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How does Bitcoin Work?

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Bitcoin functions as a digital currency, by following the same three rules that
traditional, or fiat currencies follow.
1. They need to be difficult to produce (cash) or find (gold or other precious
metals)
2. They need have a limited supply
3. They need to be recognized by other humans as having value
When we examine Bitcoin, it ticks the boxes of all three of these characteristics:
1. Bitcoin uses complex computer algorithms in its production which take a lot
of computational power and proof-of-work, so it cannot be replicated easily
or at a discount
2. There are a finite supply of Bitcoins – 21 Million to be exact. As of 2015,
roughly 2/3 of this number had been mined
3. There are hundreds of Bitcoin exchanges and Bitcoin is accepted as payment
everywhere from Subway to OKCupid
Bitcoin miners have incentive to mine as they receive Bitcoin as a reward for
their computer’s endeavors. Bitcoin was designed to be a deflationary currency,
so unlike fiat currencies, the supply of money is fixed. This, combined with the
decentralization principle ensure that no single person or government can simply
create additional coins once the supply is mined. Once all the coins are mined,
the value of the currency will in theory, continue to rise.
Bitcoin transactions are recorded on a digital ledger (or record) known as the
blockchain. The core concept that upholds Bitcoin’s usefulness is
decentralization. With decentralization, the blockchain is not owned by one
single person or entity. In fact, everyone has access to it. Therefore transactions
are publicly broadcasted across the network, which ensures that both parties
have upheld their end of the agreement. The code is open source (like Linux or
Android Operating Systems) so anyone can view it, this ensures transparency
among all parties.

Decentralization allows the blockchain to be secured by multiple points of entry
and backed up by multiple points of failure. This is turn prevents incidents like
hacking or theft. For example, if someone offers you 1 Bitcoin, you can check
the blockchain records to make sure that Bitcoin is valid and hasn’t already been
spent. This system means we do not need third parties to validate the
transactions. The only transactions costs come from the electricity or mining
power needed to run the blockchain itself.
This has tremendous real world application, from allowing cheaper international
payments (since Bitcoin has no nationality) to lowering the overall price of
certain goods.

 

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