How Bitcoin Works Education General Dictionary Economics Corporate Finance Roth IRA Stocks Mutual Funds ETFs 401(k) Investing/Trading Investing Essentials Fundamental Analysis Portfolio Management Trading Essentials Technical Analysis Risk Management News Company News Markets News Cryptocurrency News Personal Finance News Economic News Government News Simulator Your Money Personal Finance Wealth Management Budgeting/Saving Banking Credit Cards Home Ownership Retirement Planning Taxes Insurance Reviews & Ratings Best Online Brokers Best Savings Accounts Best Home Warranties Best Credit Cards Best Personal Loans Best Student Loans Best Life Insurance Best Auto Insurance Advisors Your Practice Practice Management Financial Advisor Careers Investopedia 100 Wealth Management Portfolio Construction Financial Planning Academy Popular Courses Investing for Beginners Become a Day Trader Trading for Beginners Technical Analysis Courses by Topic All Courses Trading Courses Investing Courses Financial Professional Courses Submit Table of Contents Expand Table of Contents The Bitcoin Blockchain Bitcoin Mining Keys and Wallets Bitcoin Transactions Bitcoin Security Bitcoin FAQs Cryptocurrency Bitcoin How Bitcoin Works By David Floyd Full Bio David Floyd is a reporter for Coindesk with 5+ years of experience as a freelance financial writer. He is a former staff writer for Investopedia. Learn about our editorial policies Updated May 11, 2022 Reviewed by Julius Mansa Reviewed by Julius Mansa Full Bio Julius Mansa is a CFO consultant, finance and accounting professor, investor, and U.S. Department of State Fulbright research awardee in the field of financial technology. He educates business students on topics in accounting and corporate finance. Outside of academia, Julius is a CFO consultant and financial business partner for companies that need strategic and senior-level advisory services that help grow their companies and become more profitable. Learn about our Financial Review Board Fact checked by Pete Rathburn Fact checked by Pete Rathburn Full Bio Pete Rathburn is a freelance writer, copy editor, and fact-checker with expertise in economics and personal finance. He has spent over 25 years in the field of secondary education, having taught, among other things, the necessity of financial literacy and personal finance to young people as they embark on a life of independence. Learn about our editorial policies Bitcoin is more than a cryptocurrency used as a payment or for investors to hold and hope for value increases. There is an entire ecosystem at work behind a cryptocurrency. There are many of these ecosystems working on the internet today, but because Bitcoin was the first, it's essential to understand what makes it work and how. Bitcoin works through peer-to-peer transfers on the blockchain. The blockchain is the digital network that records all cryptocurrency transactions. Because these transfers are confirmed directly between users, Bitcoin is intended to eliminate the need for central authorities, 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. Key Takeaways A blockchain is a secured distributed ledger, a database disseminated between multiple users who can make changes.Mining is the process of validating transactions, which requires miners who are rewarded in bitcoin.You access your bitcoin using a wallet, a public key, and private keys.Bitcoin users pay small transaction fees in bitcoin to miners for processing the transactions.Bitcoin's weakness is in storage methods. The blockchain has reportedly never been compromised. The Bitcoin Blockchain 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. Blocks When a block on the blockchain is opened, the blockchain creates the block hash, a 256-bit number that encodes the following information: The block version: the Bitcoin client version The previous block's hash: the hash of the block before the current one The coinbase transaction: the first transaction in the block, issuing the bitcoin reward The block height number: how far away numerically the block is from the first block Merkelroot: A 256-bit number that stores the information about all previous blocks Timestamp: the time and date the block was opened The target in bits: the network target The nonce: a randomly-generated 32-bit number 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. Bitcoin 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 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. Keys and Wallets 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 see the money in your checking account. Instead, you use credit and debit cards, which act as tools to access and use your money. You access your bitcoin using a wallet and keys. 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. Wallets 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 bitcoin is 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. However, hot storage is the vulnerability most often exploited. 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. Bitcoin Transactions 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 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. Once 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. Bitcoin Security 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 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. How Does One Make Money From Bitcoin Bitcoin wasn't designed as a means for making money but rather as a payment method accessible by 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. Can Bitcoin Be Converted to Cash You can use some exchanges to convert your bitcoin to cash. There are also some ATMs—called Bitcoin Kiosks—that will allow you to withdraw cash in exchange for bitcoin. Is Bitcoin Worth Investing in 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. Investing in cryptocurrencies and other Initial Coin Offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. Article Sources Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy. BTC.com. "Difficulty." Blockchain.com. "Average Confirmation Time." Choose "7 Day Average". Compare Accounts Advertiser Disclosure × The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. Provider Name Description Part Of Bitcoin Basics What is Bitcoin? How to Mine, Buy, and Use It 1 of 11 How Bitcoin Works 2 of 11 How to Buy Bitcoin 3 of 11 What are the Safest Ways to Store Bitcoin? 4 of 11 How Does Bitcoin Mining Work? 5 of 11 How to Pay with Cryptocurrency 6 of 11 Bitcoin vs. Credit Card Transactions: What's the Difference? 7 of 11 Benefits and Risks of Trading Forex With Bitcoin 8 of 11 Cryptocurrency IRAs: Advantages and Disadvantages 9 of 11 Gold vs. Bitcoin: Which Is Better? 10 of 11 How Much of All Money Is in Bitcoin? 11 of 11 Related Articles Bitcoin Can Crypto Be Hacked? Altcoins How Do You Mine Litecoin (LTC)? Bitcoin Is Bitcoin Mining Profitable? Bitcoin How to Buy Bitcoin Bitcoin How Does Bitcoin Mining Work? Bitcoin How to Pay with Cryptocurrency Partner Links Related Terms What is Bitcoin? How to Mine, Buy, and Use It Bitcoin (BTC) is a digital or virtual currency created in 2009 that uses peer-to-peer technology to facilitate instant payments. more What Is Ethereum and How Does It Work? Ethereum is a blockchain-based software platform with the native coin, ether. Ethereum smart contracts support a variety of distributed apps across the crypto ecosystem. more What Is a Cold Wallet? Cold wallets, a type of crypto wallet, are digital cryptocurrency storage on a platform not connected to the internet, which protects them from hackers. more What Is a Nonce? In blockchain technology, nonce means a number added to a hashed, or encrypted block, that, when rehashed, meets the difficulty level restrictions. Blockchain miners aim to solve the nonce. more 51% Attack: Definition, Who Is At Risk, Example, and Cost A 51% attack is an attack on a blockchain by a group of miners who control more than 50% of the network's mining hash rate, or computing power. more Selfish Mining Definition Selfish mining is a deceitful mining strategy that could allow blockchain attackers to control the outcome of cryptocurrency mining and rewards. more About Us Terms of Use Dictionary Editorial Policy Advertise News Privacy Policy Contact Us Careers California Privacy Notice EU Privacy # A B C D E F G H I J K L M N O P Q R S T U V W X Y Z Cookies Settings, which can also be found in the footer of the site. Cookies Settings Reject All Accept All