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How Bitcoin works. 

The Bitcoin blockchain is a chain of linked blocks. A block is a store of transactions. A transaction is an electronic record of a money transfer. I’ll explain later why transactions are stored in blocks and why those blocks need to be linked, but for now, let’s imagine that the blockchain is simply a history of all the transactions that have ever happened on the Bitcoin network and that it’s stored in some abstract place that everyone on the network can access. Any participant can spend their bitcoins by adding new transactions to the blockchain, but they can’t erase or overwrite existing transactions. 

Transaction's role in Bitcoin can be a bit of a mind-bender. That’s because money on the blockchain isn’t stored in Bitcoin wallets like it is in a bank account balance. All the money on the Bitcoin network is stored in transactions, and to make a money transfer, you have to create a new transaction by moving bitcoins from some existing transaction into it. The balance of your Bitcoin wallet is stored in the transactions you have access to, and you have access to the transactions that are “opened” by your secret cryptographic key. The main function of a Bitcoin wallet is to store this secret key. 

Let’s say your neighbor bought a jar of cucumbers from you for 1 bitcoin and, in a separate transaction, bought a jar of premium cucumbers from you for 2 bitcoins. A few years pass, and you spend 2.5 bitcoins buying 5 brand-new Audi Q5. 

You create a new transaction, give it 2 inputs (1 and 2 bitcoins), and output 2 outputs — 2.5 bitcoins to the Audi Q5 seller and 0.4 bitcoins to yourself, and leave 0.1 bitcoin as a (very generous) commission to the miner who will process this transaction. Any transaction can have any number of inputs and any number of outputs. Moreover, the total amount of bitcoins at the inputs must equal the number at the outputs. Remember how I said money for new transactions is taken from existing transactions? To be more specific, money is taken from the outputs of existing transactions, and if you use such an output when creating a new transaction, this output will be spent in full. An unspent output is called a UTXO (unspent transaction output). A data structure called a list of unspent outputs (UTXO pool or UTXO set) is stored next to the blockchain. Outputs for creating new transactions are taken from this pool, and when a transaction is confirmed, they are removed from it. 

Your unspent outputs are accessed by a private encryption key stored in your Bitcoin wallet. To understand how this works, you must familiarize yourself with asymmetric encryption. Unlike symmetric encryption, in which a message is encrypted with one cryptographic key and decrypted with the same key, asymmetric encryption uses two keys. A message encrypted with the first key can only be decrypted with the second key. One of these keys is public — it can be freely published in open sources and openly distributed over the network. The second key is private and should be stored in a safe place and not shown to anyone. An electronic digital signature works on this principle. If a server sends you an encrypted document, and you can decrypt it with the server’s public key, you can be sure that the document was issued and signed by that server because no one else could encrypt it that way. Bitcoin transactions use slightly different mathematical key processing, but they are based on the same cryptographic algorithms. 

To get a Bitcoin wallet, you need to generate a private asymmetric encryption key and a public key based on this private key. If someone wants to transfer bitcoins to your wallet, then (roughly speaking) they will transfer them to your public key. 

Each transaction output contains a mathematical problem based on the public key associated with the wallet to which the transfer is made. Only the owner of the private key can solve this problem. This means that only the owner of the target wallet will be able to form a correct, valid transaction using this output. 

If you look at the structure of a transaction, the cryptographic task to unlock the UTXO is stored in one section, and important parameters (such as the amount of the money transfer) are stored in another. Let’s imagine a situation where you agreed to send someone 5 bitcoins and decided to use a UTXO worth 10 bitcoins for this. This means you create a transaction with 2 outputs — 5 bitcoins to the recipient and 5 to yourself (let’s forget about the miner’s commission for now). Let’s say that the recipient intercepted your transaction before it entered the network and replaced the values in its sections with 10 and 0, respectively, thus ensuring that 10 bitcoins go to his account and 0 to yours. To make such attacks impossible, verifying the digital signature of all data in the new transaction, including the funds transferred, is added to the cryptographic task blocking the transaction output. An attacker won’t be able to create a valid transaction with other amounts because they won’t be able to sign it with your private key. 

Your Bitcoin wallet balance is the sum of all the UTXOs in the blockchain that you can spend using your private key. If someone steals this key, they can access all your bitcoins. If you lose your private key beyond recovery, all your bitcoins are lost to humanity — no one will ever be able to spend them. 

Let’s return to the “abstract place” where the blockchain is stored. The Bitcoin network is powered by thousands of computers called full nodes. Let’s assume that each stores a copy of the entire blockchain. That is, the history of all transactions in the Bitcoin network is stored and distributed across many computers, making it virtually impossible for any state to paralyze the network. Nodes constantly exchange data on newly confirmed transactions, and the current state of the blockchain is constantly synchronized between nodes. This makes it impossible for the owner of a single node to replace the transaction history.