Bitcoin is a decentralized digital currency created in January 2009 that you can buy, sell and exchange directly, without an intermediary authority like a bank. It relies on peer-to-peer software and cryptography technology, protocols, and processes, and Bitcoin has the lowest transaction fees than other online payment methods.
Bitcoin has inspired hundreds of digital currencies, but it remains the largest cryptocurrency by market capitalization, a distinction it has held throughout its decade-long history.
The true identity of the person who created the Bitcoin technology is still a mystery. Its development follows the ideas set out in a whitepaper by the pseudonymous Satoshi Nakamoto.
As per the Bitcoin Foundation, the word “Bitcoin” is capitalized when referring to the cryptocurrency as an entity. It is written as “bitcoin” when related to the quantity of the currency or the units themselves, and it is also abbreviated as BTC.
It is worth mentioning that each Bitcoin transaction ever been processed exists on a public ledger, making each transaction hard to fake and reverse. Governments or financial institutions do not back Bitcoins, and there’s nothing to guarantee their monetary value besides the proof integrated into the core of the bitcoin software.
Since its launch in 2009, Bitcoin value and adoption have risen exponentially. Although it once sold for under $100 per coin, as of August 1, 2021, one Bitcoin sells for $50,000. Because its supply is already limited to 21 million coins, it is expected that its price will keep rising as more large investors begin treating it as a sort of digital gold to hedge against market volatility and inflation.
As you keep traditional coins in a physical wallet, cryptocurrencies are stored in digital wallets and accessed from client-side software or various online and physical hardware tools.
How Bitcoin works?
Bitcoin is developed on a distributed digital record called a blockchain. It is a linked set of data, made up of individual units called blocks. These blocks have details about each transaction, including the total value, date and time, buyer and seller info, and a unique identifying code for each exchange.
The bitcoin ecosystem is a collection of computing machines, referred to as nodes or miners, that all run bitcoin software code and store its blockchain. Entries are put together in chronological order, creating a digital chain of blocks. After a block is added to the blockchain, it becomes accessible to all, acting as a public ledger of cryptocurrency transactions.
The intricate process that maintains this public ledger is known as mining. An extensive network of miners who record these transactions on the blockchain is at the backend of Bitcoin users who trade the cyber currency among themselves.
Recording a string of transactions is easy for a modern computer, but crypto mining is difficult because Bitcoin makes the process artificially time-consuming.
Whether they run a bitcoin node or not, anyone can see these transactions occurring in real-time. A bad actor must generate 51% of the computational processing power that creates a bitcoin to perform a malicious act. Bitcoin has approximately 10,000 nodes as of August 2021, which is expanding, making such a malicious attack extremely difficult. But if a vicious attack does happen, bitcoin miners would likely fork to a new blockchain, blocking the effort of the bad actor.
It may sound risky that anyone can edit the blockchain. It’s actually what makes bitcoin transactions secure. The transaction block is added to the Bitcoin blockchain only if the majority of all Bitcoin miners verify it.
The unique codes used to recognize bitcoin wallets and transactions must conform to the correct encryption codes. These patterns are long, random numbers, making them extremely difficult to produce by fraud.
A hacker guessing the necessary code to your Bitcoin wallet has roughly the same odds as someone winning a lottery ten times in a single row.
This level of statistical randomness of blockchain verification codes, needed for every transaction, dramatically reduces the risk of fraudulent Bitcoin transactions.
Bitcoin mining software adjusts the difficulty miners face to limit the network to a new 1-megabyte block of transactions every 10 minutes. In this way, the volume of transactions is digestible. The network has time to check the new partnership and the ledger that precedes it, and everyone can reach a consensus about the status quo.
In theory, a contract can be established between the two parties on a blockchain as long as both agree on the contract. This removes the need for a third party to be involved in any agreement. It gives a world of possibilities such as peer-to-peer financial products, wherein banks or intermediaries, are irrelevant. In the case of Bitcoin, though, the information on the blockchain is only transactions.
The decentralized nature of Bitcoin is one of the qualities that have made it popular with people suspicious of government authorities.
If any government made it illegal to participate in the bitcoin network, the mining machines keeping the records in other countries would continue.
With traditional currency, you have to transact through a bank or other financial institutions. However, Bitcoin has made this unnecessary. (It is probably no coincidence that Nakamoto’s white paper on Bitcoin was published in 2008 when trust in banks was at an all-time low.
No one must know or trust any other person for the Bitcoin core system to operate smoothly. Assuming every step is working as it should be, the cryptographic protocols ensure that each block of transactions is glued onto the last in a long, transparent, and immutable chain.
Cryptocurrency miners are rewarded with Bitcoins for verifying blocks of transactions. This reward is cut in half every 210,000 blocks mined or about every four years. This specific event is called “the halving.” The bitcoin mining system is built-in as a deflationary one for the new Bitcoin’s rate to be released into general circulation.
This process of halving is designed so that rewards for Bitcoin mining will continue until 2140. At that time, when all Bitcoins are mined from the code, and all halvings are finished, the miners will remain incentivized by the fees to charge network users. The hope is that positive competition will keep costs at a minimum.
This system integrated into bitcoin mining software drives up Bitcoin stock-to-flow ratio and lowers its inflation until it is zero. The third halving took place on May 11, 2020, and the reward for each block mined became 6.25 bitcoins.
Technical details of mining
The network of miners, who are distributed across the globe, receives the latest batch of transaction data. They execute that data through a cryptographic algorithm that generates a “hash,” a string of numbers and letters that verifies the validity of information but does not reveal the data itself.
If there is hash, 000000000000000000c2c4d562265f272bd55d64f1a7c22ffeb66e15e826ca30, you do not know what transactions the relevant block (#480504) contains. You can, however, take some data purporting to be block #480504 and make sure that it is not subject to any tampering.
If one number is out of place, the data will generate a different hash.
The bitcoin hash technology allows the Bitcoin network to check the validity of a block instantly. It would be challenging to sift the entire ledger to ensure that the person mining the most recent batch of transactions has not tried anything nefarious. Instead, the previous block’s hash appears within the new block. If some detail had been altered in the previous block, that hash would change. Even if the alteration were 5,000 blocks back in the chain, that block’s hash would set off a cascade of new hashes and alert the network.
Generating a hash is not work in a bitcoin mining system. The process is so quick that hackers could still spam the mining network and pass off fraudulent transactions a few blocks back in the blockchain, given enough computing power. To prevent this, the Bitcoin mining protocol requires a “proof of work.”
This is achieved by requiring miners to have a hash that must be below a specific target. That’s why block #480504’s hash starts with a long string of zeroes. Every data string will generate only one hash, and the quest for a sufficiently small hash involves adding nonces (“numbers used once”) to the end of the data. So a miner will run [data]. If the hash is too big, the miner will try again, [data]1. Still too big, the miner will run [data]2. Finally, [thedata]93452 yields miner a hash beginning with the required number of zeroes.
The mined block will broadcast to the global network to receive confirmations, which take some more time to process. But, this description is over-simplified. Blocks are not hashed in their entirety but broken up into more efficient structures.
Miners could improve their chances of success by combining into mining pools, sharing computing power, and dividing the rewards among themselves. Even when a group of miners split these rewards, there is still enough incentive to pursue them. Each time a new block is mined, the victorious miner receives newly created bitcoins. In the beginning, it was 50, but then it halved to 25, and now it is 12.5.
The reward will continue to halve every 210,000 blocks or every four years until it is zero. All of the 21 million bitcoins will have been mined at that stage, and miners will depend only on fees to maintain the network. When Bitcoin was launched, it was planned that its total supply would be 21 million tokens.
For the majority of people participating in the Bitcoin mining network, the process of the blockchain and hash rates are not particularly relevant. Bitcoin owners outside of the mining domain usually purchase their bitcoins through a Bitcoin exchange like coinbase, poolin, etc. These are online platforms that process transactions of Bitcoin and, often, other digital currencies bring together market traders from around the world to sell and buy cryptocurrencies. These exchanges have been increasingly popular (as Bitcoin’s popularity has grown in recent years) and fraught with regulatory, legal, and security challenges.
Perhaps even more critical for Bitcoin exchange traders than the threat of changing regulatory oversight, however, is that of nefarious activity and other malicious activity. Though the Bitcoin network has primarily been secure throughout history, individual exchanges are not necessarily the same.
Many hacking groups have targeted famous cryptocurrency exchanges, resulting in the loss of millions of dollars worth of tokens. The most notorious exchange theft is likely from Mt. Gox, which dominated the Bitcoin transaction space until 2014.
Bitcoin Keys and Wallets
Bitcoin traders must take any possible security measures to protect their holdings. To do so, these participants use software-based keys and wallets.
Bitcoin ownership essentially depends upon two numbers: a username, a public key, and a password, a private key. A hash of the public key called an address is displayed on the blockchain. By using the hash, cryptocurrency trading provides an extra layer of security.
To receive bitcoins by the buyer, it is enough for the sender to know your address, a hash of the public key. The public key is created from the private key, which you need to send bitcoins to another address. The Bitcoin system makes it easy to receive money but requires verification of identity to send it.
The most crucial distinction is between “hot” wallets, which are connected to the Internet and therefore vulnerable to hacking, and wallets, which are not connected to the Internet.
How to buy Bitcoin?
Most people buy Bitcoin via exchanges, such as Coinbase, Gemini, poolin, etc. These exchanges allow you to buy, sell and hold Bitcoins and other cryptocurrencies. Setting up a cryptocurrency trading account is easy similar to opening a brokerage account—you’ll need to verify your identity and provide some funding source, such as a bank account or debit card.
Major exchanges include Coinbase and Kraken.
While Bitcoin is very expensive, you can buy fractional Bitcoin from many online vendors like Coinbase. You should be aware of bitcoin transaction fees, which are small percentages of your crypto transaction amount but can add up on large purchases, up to 100’s of dollars. Finally, keep in mind that Bitcoin purchases are not processed instantly like many other equity purchases. Because miners must verify Bitcoin transactions, it may take at least 20 minutes or longer to see your Bitcoin purchase in your cryptocurrency exchange account.
How to Use Bitcoin?
Bitcoin traders and miners generally use Bitcoin as an alternative investment, helping diversify their monetary portfolio apart from bonds and stocks. You can also use Bitcoin to make purchases in specific market sectors, but the number of online vendors that accept the cryptocurrency is limited.
Big companies that accept Bitcoin include Seimaxim and PayPal. You may also find that some local retailers or websites accept Bitcoin, but you will have to do some online research.
PayPal has recently announced that it will enable Bitcoin as a funding source for purchases this year, financing purchases by automatically converting bitcoin to fiat currency for 346 million users and 26 million merchants.
You can also use a service from Coinbase that allows you to connect a debit card to your bitcoin account, which means you can use Bitcoin the same way you use a credit card for online purchases or in grocery stores. This sometimes involves financial providers like Crypto.com and CoinZoom that instantly convert your Bitcoins into dollars.
Currently, in countries particularly with less stable local currencies, people sometimes use cryptocurrency instead of cash. Bitcoin provides an opportunity for traders to store value without relying on money that a State government backs. It gives people an option to hedge for a worst-case scenario. It is already seen in countries like Venezuela, Argentina, and Zimbabwe. Bitcoin is getting tremendous traction in countries heavily in debt.
In the United States, when you use Bitcoin as a currency, not an investment, you must be aware of specific tax implications.
How to Invest in Bitcoin?
Similar to a stock, you can buy and hold Bitcoin as an investment fund.
Whether you choose to stock your Bitcoin, point of view on investing it vary: Some buy and maintain long term, some buy and aim to sell after a price rally, and others bet on its price decreasing. Bitcoin’s price over time has experienced significant price swings, going as low as $3,000 and as high as 50,000 in 2021.
Consumers can invest in a Bitcoin mutual fund by buying the Grayscale Bitcoin Trust (GBTC). However, it is currently only open to accredited investors who make at least $200,000 or have at least $1 million net worth. So, the majority of consumers aren’t able to buy it. In some countries, however, Bitcoin investment is becoming more accessible. In February 2021, Purpose Bitcoin ETF (BTCC) started trading, and the Ontario Securities Commission has also approved the Evolve Bitcoin ETF (EBIT). Potential investors looking for Bitcoin investment may consider blockchain ETFs that invest in Bitcoin technology.
An important note, though, is that while Bitcoin funds may add diversification to cryptocurrency holdings and decrease the risk to your funds slightly, they still carry substantially more risk and charge much higher fees than broad-based index funds that have histories of stable returns. It is advisable that investors looking to grow wealth steadily may opt for index-based mutual and exchange-traded funds.
Should you buy Bitcoin?
Many financial experts support their clients’ intent to buy cryptocurrency, but they do not recommend it unless clients express interest. The speculative nature of bitcoin leads some planners to recommend it for secondary investments only.
Bitcoin is like a single stock, and good advisors do not recommend putting a large part of your portfolio into any single company. At most, planners suggest putting close to 1% to 20% into Bitcoin if you are eager about it. If it were one stock, it is advisable to never allocate any significant portion of your investment to it.