Bitcoin (BTC) is a decentralized peer-to-peer cryptocurrency that maintains its value without backing and without a central issuer. Transactions are confirmed by the participants of a globally distributed network and documented on the blockchain in a tamper-proof manner. The functionality of the system is based on cryptographically secured protocol mechanisms and the decentralized consensus of the network participants. There is no institutional control.
Bitcoin is managed via a wallet. This wallet can be created for the first time as a so-called hot wallet by using locally executed wallet software on an internet-capable device. During the setup process, a seed phrase (12 to 24 words) is generated, from which the keys required to dispose of Bitcoin are subsequently derived.
For a higher level of security, a wallet can be set up as a so-called cold wallet using a separate hardware device, such as BitBox, Ledger or Trezor. During this process, the seed phrase is generated within the hardware device and displayed there.
From the seed phrase, a private key is mathematically derived; from this, a public key is generated by cryptographic calculation, and from that the Bitcoin address is then created.
A seed phrase consists of 12 to 24 words and serves as a human-readable backup form of the underlying access data. It enables the wallet, including all associated keys and addresses, to be restored on another device or on a hardware wallet (backup).
It is therefore the central backup and recovery mechanism for the key structure of the wallet and the Bitcoin holdings controlled through it.
Although wallets are often described as “digital wallets”, cryptocurrencies are not stored in the wallet, but on the blockchain. Wallets manage the private keys that enable the digital signing of transactions and thus the transfer of Bitcoin. The signature proves to the network that the holder of the keys is authorized to dispose of the corresponding Bitcoin.
What is visible in the network is the Bitcoin address, which is used for the receipt of Bitcoin without thereby granting access to the corresponding holdings. It can be shared publicly without security risk. The Bitcoin address is derived from the public key. The public key is used for the verification of digital signatures and enables the network to check whether a transaction was authorized with the corresponding private key.
In the case of so-called custodial services, for example Trade Republic or Coinbase, the private key is held by the custodian and not by the user. Users of such services do not hold “their own” Bitcoin on the blockchain, but merely contractual claims against the provider, for example through collective custody or derivative representations such as ETNs.
Control over Bitcoin follows solely from control over the private keys (“not your keys, not your coins”) and is therefore decisive for economic attribution and actual power of disposition.
When a transaction is initiated, the wallet software creates a protocol-compliant transaction and signs it with the sender’s private key. The signed transaction is then transmitted to the node connected to the wallet. The receiving node automatically verifies whether the transaction complies with the protocol rules. If the transaction is valid, it is stored in the so-called mempool — a local waiting list for valid but not yet confirmed transactions — and forwarded to connected peers in the network.
These peers independently verify the transaction again and propagate it further, allowing it to spread throughout the entire peer-to-peer network within a short period of time.
Miners search their local mempool, which contains valid but not yet confirmed transactions, and select from it — usually according to economic criteria such as transaction fee levels — those transactions they wish to include in the next block. From these transactions, they create a complete block draft (“block candidate”), which already contains all necessary components but only becomes a valid block through a successful Proof of Work. In addition to the transactions, the block also contains a reference to the previous block of the existing blockchain.
In the Proof-of-Work system, miners compete to add the next block to the blockchain. Technically, their task is to repeatedly perform calculations in order to generate a hash that meets the difficulty requirements specified by the protocol. The probability of finding a valid hash is proportional to the amount of computing power deployed.
Once a valid hash is generated, the block is considered validly created. This hash serves as proof of work: it demonstrates that measurable computational effort has been expended. The block is then transmitted to the network and verified by the nodes. The nodes once again check whether the proof of work is correct, whether all included transactions remain valid, and whether the block properly connects to the previous block. If the block is accepted, it is appended to the existing blockchain. From that moment onward, the transactions contained within it are considered confirmed.
Because each new block contains the hash of its predecessor, a continuous chain of blocks is created. Within the network, the authoritative chain is the one that represents the greatest cumulative computational work. In this way, a uniform and binding blockchain is formed, on which all participants in the network reach consensus.
