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How The Bitcoin Protocol Works

An increasing number of businesses and consumers are now considering bitcoin, a new type of currency that offers a potential global-encompassing digital payment method. With this growing acceptance, it’s important to learn the essential components of this platform designed to change how we buy and sell products and services. My own company — a time tracking and invoicing platform — is using it, and I’d like to share what we’ve learned. Personally, I find this technology beneficial, and hope that others will join the growing community.

Bitcoin is one of the pioneers of the peer-to-peer electronic cash system, introducing what is known as blockchain protocol to oversee the system. Here’s essentially how it works.


Fixing an Unworthy Transaction System

The current bitcoin transaction system is based on trust and the hope that every transaction will result in a particular outcome. The problem is that these electronic payments are sometimes untrustworthy, creating concerns between buyers and sellers about fraud. This untrustworthiness could stem from factors such as a user attempting to deny service from another user or type of transaction, a user trying to double-spend bitcoins, or a user seeking to manipulate the system for monetary benefit. To prevent these and other attacks, bitcoin developers built a system based on cryptographic proof through the use of digital signatures and more complex verification process.


Digital Signatures for Verification

Blockchain uses an electronic “coin,” which is a series of digital signatures that are collected as an owner transfers this electronic currency to the next owner. Each time it is passed, the owner adds a hash that signifies the previous transaction and the public key of the new owner. The notations are all added to the end of the electronic coin as it moves between owners. This provides a way to verify ownership.

Timestamp Server and Proof-of-Work System for Additional Layer of Trust

To ensure that these electronic coins are not “double spent,” bitcoin developed a process to verify how the currency has been used. A timestamp server adds a period in time to the hash to verify the transaction. This timestamp is added along with each transfer of ownership. Additionally, a proof-of-work system applies a particular value to the digital coin to further verify each transaction that is conducted with the cryptocurrency.

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