How does Bitcoin work?

Bitcoin, as mentioned in my previous article, is decentralized, operating without the need for a financial system or government authority. It utilizes peer-to-peer transfers on a blockchain that records all transactions.

The blockchain is an open-source code that chains blocks of transaction histories, preventing manipulation within the Bitcoin network. These transfers are confirmed directly between users and are located in the blockchain, eliminating the need for central facilitators like governments and banks to verify transactions.

The blockchain acts as a secure, encrypted database of transactions validated by peers. It is distributed across multiple computers and systems within the network, with no central location like a server. Each system has a copy of the blockchain.

Once you have a Bitcoin wallet, you can view your Bitcoin balance and send or receive Bitcoin within the wallet. The wallet interfaces with the blockchain and locates your Bitcoin in the network.

Before choosing a wallet for storing and transacting Bitcoin, it’s important to understand that there are two types of wallets with different functionality:

1. Custodial wallet
2. Noncustodial wallet

Custodial Wallets – These wallets are associated with trusted entities that have a founder, CEO, and organization headquarters. Custodial wallets, like Binance, allow users to sign up for their exchange and store Bitcoin on their platform. Here are some well-known established exchanges:

1. Binance
2. Coinbase
3. Bitnob

Custodial wallets are not recommended as the safest way to store your Bitcoin, but they are the easiest way to buy Bitcoin. Many custodial wallets have partnered with payment networks like VISA and Mastercard, making it easy to directly purchase Bitcoin. However, it is advisable to transfer your Bitcoin from a custodial wallet to a noncustodial wallet.

Noncustodial wallets – These wallets give users full responsibility for their Bitcoin by securing their private keys, which represent a specific wallet. Private keys can be stored on an internet-connected application like Google Backup Drive, or they can be kept offline by memorizing the keys. Private keys are often in the form of 12 words or phrases. Noncustodial wallets offer the safest way to store Bitcoin. However, if you lose your phrases, you will lose access to your Bitcoin, as there is no central authority to help you recover it. Therefore, it is crucial to keep your private keys very safe. These phrases also allow you to access your Bitcoin from a different device or location.

Bitcoin Transactions – A Bitcoin transaction occurs when you send or receive Bitcoin. Once the transaction is complete, the record is stored on the blockchain. The verification process within the network ensures that the same Bitcoin cannot be double spent. Participants who validate transactions are rewarded with Bitcoin.

To send Bitcoin, you will need the receiver’s address, similar to a bank account number. You can share it with anyone, but no one can use it to access your Bitcoin. Copy and paste the receiver’s address into the appropriate section in your wallet when sending Bitcoin.

If you want to receive Bitcoin, retrieve your receiver’s address from your wallet and share it with the sender. The same process applies when sending Bitcoin from a custodial wallet to a noncustodial wallet.

Bitcoin transactions are meant to be peer-to-peer, so it’s important to take custody of your Bitcoin and not keep them on exchanges. This practice is referred to as self-custody by Bitcoiners.

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