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Bitcoin for beginners, Part 2: Bitcoin as a technology and network

Bitcoin transactions and the block chain

By Dirk Merkel, JavaWorld.com, 12/06/11

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Dirk Merkel continues his introduction to Bitcoin with a look at the Bitcoin network as a system. He briefly explains the mechanics of transactions, blocks, and the block chain, as well as the Bitcoin wallet. He also discusses double-spending and Bitcoin mining, two controversial aspects of Bitcoin.

Having seen how Bitcoin is used (in Part 1) we're ready to look at some of its underlying concepts as a technology and network. This article introduces the mechanics of Bitcoin's core components: transactions, blocks, and the block chain. I also demystify controversial aspects of Bitcoin such as encryption (added in v0.4 of the standard client), the problem of double-spending, and how and why Bitcoin mining happens. Finally, I use Bitcoin Block Explorer to extract some data that I then use to gauge the overall health of the Bitcoin economy today.

To get started, consider Figure 1, which illustrates the relationship between the block chain, individual blocks, and transactions, as well as the structure of each component. I discuss the components below.

Figure 1. The Bitcoin network system (click for larger image)

Transactions

Bitcoin uses public-key cryptography for signing transactions. In the Bitcoin marketplace, coins are transferred between users via an exchange of keys. First, an amount of coins is associated with a given user via a key pair. The public key serves as an address to which Bitcoins can be sent, similar to an account number in traditional banking. The private key is like an ATM PIN that can be used to both access the funds and authorize their transfer to another user. The private key holder is the only one who can transfer or spend the Bitcoins associated with a given public key. Whereas your bank can reset your ATM PIN, losing your private keys results in an irreversible loss of the funds.

Someone using the Bitcoin marketplace who wants to transfer Bitcoins to another user must first associate the recipient's address (public key) with the desired number of Bitcoins. This tells the Bitcoin network where the Bitcoins will go. Next, he signs the transaction with his private key, which must correspond to the public key at which he originally received the Bitcoins. This signing process ensures the Bitcoin network that the transaction is initiated by the current owner of the Bitcoins being traded. Finally, the sender broadcasts the signed transaction to the network where it will be propagated from one node to the next and integrated into the Bitcoin block chain (discussed below).

Public key cryptography

Public-key cryptography uses key pairs, a public and a private one, that can be generated by a user at any time. As the name implies, the public key gets distributed, while the private one remains in the possession of a single person or entity. The private key is meant to be kept safe and secure by the owner. The private key can be used to sign messages such that anybody with the key pair's corresponding public key can verify with certainty that only the holder of the private key could have signed the message.

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