How Bitcoin Works

Bitcoin proved blockchain works in practice. But it was designed for one thing: transferring money without banks. Every design decision reflects this singular focus.

How does Bitcoin work? Bitcoin solved the double-spending problem and created digital money without central authority using blockchain technology. The Bitcoin blockchain design optimizes for security and decentralization over speed and flexibility.

Bitcoin's Design Philosophy

Bitcoin was not designed to be a general-purpose computer. It was built to solve one specific problem: creating digital money that works without banks or governments.

Bitcoin prioritizes security and decentralization over throughput. Every design decision follows from this priority.

10-minute block times: Bitcoin produces one block every 10 minutes. This timing is not arbitrary. Faster blocks would cause network splits where miners work on different blockchain versions because blocks propagate slower than new blocks are created. Slower blocks would delay confirmation times too much for practical use. 10 minutes balances these concerns.

Limited scripting: Bitcoin includes a simple scripting language for basic conditions like multi-signature wallets and time locks. The language is deliberately limited—it lacks loops and complex operations. This prevents bugs and reduces attack surface, but means Bitcoin cannot run complex applications.

Small blocks: Bitcoin blocks are limited to approximately 1 megabyte. This keeps the blockchain size manageable, allowing more people to run full nodes and verify the chain independently. The cost is low throughput: Bitcoin processes about 7 transactions per second.

These choices prioritize security and decentralization. Bitcoin sacrifices speed and flexibility to remain secure and accessible to anyone who wants to validate transactions independently.

The UTXO Model

Bitcoin does not track account balances like banks do. Instead, it tracks individual "coins" using UTXOs (Unspent Transaction Outputs), which work like physical cash.

You have three $20 bills in your wallet and want to buy something that costs $35. You cannot split a $20 bill, so you give the cashier two bills ($40) and receive $5 in change. Bitcoin works exactly the same.

Let's say Alice has received bitcoin in three separate transactions:

• UTXO #1: 0.5 BTC (from Bob)

• UTXO #2: 0.3 BTC (from Carol)

• UTXO #3: 0.8 BTC (from Dave)

Alice's "balance" is 1.6 BTC, but there is no single account storing this number. Instead, the blockchain records three separate UTXOs that Alice can spend.

When Alice wants to send 1.0 BTC to Eve, she must:

1. Select UTXOs that total at least 1.0 BTC (she chooses UTXO #1 and #3, totaling 1.3 BTC)

2. Create a transaction where she sends 1.0 BTC to Eve and 0.3 BTC back to herself as change

3. Sign the transaction with her private key to prove she owns the input UTXOs

The transaction consumes UTXOs #1 and #3 (they are now "spent") and creates two new UTXOs: one for Eve and one change UTXO for Alice.

Since each UTXO can only be spent once, transactions using different UTXOs do not conflict. Miners can validate thousands of transactions simultaneously without worrying about double-spending, as long as each transaction references different UTXOs. There is no global account that reveals your total balance. Your bitcoins are spread across multiple UTXOs, making it harder for observers to determine your total wealth. Each UTXO might be linked to a different address, obscuring ownership patterns.

Each transaction can be verified independently by checking that the input UTXOs exist and have not been spent, and that the digital signatures are valid. You do not need to maintain complex account state or worry about the order of transactions affecting balances. Either a transaction succeeds completely (consuming all inputs and creating all outputs) or fails completely. There is no risk of partial state where some money is deducted but not transferred.

Mining and Block Rewards

Bitcoin miners compete to solve computational puzzles. The first miner to find a valid solution proposes the next block and earns a reward.

Block reward: The miner who successfully mines a block receives newly created bitcoins. This reward started at 50 BTC per block and halves every 210,000 blocks (approximately every 4 years). The current reward is 3.125 BTC per block.

Halving: Every 210,000 blocks, the block reward cuts in half. This creates a predictable supply schedule. Bitcoin's total supply will reach 21 million coins around the year 2140. After that, miners earn only transaction fees.

Transaction fees: In addition to the block reward, miners collect transaction fees from users. When you send a bitcoin transaction, you specify a fee. Miners prioritize transactions with higher fees because they earn more. As block rewards diminish, transaction fees will become miners' primary income.

Difficulty adjustment: Every 2,016 blocks (approximately two weeks), Bitcoin recalculates mining difficulty. If blocks came faster than 10 minutes on average, difficulty increases. If blocks came slower, difficulty decreases. This self-adjustment maintains consistent block production regardless of how much mining power exists.

Mining secures the network by making attacks expensive while distributing new coins without requiring a central authority to allocate them.

What Bitcoin Does Well

Bitcoin excels as a store of value and censorship-resistant payment system.

Store of value: Bitcoin's fixed supply (21 million coins maximum) and proven security make it digital gold. No one can create more bitcoins beyond the protocol's schedule. No government can seize bitcoins if you properly secure your private keys. The network has operated continuously since 2009 without downtime or successful attacks.

Censorship resistance: No one can block your transaction if you pay sufficient fees. Bitcoin nodes are distributed globally. Shutting down Bitcoin would require shutting down the internet in every country simultaneously. Individuals in countries with unstable currencies or authoritarian governments can store and transfer value without permission.

Simplicity: Bitcoin's limited functionality is a feature. The protocol is simple to understand, audit, and verify. Fewer features mean fewer bugs and smaller attack surface. This simplicity contributes to Bitcoin's reliability and security.

Proven track record: Bitcoin is the longest-running blockchain. It has survived multiple market cycles, numerous attack attempts, and countless predictions of failure. This resilience gives confidence that the system works as designed.

What Bitcoin Doesn't Do

Bitcoin's design choices create limitations.

Low throughput: Bitcoin processes approximately 7 transactions per second. Visa processes 65,000 transactions per second. This makes Bitcoin impractical for everyday purchases at scale. Transaction fees spike during high usage periods.

No smart contracts: Bitcoin's scripting language cannot implement complex logic. You cannot build lending protocols, decentralized exchanges, or autonomous organizations on Bitcoin's base layer. The protocol supports only basic transfer conditions.

Slow finality: Transactions take 10 minutes for the first confirmation and typically require six confirmations (60 minutes) to be considered final. This is too slow for point-of-sale purchases or time-sensitive transfers.

Energy intensive: Proof of Work requires massive electricity consumption. Bitcoin mining uses more electricity annually than some countries. This environmental cost concerns critics and limits where mining can profitably operate.

Bitcoin's design priorities created these limitations. Security and decentralization require these tradeoffs, making Bitcoin function as digital gold rather than a high-throughput payment network.

Bitcoin's Legacy

Bitcoin's design choices—UTXO model, Proof of Work consensus, limited scripting, conservative parameter tuning—optimize for security and resilience. Thousands of strangers can maintain a shared ledger without trusting each other or relying on intermediaries. The economic security model aligns incentives to maintain network integrity.

Bitcoin optimized for security over flexibility. Ethereum took the next step and transformed blockchain from payments into programmable money.