How Does Bitcoin Work?
Bitcoin is maintained by a peer-to-peer network, which allows Bitcoin transactions (the transfer of Bitcoin value from one Bitcoin address to another using cryptographic algorithms) to occur directly between a buyer and seller. This direct connection of buyer and seller eliminates the need for a financial intermediary such as a central bank or Federal Reserve. Instead of using an intermediary, Bitcoin transactions are facilitated by an independent collective network of Bitcoin “miners” that process transactions and validate Bitcoin authenticity and proof of ownership. Anyone with an internet connection can mine Bitcoins by running Bitcoin mining software.
The sum total of the miners’ collective computing power is called the “Bitcoin Network.” The larger the Bitcoin Network, the more secure it becomes. The reason for this is because it becomes more computationally impractical for malicious software to attack the Bitcoin Network as the Network expands its computer resources. The only way a malicious attack could effectively be made on the Bitcoin Network is if the attack came from a network larger and with more processing power than the Bitcoin Network. Whereas banks charge transaction fees to recoup the billions of dollars invested in infrastructure to facilitate transactions, Bitcoin miners have the opportunity to receive a transaction fee for their expenditure computing power and electricity.
Transaction fees between independent Bitcoin buyers and sellers are voluntary and are set by the parties; transactions with the highest fees will almost always be processed faster, but even transactions with no fees will eventually be processed. The transaction fee is designed to incentivize people to become miners (or join a mining pool) in order to expand the Bitcoin network’s available computer resources that are required to verify transactions. Transaction fees for converting Bitcoin into other currencies and merchant transactions operate differently and are established by the Bitcoin service provider such as CoinBase.com and BitPay.com. Currently, the standard transaction fee is competitively bench-marked at 1%.
The Bitcoin network of miners performs two vital functions: it processes and validates Bitcoin transactions using sophisticated algorithms, and it introduces new Bitcoin into the Bitcoin economy by a process known as “mining.”