You probably know that there will only ever be 21 million Bitcoins, that it is decentralized, and that no one can create money out of thin air, censor transactions, confiscate funds, or create invalid transactions. But how is any of this possible?
To make Bitcoin easy to understand, we have broken it down into multiple sections:
- Public-Key Cryptography
- A Bitcoin Wallet
- Self-Custody
- Bitcoin Transactions
- Blockchain
- A Bitcoin Node
- A Mempool
- Bitcoin Mining
- Proof of Work
- Block Construction
- Difficulty Adjustment
- How are Bitcoins Created
Let's break these concepts down.
It all starts with Public Key Cryptography
Bitcoin relies on public key cryptography, also known as asymmetric cryptography. Key pairs are generated using the ECDSA algorithm, which is a one-way mathematical function. While a public key can be derived from a private key, the reverse is not possible. This property is what makes Bitcoin secure.
You can generate a Bitcoin address from a public key. This is the address that you share to receive Bitcoin. Examples include:
- 1JJWhbEijNpARPdL3xXBLWP3NnVca1MY7S
- 3C1JBGy9vMeJjP8ZeE8LuruTdEW5vtjyb7
- bc1qwzrryqr3ja8w7hnja2spmkgfdcgvqwp5swz4af4ngsjecfz0w0pqud7k38
Once you receive bitcoin in your wallet, it can only be spent using a cryptographic signature produced by your private key. This proves ownership without revealing the private key itself.
What is a Bitcoin Wallet?
A Bitcoin wallet is software or hardware that generates private keys, and helps you back them up with a human-readable recovery phrase. It also generates Bitcoin addresses to which you can receive funds.
It is crucial that you securely back up your 12- or 24-word recovery phrase and never share it. Anyone with that phrase can steal your Bitcoin. If your holdings grow, consider using a hardware device that keeps your private keys offline to reduce the risk of hacking.
An example of a Bitcoin wallet is Blue Wallet:
Wallets typically have Receive and Send functions. Each time you receive a payment, a new address is generated. To ensure privacy and security, avoid reusing bitcoin addresses.
What is self-custody?
Self-custody means having exclusive control of your Bitcoin. When you purchase Bitcoin on a platform like Aureo, you have the option to withdraw it to your own wallet and take ownership. Although there are credible platforms, keeping funds on centralized services exposes you to custody risk.
However, control requires responsibility, and a minimum of technical know-how. Some users prefer newer custody models, such as multi-institution custody (MIC), which strike a balance between institutional security and risk management. Read our dedicated article to learn more about MIC.
How does a Bitcoin transaction work?
When you receive bitcoin, you receive what is called an unspent transaction output (UTXO). Each UTXO acts as a separate coin. Multiple UTXOs can exist in a single wallet.
For instance, if you receive three deposits of 0.01 BTC each, you will have three UTXOs. If you want to spend 0.005 BTC, your wallet will use one UTXO and create two outputs: one for the full amount and another for the change. For a payment of 0.015 BTC, two UTXOs might be combined.
An example of what a Bitcoin transaction would look like:
Your wallet automatically handles UTXOs. However, advanced users sometimes choose UTXOs manually (coin control) for privacy or accounting reasons.
Bitcoin transactions incur fees. These fees depend on the size of your transaction in virtual bytes (vB), multiplied by the fee rate, measured in sat/vB. One satoshi equals 0.00000001 BTC.
After broadcasting a transaction, it enters the Bitcoin network and eventually appears in the blockchain. Now, let's explore what that means.
What is the blockchain?
The Bitcoin blockchain is a public ledger that records all confirmed transactions. Each block contains a batch of transactions (between 2,000 and 4,000). Blocks reference previous blocks, forming an ordered chain.
For instance, if you receive Bitcoin in block 800,000 and then spend it in block 800,021, this transaction history is reflected in the blockchain.
For the network to remain decentralized and secure, Bitcoin’s blockchain must be public. However, Bitcoin is pseudonymous, not anonymous. Addresses are not tied to real names by default, but patterns can be analyzed.
Now that you understand that the blockchain is a public ledger of all confirmed transactions, the next question is: Who maintains it and ensures that every update follows the Bitcoin protocol's rules? This responsibility does not fall on any central server or authority. Instead, it is distributed across thousands of independent computers, known as Bitcoin nodes.
What is a Bitcoin node?
A Bitcoin node is software that downloads every block and transaction, verifies their cryptographic signatures, and ensures they adhere to all Bitcoin consensus rules. Nodes enforce limits on the block size, valid transaction formats, and the existence of coins being spent.
After validating the blockchain, a node can opt to store it in its entirety or prune older data once it has built a database of the current unspent transaction outputs (UTXO set). All nodes maintain a copy of the UTXO set, representing the system's spendable coins.
Nodes connect to share blocks and transactions, forming a decentralized peer-to-peer network. When you use a wallet, it connects to a node to retrieve your balance and broadcast your transactions. By default, wallets connect to public nodes, but advanced users can connect to their own node for maximum security.
Running your own node is the only way to independently verify that the transactions you receive are valid according to the rules you personally choose to enforce. While not running a node is safe in practice, running a node provides absolute certainty.
What is a mempool?
When you broadcast a transaction to the network from your wallet, it enters the mempool, which is a temporary holding area for unconfirmed transactions. A transaction is not considered confirmed (final) until it is included in a block. Miners decide which transactions to include in blocks and prioritize them based on transaction fees.
What is Bitcoin mining?
Bitcoin mining answers a critical question: how does a decentralized network agree on the next set of transactions without a central authority?
What is proof of work?
Proof of work is a cryptographic mechanism that allows miners to demonstrate the computing effort they expended to discover a valid block’s hash. Miners select transactions from the mempool and try different combinations of inputs until the block’s hash meets the target set by the network. Although finding a valid hash is difficult and requires significant computing power, verifying the result is quick. This asymmetry makes cheating impractical and verification easy.
Miners use specialized hardware known as Application-Specific Integrated Circuits (ASICs) to generate trillions of guesses per second, per machine. On average, a miner will find the required cryptographic hash every 10 minutes. (more on that later)
When a miner finds a valid block hash, he broadcasts it to the network. Nodes verify the proof of work and the included transactions, then accept the block if everything follows Bitcoin’s rules. The miner earns the block reward and transaction fees, which align incentives with honest behavior.
How do miners construct blocks?
Miners have complete freedom in which transactions to include in a block. They are incentivized to select those with higher fees relative to their size. Due to the block size rule, miners must carefully select the transactions they include. Users who pay higher fees have their transactions confirmed faster.
Once a miner finds a valid block, the nodes verify first that the block hash meets the target and then, if the included transactions respect the consensus rules. The global network achieves decentralized consensus within seconds.
What is the difficulty adjustment?
If Bitcoin mining is an open market where miners are free to join or leave at any time, how does the network maintain its schedule of producing one block roughly every ten minutes? The answer is the difficulty adjustment, one of Bitcoin’s most elegant and underappreciated design features.
The difficulty adjustment is a mechanism built into Bitcoin’s software that periodically changes the difficulty of finding a valid block. It does this by adjusting the "target" that a block's hash must meet. As more miners join the network and add computational power, blocks are found more quickly. When miners leave or shut down their machines, blocks take longer to be found.
To maintain stability, Bitcoin adjusts its difficulty level every 2016 blocks, or about every two weeks. At that time, the software evaluates how long it took to mine the previous 2016 blocks.
- If it took less than two weeks, the blocks were found too quickly, so the difficulty increases.
- If it took more than two weeks, the blocks were found too slowly, so the difficulty decreases.
- If it took exactly two weeks, the difficulty level stays the same.
This feedback loop maintains an average block time of around ten minutes, regardless of the total amount of mining power applied to the network.
In the early days, Bitcoin’s difficulty was extremely low because only a handful of CPUs were mining. As more miners joined, and specialized ASIC hardware was developed, the network’s total hashrate increased dramatically, and difficulty skyrocketed in response. Today, mining represents billions of dollars in infrastructure, which explains why the difficulty level is so high.
Without the difficulty adjustment, Bitcoin would break in either direction:
- If mining became too easy, blocks would arrive too quickly, making global consensus fragile.
- If mining became too hard, blocks might arrive once every few hours or days, making the network practically unusable.
Instead, Bitcoin adapts automatically and indefinitely. It is a self-regulating system that reacts to changes in market conditions, energy prices, hardware innovation, and miner competition. This design ensures predictable issuance, reliable settlement, and long-term network security.
How are bitcoins created?
New bitcoins enter circulation through a reward called the block subsidy, which miners receive for successfully adding a block to the blockchain. This subsidy started at 50 BTC per block and automatically halves every 210,000 blocks, roughly every four years, in an event known as the Halving. This schedule controls Bitcoin’s supply and is why a maximum of 21 million bitcoin will ever exist.
Alongside the subsidy, miners also collect transaction fees from all transactions included in the block. Over time, as the subsidy approaches zero (around the year 2140), fees are expected to become the primary incentive that compensates miners for securing the network.
Every block, therefore, achieves two things at once:
- It mints new bitcoins according to the network’s fixed issuance schedule.
- It settles transactions and pays fees to the miner who found the block.
This design ensures that new bitcoins are created predictably, transparently, and without central authority, while gradually transitioning miner compensation from inflation to user-paid transaction fees.
Conclusion
These concepts only scratch the surface of how Bitcoin works. At Aureo, we believe Bitcoin education is essential for Latin America, and this series of articles is part of our mission to raise the standard in the region.
If you want to follow Bitcoin’s technical progress, we recommend the Bitcoin Optech newsletter, where Aureo’s CEO Gustavo Flores Echaiz contributes regularly. We also recommend reading "Mastering Bitcoin" by Andreas M. Antonopoulos, which is available for free online.
If you understood this article, you now grasp how Bitcoin works and why it is revolutionary. You should not wait any longer to start buying Bitcoin. Start today by signing up with Aureo.