How Bitcoin Works

Bitcoin is more than a cryptocurrency used for payments or as an investment. There is an entire ecosystem at work behind a cryptocurrency. In fact, many such ecosystems are at work on the internet today, but because Bitcoin was the first, it's useful to understand how it functions.

So how does Bitcoin work? Bitcoin is a decentralized digital currency that operates without a financial system or government authorities. It utilizes peer-to-peer transfers on a digital network that records all cryptocurrency transactions. This network is powered by a blockchain, an open-source code that chains transaction histories to prevent manipulation.

Because these transfers are confirmed directly between users and are located on a shared public ledger, Bitcoin eliminates the need for central facilitators, like governments and banks, to verify currency transactions.

Learn what's going on behind the scenes in the Bitcoin network to help you further your understanding of this digital phenomenon and how it influences the world's finances.

The Bitcoin blockchain is a database of transactions secured by encryption and validated by peers. Here's how it works. The blockchain is not stored in one place; it is distributed across multiple computers and systems within the network. These systems are called nodes. Every node has a copy of the blockchain, and every copy is updated whenever there is a validated change to the blockchain.

The blockchain consists of blocks, which store data about transactions, previous blocks, addresses, and the code that executes the transactions and runs the blockchain. So, to understand the blockchain, it's important first to understand blocks.

When a block on the blockchain is opened, the blockchain creates the block hash, a 256-bit number that encodes the following information:

Queued transactions are entered into the block, the block is closed, and the blockchain creates the hash. Each block contains information from the previous blocks, so the blockchain cannot be altered because each block is "chained" to the one before it. Blocks are validated and opened by a process called mining.

Mining is the process of validating transactions and creating a new block on the blockchain. Mining is conducted by software applications that run on computers or machines designed specifically for mining called Application Specific Integrated Circuits.

The hash is the focus of the mining programs and machines. They are working to generate a number that matches the block hash. The programs randomly generate a hash and try to match the block hash, using the nonce as the variable number, increasing it every time a guess is made. The number of hashes a miner can produce per second is its hash rate.

Mining programs across the network generate hashes. The miners compete to see which one will solve the hash first—the one that does receives the bitcoin reward, a new block is created, and the process repeats for the next group of transactions.

Bitcoin's protocol will require a longer string of zeroes depending on the number of miners, adjusting the difficulty to hit a rate of one new block every 10 minutes. The difficulty—or the average number of tries it takes to verify the hash—has been increasing since Bitcoin was introduced, reaching tens of trillions of average attempts to solve the hash. As this suggests, it has become significantly more difficult to mine Bitcoin since the cryptocurrency launched.

Mining is intensive, requiring big, expensive rigs and a lot of electricity to power them. And it's competitive. There's no telling what nonce will work, so the goal is to plow through them as quickly as possible with as many machines working on the hash as possible to get the reward. This is why mining farms and mining pools were created.

Halving is an important concept in Bitcoin mining. At first, the mining reward was 50 BTC for solving the hash. About every four years, or 210,000 blocks, the reward is cut in half. So rewards were cut to 25 in 2012, 12.5 in 2016, and 6.25 in 2020. The next halving is expected to occur in 2024, when the reward will reduce to 3.125, followed by a reduction to 1.5625 around 2028.

The last bitcoin is expected to be mined somewhere around 2140. All 21 million bitcoins will have been mined at that time, and miners will depend solely on fees to maintain the network.

A common question from those new to Bitcoin is, "I've purchased a bitcoin, now where is it?" The easiest way to understand this is to think about the Bitcoin blockchain as a community bank that stores everyone's funds. You view your balance using a wallet, which is like your bank's mobile application.

If you're like many people today, you don't use cash very often and never physically see the money in your checking account. Instead, you use credit and debit cards with security numbers, which act as tools to access and use your money. You access your bitcoin using a wallet and keys.

A bitcoin, at its core, is data with ownership assigned. Data ownership is transferred when transactions are made, much like using your debit card to transfer money to an online retailer. You use your wallet, the mobile application, to send or receive bitcoin.

When bitcoin is assigned to an owner via a transaction on the blockchain, that owner receives a number, their private key. Your wallet has a public address—called your public key—that is used when someone sends you a bitcoin, similar to the way they enter your email address in an email.

You can think of the public and private keys like a username (public key) and password (private key) used to access your funds.

A wallet is a software application used to view your balance and send or receive bitcoin. The wallet interfaces with the blockchain network and locates your bitcoin for you. The blockchain is a ledger with portions of bitcoin stored on it. Because bitcoins are data inputs and outputs, they are scattered all over the blockchain in pieces because they have been used in previous transactions. Your wallet application finds them all, totals the amount, and displays it.

There are two types of wallets, custodial and noncustodial. A custodial wallet is one where a trusted entity, like an exchange, holds your keys for you. For example, when you sign up for a Coinbase exchange account, you can elect to have them store your keys for you as custodians.

Noncustodial wallets are wallets where the user takes responsibility for securing the keys, such as in your wallet application on your mobile phone. Storing keys in an application connected to the internet is referred to as hot storage. Hot storage is the vulnerability most often exploited by hackers and thieves.

You should always use a reputable wallet provider, like from a registered cryptocurrency exchange. Read reviews and research wallets to ensure you're choosing one that is reliable.

To remedy this, the cryptocurrency community has developed methods for storing your keys offline. Most commonly, you'll hear about hot storage, cold storage, and deep cold storage. Hot storage is any wallet that stores your keys and has an active connection to the internet; this is the most vulnerable method. An example of a hot wallet is the wallet application on your mobile device.

Cold storage is any method that is not connected to the internet. This could be a removable USB drive or a piece of paper with your keys written on it (this is called a paper wallet). Deep cold storage is any cold storage method that is secured somewhere that requires additional steps to access the keys beyond removing the USB drive from your desk drawer and plugging it in. Examples might be a personal safe or storage deposit box—anything that takes extra effort to retrieve your keys.

A bitcoin transaction happens when you send or receive a bitcoin. To send a coin, you enter the receiver's address in your wallet application, enter your private key, and agree to the transaction fee. Then, press whichever button corresponds to "send." The receiver must wait for the transaction to be verified by the mining network, which can take up to 30 minutes (occasionally several hours) because transactions wait in a mining queue called the mempool.

(Minutes, 7-day average)

The mempool is where transactions waiting to be verified go. The network, on average, confirms a block of transactions about every ten minutes, but not all new transactions go into the new block that is created. This is because blocks only hold a certain amount of information, and each transaction comes with a mining fee.

Transactions must meet the minimum transaction fee threshold to be processed, and the transactions with the highest fees are processed first. This is why you may hear about the problem of rising fees. Bitcoin is so popular that demand for transactions has increased, allowing (or requiring) miners to charge higher fees.

Transaction fees were established to create an incentive for people to become network nodes and miners. Bitcoin mining is also expensive, so fees help to offset the cost of equipment and electricity used.

Once the fee is met, the transaction is transferred to a block, where it is processed. Then, the transaction information within the block is validated by miners, the block is closed, and all receivers collect their bitcoin. Both wallets display their appropriate balances, and the next transactions are processed.

There are many parts that make up the Bitcoin blockchain and network, but it is not necessary to understand it all to use this new currency technology. You only need to know that you use a wallet to send, receive, and store your Bitcoin keys; you also should use a cold storage method for security because non-custodial wallets can be hacked.

Custodial wallets can also be hacked, but many who offer this service take measures to reduce the chances that hackers can get into the storage systems. Most are turning to the enterprise-level cold storage techniques businesses use to store essential data for extended timeframes.

For good reason, many people are concerned about Bitcoin's level of security, especially since it involves exchanging money for encrypted data ownership. However, it's important to note that the Bitcoin blockchain has never been hacked because of the community consensus mechanisms used.

Wallets are the weak spot, so if you're looking to get involved in Bitcoin, it's essential to understand how to utilize cold storage methods and keep your keys out of your hot wallet.

Bitcoin wasn't designed to make money but as a payment method accessible to everyone. However, some people use it as an investment. This is very risky and should only be done after talking to a professional financial advisor about your financial circumstances.

You can use some exchanges to convert your bitcoin to cash. Some ATMs—called Bitcoin Kiosks—will allow you to withdraw cash in exchange for bitcoin.

Bitcoin's price is very volatile, which means it rises and falls very often, sometimes in large dollar increments. You can generate significant returns investing in Bitcoin, but you can also quickly lose substantial money. It's best to speak to a professional investment or financial advisor about your financial circumstances before investing in Bitcoin.

Bitcoin is a payment that uses virtual currency instead of fiat or physical currency. It uses a blockchain to secure transaction information out of the reach of centralized third parties who traditionally facilitate and regulate transactions.

The comments, opinions, and analyses expressed on Investopedia are for informational purposes online. Read our warranty and liability disclaimer for more info. As of the date this article was written, the author does not own bitcoin.

Microsoft partners with Aptos blockchain to marry AI and web3

Artificial intelligence has captured the hearts, minds and wallets of the technology industry. So it’s little surprise that Microsoft, which has several irons in the AI fire, is working to expand its footprint in the area. On Wednesday, the company announced that it is partnering with layer-1 blockchain Aptos Labs to work on AI and web3.

“The primary focus for both of us is solving our respective industries problems,” Mo Shaikh, co-founder and CEO of Aptos Labs, told TechCrunch+.

The collaboration allows Microsoft’s AI models to be trained using Aptos’ verified blockchain information, Shaikh explained. Aptos will also run validator nodes for its blockchain on Microsoft’s Azure cloud, which it anticipates will bring greater reliability and security to its service.

Microsoft is also looking to the future. “We predict that AI will be infused into web3 solutions at greater scale in the coming months and years,” Daniel An, global director of business development for AI and web3 at Microsoft, said in an email to TechCrunch+.

There’s little doubt that AI is having a massive impact on society. “We can become incredibly efficient in using these tools every day in our lives,” Shaikh said. “Whether it’s searching and putting together an index of the best restaurants in your neighborhood or helping you write code for your job or research.”

For technologist’s AI aspirations to come true, there is a growing need for transparency, trust and verification of AI-generated content, An said. “For example, how do we know that LLM-generated outputs are authentic [and] trustworthy? How do we know that the training data is bias free in the first place? Blockchain-based solutions can help with verifying, time-stamping and attributing content to its source, thereby improving credibility in a distributed digital economy.”

An compares large language models to content creators “on steroids” and blockchains as “a yardstick for transparency and trust.” To help people become more comfortable with AI — and LLMs more specifically — companies have to make sure users trust how the technology works. “The openness and immutability of blockchain can improve the trust that people place in AI-generated content and provide confidence that they’re making the right decisions.”

AI needs to evolve responsibly, and web3 could help it earn the required credibility, Shaikh said. “Everything we capture onchain is verified and that verification can [help] train these models in a way that you’re relying on credible information.”

Microsoft’s interest is in having credible information to train models in a way that’s verifiable, which is where Aptos can fit in, Shaikh said. “In order to do that you need an incredibly performant blockchain with high throughput.”

The throughput of Aptos’ blockchain can support up to 160,000 transactions per second and has a goal of reaching the ability to handle “hundreds of thousands by the end of the year,” Shaikh said. It also ranks as one of the fastest blockchain networks, alongside Avalanche, with a time-to-finality of less than one second, according to Messari research.

With fast throughput, quick settlement times and a cost to use at a fraction of a cent, Aptos’ blockchain may have all three things needed to make it attractive to Big Tech companies interested in building AI-related products and services — like Microsoft.

Helping mature tech companies use web3 tech to delve deeper into AI may assist those companies getting deeper into the blockchain realm. A major impediment to onboarding more developers into web3 today is how hard it is to write safe and secure smart contracts because it’s not super intuitive, An said.

“If you want to come and write a smart contract or development application, it’s difficult to do that today,” Shaikh said. But applications like the GitHub Copilot integration, which supports blockchain-based contract development, and Aptos Assistant, an AI chatbot that aims to bridge Web 2.0 and web3, could help non-web3-native companies access smart contracts and other decentralized tech.

Why You Should Care About Litecoin: It's the Backbone of Dogecoin

Some industry veterans may dismiss Litecoin as a “ghost chain” – a network where cutting-edge technological development has all but disappeared. But here’s why today’s degenerate crypto traders might actually care about what happens to the network: The Litecoin blockchain provides security to Dogecoin, one of the best-known and most valuable blockchain projects.

Created as a joke in 2014 by software engineers Billy Markus and Jackson Palmer, Dogecoin has gotten added attention from Tesla CEO Elon Musk, who regularly posts about it to his 150 million followers on his X social-media platform, formerly known as Twitter. The blockchain's DOGE cryptocurrency is inextricably linked to the adorable image of its mascot, the Shiba inu dog breed.

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What’s no joke is that DOGE, one of the industry’s quintessential “meme coins,” has a market capitalization of nearly $11 billion, making it the eighth largest cryptocurrency ahead of Litecoin’s own $7 billion.

It’s no secret that Litecoin provides security to Dogecoin; CoinDesk wrote about it in 2014.

But the fact bears repeating now, with Litecoin making headlines Wednesday about its highly anticipated quadrennial blockchain “halving."

Litecoin founder Charlie Lee, a computer scientist trained at the prestigious Massachusetts Institute of Technology (MIT), created the network in 2011 by cloning Bitcoin’s code, which was the original blockchain, launched two years earlier by inventor Satoshi Nakamoto.

A couple of years after Litecoin’s debut, two software engineers, Billy Markus and Jackson Palmer, created Dogecoin by allegedly cloning Luckycoin – itself a clone of Litecoin.

But there were some deficiencies in Dogecoin’s issuance model – the mechanics of its money supply – partly because it strayed from Bitcoin’s original parameters.

All three blockchains rely on a “proof-of-work” system that recruits “miners” to process transactions and secure the network in exchange for a form of compensation called a “block reward.” For Bitcoin and Litecoin, the reward is a combination of variable transaction fees and a predetermined “subsidy” that gets halved approximately every four years – a carefully chosen, marathon-like pace of issuance. (This is what happened Wednesday on Litecoin.)

Dogecoin’s halving schedule (and subsequent rate of issuance) before 2015, in stark contrast to that of its progenitors, was akin to a 100-meter dash. Blocks were generating every minute and rewards were getting halved every 69 days, resulting in block subsidies that rapidly depleted the network’s fixed supply of 100 billion DOGE.

“Because of that, the network security of Dogecoin went down really quickly,” Lee said.

Without a subsidy, and with transaction fees too low to incentivize miners to stick around and secure the chain, the lighthearted dog-themed project would face a high probability of attack and subsequent implosion.

“Dogecoin was built to die quickly – none of us expected it to grow into the absurd entity it is today,” wrote Josh Mohland on the popular community site Reddit, in 2014. Mohland created the now defunct DOGE tipping service, Dogetipbot.

The situation became so dire that by 2014, Dogecoin had to hard fork – make a permanent change to its blockchain – to allow “merged mining” or auxiliary proof-of-work (AuxPoW) with Litecoin. It was essentially a method for miners to provide security to both blockchains simultaneously.

“There's absolutely an easy way to save the coin from its certain death (and by death, I mean 51% attacked for the lulz),” Mohland continued. “And that's AuxPoW."

Merged mining is when miners simultaneously secure two or more networks, receiving rewards from both without a deterioration in performance. The reason it’s called auxiliary proof-of-work is because the process involves a less secure auxiliary blockchain borrowing security from a parent network with stronger security. In this scenario, Lee suggested that Litecoin could provide much-needed security to the embattled Dogecoin network.

“That was one of the main reasons why they needed to switch on merged mining with Litecoin,” Lee said. “And also one of the reasons why I stuck with Bitcoin’s halving schedule.”

“So that the Dogecoin network wouldn't be easily attacked,” he explained.

Dogecoin still generates blocks every minute or so, but nowadays, there are no more halvings and the 100 billion DOGE cap has been removed to allow for a 10,000 DOGE reward per block, indefinitely.