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Bitcoin's Insight: A Working Decentralized Ledger
4 min read
At a high level, bitcoin describes what's known as a consensus protocol that allows for the successful implementation of a decentralized ledger.
What is a consensus protocol?
It's a set of rules that you and everyone around you follow so that everyone can agree on which transactions are legitimate, and which aren't. American democracy, for example, can be thought of as a very complicated and very slow consensus protocol. The rules described in the constitution and all the other legislative documents dictate what laws are created, and ultimately lead to a population-wide "consensus" on what constitutes proper behavior and what doesn't. The bitcoin protocol is effectively a very, very clever constitution for transactions that allows us to implement a decentralized ledger.
This comprehensive guide covers everything you need to know about how bitcoin works. No prerequisites are needed — you don't need a university degree in computer science to understand these concepts. This guide will teach you the important points in a concise and easy-to-understand way.
Why do you need to learn how Bitcoin works before investing?
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The first thing to remember is that bitcoins don't actually exist. Note that nothing in the earlier example requires real-world assets or paper money in order to function — everyone's money is just information listed on the chalkboard. This is actually similar to how modern digital banks work. The savings in your account aren't backed by gold or anything real, they're just numbers in a database, and if the bank lost that data nobody would know how much money you had. Similarly, when you "buy" bitcoin, you're not getting anything real — rather, you're just increasing your balance in the global bitcoin database (the decentralized ledger), and decreasing your balance in the traditional banking database. This is a critical point in understanding how bitcoins (or any other cryptocurrencies) are stored.
Addresses as Wallets
Addresses are public keys and they're like wallets.
In the concrete example we had earlier, everyone sto...
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In late 2008, a person with the alias Satoshi Nakamoto published a technical white paper describing the bitcoin protocol to a cryptography mailing list.
A few months later, in early 2009, he released a full, open-source implementation of the protocol described in the paper.
Commerce on the Internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments. While the system works well enough for most transactions, it still suffers from the inherent weaknesses of the trust based model. — Satoshi Nakomoto
Over the last decade, we have seen a huge rise in e-...
The big insight that bitcoin makes here is that the ledger doesn't have to be centralized.
Going back to the town example, imagine that instead of having a chalkboard ledger in the middle of the town, you instead had everyone keep an up-to-date notebook containing the balances of themselves and everyone else in the town. Then, if you wanted to pay someone, you'd have to update the balances of yourself and your counterparty not only in your own personal ledgers, but you'd also have to update them in everyone else's ledgers as well. If you could do this, you'd have what would collectively be called a decentralized ledger, consisting of all the information across everyone's notebooks.
Validators are actually miners, and they aren't chosen at random.
Now we know that there's this block chain, and that new blocks can only be added by "validators" that are selected every ten minutes. These validators are knows as miners.
But how does the bitcoin protocol select who gets to validate the new blocks that are being created, especially given that the network is completely decentralized?
This brings us to the second incredible innovation that bitcoin made, a system called Proof-of-Work (PoW for short). Bitcoin selects the next miner based on having everyone solve an incredibly computationally expensive mathematical puzzle (technical details at the bottom). Every time a block is created, a new mathematical puzzle that should take approximately ten minutes to solve, is assigned to everyone in the network. After the puzzle is out there, every miner runs ...