What is Bitcoin? How it works, in plain words

Bitcoin is a form of digital money that no bank or government issues or runs. Instead of balances held at a bank, there is one public ledger, the blockchain, that thousands of computers around the world keep copies of and check against each other. New bitcoin is created on a fixed schedule, and there will never be more than 21 million of them.

In short

• Bitcoin is a network and a currency at once: the network moves the money, and new money pays the people who secure the network.
• Anyone can read the whole history of transactions. Owning bitcoin means holding the key that can spend it.
• The supply is capped at 21 million, released on a schedule that halves about every four years.

Where did Bitcoin come from?

On 31 October 2008, someone using the name Satoshi Nakamoto sent a nine-page paper to a cryptography mailing list: Bitcoin: A Peer-to-Peer Electronic Cash System. It proposed a way for two people to pay each other online without a bank in the middle. The network started on 3 January 2009, when Nakamoto created its first block. That block carries a line from that day's front page of The Times about a second bank bailout, a timestamp and, many read it, a comment.

The hard problem Nakamoto solved was double spending. A digital coin is just data, and data can be copied. Banks prevent you from spending the same money twice by keeping the only ledger that counts. Bitcoin had to stop double spending with no one in charge of the ledger. Nakamoto stepped away from the project in 2010 and 2011, and who Nakamoto is remains unknown.

How does Bitcoin work?

A payment starts as a message: move this amount from these coins to that address, signed with the key that controls the coins. Your wallet broadcasts it to the network, and the computers running Bitcoin's software, called nodes, check it. Is the signature valid? Have these coins already been spent? A payment that fails either check is ignored.

Valid payments wait to be written into the ledger. About every ten minutes, a new block of them is added, and each block includes a fingerprint of the one before it, which is what makes the record a chain: a blockchain. Changing an old payment would change that block's fingerprint, break the link to every block after it, and be rejected.

Who gets to add the next block is decided by mining. Miners race to find a number that, combined with the block's contents, produces a fingerprint below a target. There is no shortcut: the only way is to guess, and a single modern mining machine makes trillions of guesses a second, which is why mining uses so much electricity. This is called proof of work. The winner adds the block and is paid in newly created bitcoin plus the fees in the block. Every 2,016 blocks, about two weeks, the network resets the target so that blocks keep arriving about ten minutes apart however much computing power joins.

When two versions of the chain compete, nodes follow the one with the most work behind it. To rewrite history, an attacker would need more computing power than the rest of the network put together, which is known as a 51% attack. On a network this size, that would cost more than it could likely earn.

Who controls Bitcoin?

No company, foundation or government controls Bitcoin. Its rules live in open-source software, and the most widely used version, Bitcoin Core, is maintained by volunteers and funded developers in public. Each person running a node enforces those rules for themselves: a node rejects any block that breaks them, whoever mined it.

That makes the rules hard to change. Upgrades need broad agreement among users, miners and developers, and the large ones take years. SegWit, which changed how transactions are stored, came into force in 2017. Taproot, which improved privacy and scripting, came in 2021. Miners choose which payments go into the next block, but they can't change the rules, spend anyone else's coins, or create more than the schedule allows.

What does it mean to own bitcoin?

There are no coins in a wallet. Owning bitcoin means controlling a private key that can sign for it. A wallet is software that keeps those keys and shows a balance by reading the ledger. Most wallets back the keys up as a seed phrase, usually twelve or twenty-four words, which restores them on any device.

If you buy bitcoin on an exchange and leave it there, the exchange holds the keys and you hold a claim on the exchange — which is all FTX's customers had left when it collapsed in 2022, and why the saying goes "not your keys, not your coins." If you hold the keys yourself, nobody can freeze or take the coins without them, and nobody can get them back for you if you lose them. A share of all the bitcoin ever mined is thought to be lost for good for exactly that reason.

Why will there only be 21 million bitcoin?

The supply is written into the software. The first miners were paid 50 bitcoin a block. Every 210,000 blocks, roughly four years, that reward halves: to 25 in 2012, 12.5 in 2016, 6.25 in 2020 and 3.125 in April 2024. The halvings add up to a little under 21 million in total, the last fraction of which should be mined around the year 2140. After that, miners would be paid by fees alone. The next halving is due around 2028.

A bitcoin divides into 100 million units called satoshis, so a fixed supply doesn't mean the coins are too few to use. It means no one can decide to issue more, which is the property its supporters value most and its critics doubt matters.

What is Bitcoin used for, and what are its limits?

People use Bitcoin to send value across borders without a bank, to hold savings outside any single country's currency, and, most of all, to invest or speculate on its price. Since January 2024, investors in the United States have also been able to buy spot bitcoin funds on ordinary stock exchanges, after the Securities and Exchange Commission approved them.

Its limits are real. The price swings far more than any major currency's, which makes it awkward for everyday prices. The base network handles only a handful of payments a second, so fees rise when demand does, and small payments are moving to layers built on top, such as the Lightning Network. Mining uses a great deal of electricity: the University of Cambridge publishes a running estimate comparable to a mid-sized country's use. And because payments can't be reversed, scams and theft are hard to undo.

Still argued

Whether Bitcoin is a good store of value, "digital gold", is argued rather than settled. Its price has risen enormously over its life, and it has also fallen by more than half several times. This note explains how it works; it isn't advice on whether to buy it.

Bitcoin was the first cryptocurrency, and most of the thousands that followed borrowed its design. Ethereum took the shared ledger further, running programs on it as well as payments.

Check yourself

• Without looking back: what stops someone spending the same bitcoin twice?
• Why does the network reset the mining target, and how often?
• What exactly do you own when you own a bitcoin?

Sources

• Bitcoin: A Peer-to-Peer Electronic Cash System — Satoshi Nakamoto, 2008
• Block chain, in the Bitcoin developer guide — Bitcoin Project
• Controlled supply — Bitcoin Wiki
• Cambridge Bitcoin Electricity Consumption Index — Cambridge Centre for Alternative Finance
• Statement on the approval of spot bitcoin exchange-traded products — U.S. Securities and Exchange Commission, 10 January 2024
• About Bitcoin Core — Bitcoin Core