Target |
| - Nonce             |
+---------------------+
| Transactions        |
| - TX 1              |
| - TX 2              |
| - ...               |
+---------------------+

Key components:

• Merkle Tree: Efficient transaction verification via cryptographic hashing

• Proof-of-Work: Miners compete to find Nonce values satisfying:

  SHA256(SHA256(block_header)) < target_difficulty

• Block Reward: Currently 6.25 BTC per block (halving every 210,000 blocks)

Bitcoin Network Operations

1. Transaction broadcast to all nodes
2. Miners collect transactions into candidate blocks
3. Mining competition to find valid Nonce
4. Successful miner broadcasts new block

5. Nodes verify:

   • Valid transactions
   • No double-spending
6. Chain extension continues with next block

👉 Discover how Bitcoin mining works in depth

Frequently Asked Questions

How secure is Bitcoin against attacks?

Bitcoin's security relies on cryptographic proof rather than trust. The network's decentralized nature and proof-of-work mechanism make attacks economically impractical—an attacker would need over 51% of the total network hash power.

What happens when all 21 million Bitcoin are mined?

After the final Bitcoin is mined around 2140, miners will earn income solely from transaction fees. The fixed supply is programmed into Bitcoin's protocol to ensure scarcity.

How are lost Bitcoins handled?

Lost Bitcoins (from forgotten private keys) effectively reduce circulating supply. The network continues operating normally, as the protocol doesn't distinguish between "lost" and "unspent" coins.

👉 Learn about Bitcoin wallet security best practices

Advanced Concepts

Simplified Payment Verification (SPV)

Lightweight clients can verify payments without storing the full blockchain by:

1. Downloading block headers (80 bytes each)
2. Receiving Merkle branches for specific transactions
3. Verifying transaction inclusion in blocks
4. Checking confirmation depth

Disk Space Reclamation

Old transactions can be pruned once:

• Their outputs are fully spent
• Sufficient confirmations exist (typically 100+ blocks)
  This reduces storage requirements while maintaining security.

Conclusion

Bitcoin's decentralized architecture combines cryptography, game theory, and distributed systems to create a revolutionary payment network. As the protocol continues evolving, its core innovation—enabling trustless transactions through mathematical proof—remains unchanged.

Note: All technical descriptions reflect Bitcoin's operation as of 2025. Protocol upgrades may introduce changes over time.