THE BITCOIN NETWORK
The easiest way to describe the Bitcoin network is to think of it as a distributed ledger of account balances, denominated in Bitcoin. We refer to a Bitcoin account as an “address,” which is a unique string of letters and numbers that references a specific account. The ledger of accounts we mentioned includes not only a complete list of accounts (addresses), as well as their current balance, but every transaction that has occurred since day one. We say it is distributed because it is stored on thousands of computers around the world, which provides redundancy against any single point of failure. While one person, region or country could be disconnected from the network, Bitcoin is functional as long as there are 2 or more instances of the software running.
Transactions between addresses are stored incrementally, approximately every 10 minutes. We call these incremental lists of transactions “blocks.” Each block must reference the previous block before it, resulting in a chain of blocks known as the blockchain. The blockchain is essentially the Bitcoin network’s database that stores a record of every transaction, dating all the way back to the original Genesis block. Bitcoins ONLY exist in the blockchain, so clearly we need to verify that the blockchain is not only accurate, but secure against attack or fraud. This is where mining comes in, which secures the transactions in the ledger.
Think of mining as a globally distributed security system for Bitcoin. Mining is the process of encapsulating all of the most recent transactions into a new block of transactions, which must fulfill a number of specific rules. First, in order for a mined block to be considered permanent, it must refer to the previous block before it. Second, it must include as many transactions to date as possible. Third, it must fulfill a very complex mathematical equation. The mathematical equation involves “hashing” long strings of letters and numbers using the SHA-256 algorithm to generate a very large number. Once this calculation is performed, and submitted to the network, this is considered a “hash”. Most hardware routinely performs billions or trillions of these calculations per second. The miner who provides the best solution to a given block, which satisfies all three requirements, receives a reward of 25 Bitcoins! Bitcoin mining evolved from using personal computers that were able to process thousands of these calculations per second to Bitcoin-specific chips that can process billions of SHA-256 hashes per second.
An important point to mention is that production of Bitcoin is designed to decrease over time, which means the Bitcoin block reward will decrease by half every four years. As of early 2015, approximately 13.5 million Bitcoins have been produced. There is a limit of 21 million Bitcoins that will be produced before the year 2140, which means 64% of the world Bitcoin supply has already been created. The next “halving day” is expected at the end of 2016, when the award will be cut in half, to 12.5 Bitcoins per block.