How the Bitcoin protocol actually works

Many thousands of articles have been written purporting to explain Bitcoin, the online, peer-to-peer currency. Most of those articles give a hand-wavy account of the underlying cryptographic protocol, omitting many details. Even those articles which delve deeper often gloss over crucial points. My aim in this post is to explain the major ideas behind the Bitcoin protocol in a clear, easily comprehensible way. We’ll start from first principles, build up to a broad theoretical understanding of how the protocol works, and then dig down into the nitty-gritty, examining the raw data in a Bitcoin transaction.
Understanding the protocol in this detailed way is hard work. It is tempting instead to take Bitcoin as given, and to engage in speculation about how to get rich with Bitcoin, whether Bitcoin is a bubble, whether Bitcoin might one day mean the end of taxation, and so on. That’s fun, but severely limits your understanding. Understanding the details of the Bitcoin protocol opens up otherwise inaccessible vistas. In particular, it’s the basis for understanding Bitcoin’s built-in scripting language, which makes it possible to use Bitcoin to create new types of financial instruments, such as smart contracts. New financial instruments can, in turn, be used to create new markets and to enable new forms of collective human behaviour. Talk about fun!
I’ll describe Bitcoin scripting and concepts such as smart contracts in future posts. This post concentrates on explaining the nuts-and-bolts of the Bitcoin protocol. To understand the post, you need to be comfortable with public key cryptography, and with the closely related idea of digital signatures. I’ll also assume you’re familiar with cryptographic hashing. None of this is especially difficult. The basic ideas can be taught in freshman university mathematics or computer science classes. The ideas are beautiful, so if you’re not familiar with them, I recommend taking a few hours to get familiar.
It may seem surprising that Bitcoin’s basis is cryptography. Isn’t Bitcoin a currency, not a way of sending secret messages? In fact, the problems Bitcoin needs to solve are largely about securing transactions — making sure people can’t steal from one another, or impersonate one another, and so on. In the world of atoms we achieve security with devices such as locks, safes, signatures, and bank vaults. In the world of bits we achieve this kind of security with cryptography. And that’s why Bitcoin is at heart a cryptographic protocol.
My strategy in the post is to build Bitcoin up in stages. I’ll begin by explaining a very simple digital currency, based on ideas that are almost obvious. We’ll call that currency Infocoin, to distinguish it from Bitcoin. Of course, our first version of Infocoin will have many deficiencies, and so we’ll go through several iterations of Infocoin, with each iteration introducing just one or two simple new ideas. After several such iterations, we’ll arrive at the full Bitcoin protocol. We will have reinvented Bitcoin!
This strategy is slower than if I explained the entire Bitcoin protocol in one shot. But while you can understand the mechanics of Bitcoin through such a one-shot explanation, it would be difficult to understand why Bitcoin is designed the way it is. The advantage of the slower iterative explanation is that it gives us a much sharper understanding of each element of Bitcoin.
Finally, I should mention that I’m a relative newcomer to Bitcoin. I’ve been following it loosely since 2011 (and cryptocurrencies since the late 1990s), but only got seriously into the details of the Bitcoin protocol earlier this year. So I’d certainly appreciate corrections of any misapprehensions on my part. Also in the post I’ve included a number of “problems for the author” – notes to myself about questions that came up during the writing. You may find these interesting, but you can also skip them entirely without losing track of the main text.

By Michael Nielsen
Source and read the full article:
http://www.michaelnielsen.org/ddi/how-the-bitcoin-protocol-actually-works/

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