Bitcoin Protocol & How it Works.

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What is Bitcoin?

Bitcoin is a digital currency first created in 2009 by the mysterious Satoshi Nakamoto. Now, for better understanding, we’ll take into consideration the relation of Physical Money and Plastic Money. There are currency notes and coins out in the market and to digitize physical currency, plastic money was brought into picture. Even though you have a credit card, there’s still physical money being minted and circulated. But on the contrary, there are no physical bitcoins and only a digital version of them exists in the industry. A balance is then kept on an online distributed ledger which is popularly and excitingly known as Blockchain. Blockchain came into existence because of the invention of Bitcoin it was the first time when its applicability asked some serious questions! Bitcoins aren’t issued by any Government or Banking Institution nor they are valuable as an individual commodity. It promises to lower the transaction costs and has a secure tamper proof way of carrying them out. They aren’t operated by any Centralized Authority like banks are, and use a decentralized Peer-to-Peer Network instead. This takes care of the most commonly faced problem of One Point Failure. Even though Bitcoin isn’t legal tender, it is very popular among investors and developers alike! Bitcoin’s invention provided an inspiration for the inventions of various other Cryptocurrencies like Peercoin and Litecoin etc. which are alternatively known as AltCoins.

Bitcoin Transactions

                                                                          

We will now proceed to learn how bitcoin transactions take place and how they particularly look.

A Bitcoin transaction essentially contains the following information:

  • ID: Unique transaction ID which is the SHA256 double-hash of the transaction data.
  • Input: The bitcoin addresses that identify the sources of the bitcoins to be transferred. These are usually a previous transaction’s output and are used to verify the sender and check the available balance.
  • Amount: The number of bitcoins to be transferred.
  • Output: The receiver’s bitcoin address. In cases where there is leftover bitcoin change, the output should also include an entry for the sender’s address to send it back, to be collected as “Transaction Fee” or to be sent to another receiver.

Output from one transaction is used as an input for another transaction. This creates a chain of ownership as the bitcoin value is moved from address to address.

Transaction Validation

All digital cash transactions also need to be checked and verified for authenticity, duplicity, and cash availability. The validation of the transactions is not centralized and all participating nodes are authorized for it.

As we already know, Bitcoin uses Decentralized way of carrying out and recording transactions, their validation also is carried out in a decentralized way. All participating nodes are required to authorize a transaction. All Bitcoin wallets have a Bitcoin Address and a pair of Public and Private keys. To verify the transaction, transactions are signed digitally by using the sender’s private key and is validated by his public key that is available with all the nodes.

Bitcoin Protocol

The Bitcoin Protocol works in the following way when it comes to monitoring transactions:

  • A new transaction is broadcast to all participating nodes in the network.
  • Each node collects new transactions into a block.
  • Each node tries to validate the new transaction and all previous ones by finding a solution to the Proof of Work for the block.
  • The node which finds the solution broadcasts the solved block to the network.
  • Nodes validate the transactions in the block and accept the block.
  • Nodes start working on the next block. A hash of the last accepted block is created and used as a reference in the next block.

Conclusion

Bitcoin Protocol ensures that the set of rules and standards are followed thoroughly to provide better, safer, faster transactions. It also ensures that the identities of Miners, Investors and Individuals are kept intact and uncompromised. 

Reference- Dzone.

-Devansh Sharma.

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