The Bitcoin Network functions in the following way:
Firstly, new transactions are broadcasted to all nodes. Then, each node gathers new transactions into a block. Next, each node works on finding a Proof-of-Work for its block. Once found, it broadcasts the block with the resultant PoW hash to all nodes. Nodes accept the block only if all transactions in it are valid and not already spent. Nodes express their acceptance of the block by working on creating the next block in the chain, using the hash of the accepted block as the previous hash.


Bitcoin Network

Transactions are grouped into blocks and the system works to make the block's hash contain a certain number of leading zero bits. Once a proof-of-work is completed, a block cannot be changed unless the work is redone. As more blocks are added to the chain, changing the block would require redoing the work for all the following blocks too. A result of this system is that the network accepts the longest chain as the legitimate chain.

Proof-of-Work

In a Bitcoin transaction, the current owner transfers the coin to the next owner by signing the hash of the previous owner and the next owner's public key. In addition, all transactions are publicly announced, avoiding a third-party to verify transactions. To avoid double-spending, only the earliest transaction counts.

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- Transactions
- Timestamp Server
- Proof-of-Work
- Network
- Incentive
- Reclaiming Disk Space
- Simplified Payment Verification
- Combining and Splitting Value
- Privacy


Key Bitcoin Terms

Cryptographic Hashes are computational algorithms that ensure any alteration to a transaction input, which result in a different hash value being computed. This process guarantees that changes to the ledger must once again be reviewed by all miners and go through the consensus process.

Cryptographic Hashes

Nakamoto, Satoshi. (2008). Bitcoin: A Peer-to-Peer Electronic Cash System. https://bitcoin.org/bitcoin.pdf

Bitcoin Whitepaper

The first transaction in a block starts a new coin owned by the creator of the block, automatically distributing coins into circulation and providing an incentive for nodes to support the network. Incentives can also be funded by transaction fees, which are added to the incentive value of the block containing the transaction.

Incentive

Once the latest transaction in a coin is buried under enough blocks, the transactions before it can be discarded to save disk space. To do this without breaking the block's hash, transactions are hashed in a Merkle Tree, with only the root included in the block's hash. Old blocks can then be compacted by stubbing off branches of the tree, since the interior hashes do not need to be stored.

Reclaiming Disk Space

Payments can be verified without running a full network node by keeping the block headers of the longest proof-of-work chain and obtaining the Merkle branch linking the transaction to the block it's timestamped in. By linking a transaction to a place in the chain, users can confirm that the network has accepted it, which is further confirmed by the blocks added after it.

Simplified Payment Verification

To allow value to be split and combined, transactions on the bitcoin network contain multiple inputs and outputs. There will usually be a single input from a larger previous transaction or multiple inputs combining smaller amounts, and at most two outputs: one for the payment, and one returning the change to the sender.

Combining and Splitting Value

In traditional banking, access to information about transactions is limited to the parties involved and the bank itself. This is not possible on the blockchain, where all transactions must be announced publicly, but privacy can still be maintained by keeping public keys anonymous. The public can see that someone is sending
an amount to someone else, but without information linking the transaction to anyone.

Bitcoin and Privacy

A timestamp server, as the name implies, provides a record of the time each Bitcoin transaction took place. It does this by taking a hash of a block and publicly publishing the hash. This provides a "proof-of-existence" for whether or not data existed previously.

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