I'll explain how Bitcoin works.

How Does Bitcoin Work?

By now you’ve probably heard about Bitcoin and know that it’s not an actual physical coin. But if it’s not a coin, then what is it? How do you “own” one? Why is it worth money? How do you give it away? This short article contains a brief answer to these questions and how Bitcoin works.

How Does Money Work?

Money only has value because we all agree that it has value. Green pieces of paper with images of dead presidents can only be exchanged for food because we agree to exchange them for food. We could exchange anything else we agree has value.

Cash is convenient since it is lightweight and easily exchangeable. But on the island of Yap, money takes the form of gigantic stone coins the size of statues. No one moves them around – they simply agree on who owns them. When something large and important needs to be purchased, the community agrees that ownership of the “Yapcoin” has been exchanged. People on the island know who owns which Yapcoins. In addition to knowing how Bitcoin works, nerdy people might even know the entire history of all the Yapcoins.

Bitcoin: The Yapcoin Of The Internet

Find out how Bitcoin works.

Unlike cash, Bitcoin isn’t a physical form of currency.

Bitcoin works more like Yapcoins than cash. The key difference is that a Bitcoin isn’t a physical object at all. It’s a digital object which doesn’t “exist.” Like on Yap, a Bitcoin is owned by whoever we agree owns it. But unlike on Yap, the Bitcoin’s ownership is recorded in a digital ledger, which is a digital notebook that records Bitcoin exchanges.

On Yap, the history of coin exchanges is stored as knowledge among the community and is distributed. Each family probably knows the history of whichever Yapcoins they own, and maybe whichever ones are also nearby. Like on Yap, the ledger Bitcoin uses is distributed among hundreds or thousands of servers. Copies of the digital ledger exist on several servers throughout the world. You can even download the most recent version if you have enough hard disk space (and patience).

Preventing Dodgy Entries

If you’re an unscrupulous hacker, you might wonder how Bitcoin works and if it’s possible to alter the ledger to give yourself more digital currency. This isn’t possible, in part because each entry in the distributed ledger contains a fingerprint of the entire history which precedes it.

Let’s think about the ledger as a chain of entries that are arranged in order on a line. Each entry contains a special number which serves as its “fingerprint,” along with information about how much money was sent. The crucial point is this: the fingerprint of each entry is computed using the fingerprint of the previous entry as input. Since each entry depends mathematically on the previous entry, any change at any point along the chain will require a change in the fingerprints of all future entries.

If you were diligent, you could download a copy of the ledger and “cook the books” by changing all the required entries in your local copy. But since the distributed ledger is publicly available, your cooked books will be easily detected. No one will agree that your copy of the ledger is correct. It would be like arriving on Yap and claiming that you own a Yapcoin that everyone knows belongs to a local fisherman.

Blockchain is a complicated technology, and there are many details which are not present in this simplified explanation. I hope that I’ve given you enough insight into blockchain for you to understand how Bitcoin works. It’s just a number in a ledger, which has been copied to many, many locations, in order to make it very difficult to “cook the books.”