From The Bitcoin Reference, the plain-language encyclopedia of Bitcoin vocabulary

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If you are new to Bitcoin, read these seven steps in order. Each one introduces a handful of ideas, names the glossary entries behind them, and ends with a question to think about. By the end you will be able to follow most explanations of how Bitcoin works, whoever is giving them.

No mathematics beyond counting is needed, and nothing here assumes you own any bitcoin. The steps build on one another: a transaction needs outputs, outputs need keys, blocks collect transactions, mining orders the blocks, and nodes check all of it. Teachers may find it useful to set one step per session, or to print the whole path using the button below.

1. 1

   Step 1

   A shared record with no keeper

   Start with the problem. Money has always needed a record keeper, someone to note who has what and to refuse a payment that has already been spent. Online, that keeper is usually a single organisation. Bitcoin takes a different route. It is a Peer-to-peer system in which many independently run computers each hold a copy of the same record, the Blockchain, and all follow the same published rules for adding to it.

   The central difficulty is the Double spend. Digital information can be copied at no cost, so what stops the same coins being sent to two different people? Everything else on this path, from outputs to blocks to mining, is part of the answer. The design was set out in a short Whitepaper in 2008, and the first block followed in January 2009.

   Keep one idea in mind as you read: nothing here asks you to trust a particular party. It asks you to understand rules that anyone can check.

   Key terms Peer-to-peer Blockchain Double spend Whitepaper

   Pause and check

   Question. In your own words, what problem does the term “double spend” describe?

   Answer. It is the risk that the same digital coins are sent to two different recipients. Preventing it without a central record keeper is the problem that Bitcoin’s design sets out to solve.

   Mark step 1 as read

2. 2

   Step 2

   Coins are outputs

   Bitcoin has no accounts with balances. Instead, a Transaction spends earlier outputs and creates new ones. An output that has not yet been spent is called a UTXO, short for unspent transaction output. When a transaction names an output that it intends to spend, that reference is an Input.

   Think of banknotes. If you hold a note worth more than your purchase, you hand it over and receive change. A transaction behaves the same way: its inputs are used up whole, its outputs pay the recipient, and a Change output returns the rest to the sender. The small gap between what goes in and what comes out is the Fee, which the miner collects.

   A wallet’s “balance” is simply the sum of the unspent outputs it is able to spend, added up for your convenience. The ledger itself never stores a single balance.

   Key terms Transaction UTXO Input Output Change output Fee

   Pause and check

   Question. A wallet holds one unspent output worth more than the payment you want to make. What happens to the difference?

   Answer. A change output normally returns it to an address controlled by the sender. If no output claims the difference, it becomes a fee for the miner, which is why wallets check amounts carefully.

   Mark step 2 as read

3. 3

   Step 3

   Keys prove the right to spend

   Each output is locked by a condition, most often “a valid signature from the holder of a particular key”. Two numbers make this work. A Private key is a secret. The matching Public key is calculated from it and can be shared freely. Producing a Digital signature needs the private key, while checking one needs only the public key, so everyone can confirm that a payment was authorised without being able to forge it.

   An Address is a compact destination built from a public key or a script. Most wallets generate many keys from one Seed phrase, a list of words that acts as the master backup. Anyone who has the words can spend the coins, and losing them with no other backup means losing access. The quality of the randomness used at the start, the Entropy, matters a great deal.

   Key terms Private key Public key Digital signature Address Seed phrase Entropy

   Pause and check

   Question. Of a public key, an address and a seed phrase, which one is never meant to be shared?

   Answer. The seed phrase. A public key and an address are designed to be shared, but the seed phrase can regenerate the private keys and so can be used to spend.

   Mark step 3 as read

4. 4

   Step 4

   Blocks and the chain

   Transactions that are waiting to be confirmed sit in each node’s Mempool. Miners gather some of them into a Block, a bundle that carries a Block header. The header includes the hash of the previous block’s header, and that link is what makes a chain. Change an old block and its hash changes, which breaks the link in every block after it.

   A Merkle tree condenses all of a block’s transactions into one fingerprint in the header. The first block ever created, the Genesis block, dates from January 2009, and the Block height of any block counts how far it is from there. A transaction becomes harder to reverse with every Confirmation, meaning every block built on top of the one that contains it.

   Key terms Mempool Block Block header Merkle tree Genesis block Confirmation

   Pause and check

   Question. Why does altering an old block break every block after it?

   Answer. Each header contains the hash of the previous header. Altering an old block changes its hash, so the next block’s reference no longer matches, and the mismatch continues up the chain unless all of the work is redone.

   Mark step 4 as read

5. 5

   Step 5

   Mining and proof of work

   Anyone can propose a block, so the network needs a way to decide whose block comes next. Mining provides it. Miners search for a block header whose hash falls below a target by changing the Nonce over and over. This is Proof of work: costly to produce, yet checked by anyone with a single hash.

   The target is set by Difficulty, which is recalculated every 2,016 blocks so that blocks keep arriving about every ten minutes on average, however much total Hash rate there is. The successful miner claims the Block subsidy and the fees through the Coinbase transaction. The subsidy began at 50 bitcoin and is cut in half every 210,000 blocks, an event called the Halving. That schedule is why the total supply approaches, but never exceeds, 21 million.

   Key terms Mining Proof of work Difficulty Hash rate Block subsidy Halving

   Pause and check

   Question. Why does it matter that proof of work is easy to check?

   Answer. Every node can verify a block with a single hash, so nobody has to take the miner’s word for it. The cost falls on the producer, while checking is cheap for everyone.

   Mark step 5 as read

6. 6

   Step 6

   Nodes, consensus and changing the rules

   Miners propose blocks; nodes decide. A Full node checks every block against the same rules and rejects any that break them. Consensus is the result: independent nodes following identical rules and the valid chain with the most work. Occasionally two blocks are found at once and a Stale block results, or a Reorganization moves nodes to a heavier branch.

   Rules can change, but cautiously. A Soft fork tightens the rules and stays compatible with nodes that have not upgraded, whereas a Hard fork loosens them and needs everyone to upgrade. Changes are usually discussed first as a BIP (Bitcoin Improvement Proposal). SegWit (Segregated Witness) and Taproot are two upgrades that arrived as soft forks.

   Key terms Full node Consensus Stale block Soft fork Hard fork BIP

   Pause and check

   Question. Why can a miner not simply break a rule and keep the block?

   Answer. Because nodes verify blocks independently. A block that violates the rules is rejected no matter how much work stands behind it.

   Mark step 6 as read

7. 7

   Step 7

   Holding and spending with care

   Finally, how people use the system. A Wallet manages keys and builds transactions; it does not contain coins. A Hot wallet sits on an internet-connected device, while Cold storage keeps keys offline, for example on a Hardware wallet. Self-custody means holding the keys yourself, with all of the responsibility that implies.

   Some common precautions follow from what you have read. Check an Address carefully before paying, because a payment cannot be recalled. Keep the Seed phrase off connected devices. Use a Block explorer to look up a transaction, and wait for enough confirmations when the amount matters. Beyond this path, the Lightning Network adds faster small payments on top of Bitcoin, and a Testnet allows practice with coins that carry no value.

   Key terms Wallet Hot wallet Cold storage Hardware wallet Self-custody Testnet

   Pause and check

   Question. A wallet does not contain coins. What does it contain?

   Answer. It holds the keys that control outputs on the public ledger, along with bookkeeping about which outputs are available to spend. The coins themselves exist only as outputs in the chain.

   Mark step 7 as read

Where to go next

With the seven steps behind you, test your understanding with the twelve-question quiz. Each answer is explained, and anything you miss is gathered into a review with links back to the relevant entries.

The glossary is the place for everything else. Search for any word you meet elsewhere, and follow the “see also” links to widen your picture. If you are teaching, the notes for teachers on the About page suggest ways to use each part of this reference in a lesson.