What is Bitcoin?
What Is Bitcoin?
Bitcoin (BTC) is a cryptocurrency. It is designed to act as money and a form of payment outside the control of any one person, group, or entity. This removes the need for trusted third-party involvement (e.g., a mint or bank) in financial transactions. It's an appealingly simple concept: bitcoin is digital money that allows for secure peer-to-peer transactions on the internet.
Unlike services like Venmo and PayPal, which rely on the traditional financial system for permission to transfer money and on existing debit/credit accounts, bitcoin is decentralized: any two people, anywhere in the world, can send bitcoin to each other without the involvement of a bank, government, or other institution.
It is a virtual currency. Bitcoin can be used as a currency or an investment.
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key takeaways:
1. Bitcoin is the end product of the work of many people, but it is generally accepted that Satoshi Nakamoto created it and introduced it in 2008.
2. Bitcoin is the public blockchain used to create and manage the cryptocurrency of the same name.
3. Bitcoin mining is the race between miners to hash block information, find the solution to a hashing problem, and add a block to the blockchain. The winning miner is rewarded with bitcoins.
4. Bitcoin can be used by speculators, investors for investing purposes, and consumers for purchases or value exchange.
5. There are many risks involved with investing in and using bitcoins, including volatility, fraud, and theft
6. Bitcoin operates without government or central bank control, relying on a blockchain maintained by a global network of users.
7. With a limit of 21 million coins, Bitcoin is scarce, which helps to drive its value as a potential store of wealth.
8. Bitcoin transactions are verified through a proof-of-work system, where miners compete to add new blocks to the blockchain.
9. Initially designed for transactions, Bitcoin is now widely used as an investment and peer-to-peer financial tool.
10. Bitcoin can be stored in software wallets for convenience or hardware wallets for greater security.
The Bitcoin protocol is built on three essential components:
Public-private key cryptography: Wallet software assigns Bitcoin owners both a public key and a private key. A public key is used to create a public wallet address for receiving inbound transactions and verifying digital signatures. A private key functions like a password, and is used to create digital signatures that prove you own funds when sending transactions.
Peer-to-peer networking: Nodes (computers running the software) review transactions to ensure the software’s rules are being followed. Bitcoin miners (nodes that use a specialized computer program that allows them to verify newly submitted transactions) then compete for the right to propose a new batch of pending transactions to join the blockchain.
A finite supply: According to the software rules, no more than 21 million Bitcoin can ever be in circulation—a limit that gives Bitcoin value.
How Bitcoin works:
Unlike credit card networks like Visa and payment processors like Paypal, bitcoin is not owned by an individual or company. Bitcoin is the world’s first completely open payment network which anyone with an internet connection can participate in. Bitcoin was designed to be used on the internet, and doesn’t depend on banks or private companies to process transactions.
One of the most important elements of Bitcoin is the blockchain, which tracks who owns what, similar to how a bank tracks assets. What sets the Bitcoin blockchain apart from a bank's ledger is that it is decentralized, meaning anyone can view it and no single entity controls it.
Each Bitcoin is a digital asset that can be stored at a cryptocurrency exchange or in a digital wallet. Each individual coin represents the value of Bitcoin’s current price, but you can also own partial shares of each coin. The smallest denomination of each Bitcoin is called a Satoshi, sharing its name with Bitcoin’s creator. Each Satoshi is equivalent to a hundred millionth of one Bitcoin, so owning fractional shares of Bitcoin is quite common.
Blockchain: Bitcoin is powered by open-source code known as blockchain, which creates a shared public history of transactions organized into "blocks" that are "chained" together to prevent tampering. This technology creates a permanent record of each transaction, and it provides a way for every Bitcoin user to operate with the same understanding of who owns what.
Private and public keys: A Bitcoin wallet contains a public key and a private key, which work together to allow the owner to initiate and digitally sign transactions. This unlocks the central function of Bitcoin securely transferring ownership from one user to another.
Bitcoin mining: Users on the Bitcoin network verify transactions through a process known as mining, which is designed to confirm that new transactions are consistent with other transactions that have been completed in the past. This ensures that you can’t spend a Bitcoin you don’t have, or that you have previously spent.
How To Buy Bitcoin:
If you don't want to mine Bitcoin, you can buy it using a cryptocurrency exchange. Most people will be unable to purchase an entire BTC because of its price, but you can buy portions of one BTC on these exchanges in fiat currency, such as U.S. dollars.
The easiest way to buy bitcoin is to purchase it through an online exchange like Coinbase. Coinbase makes it easy to buy, sell, send, receive, and store bitcoin without needing to hold it yourself using something called public and private keys.
However, if you choose to buy and store bitcoin outside of an online exchange, here’s how that works.
1. Each person who joins the bitcoin network is issued a public key, which is a long string of letters and numbers that you can think of like an email address, and a private key, which is equivalent to a password.
2. When you buy bitcoin—or send/receive it—you get a public key, which you can think of as a key that unlocks a virtual vault and gives you access to your money.
3. Anyone can send bitcoin to you via your public key, but only the holder of the private key can access the bitcoin in the “virtual vault” once it’s been sent.
4. There are many ways to store bitcoin both online and off. The simplest solution is a virtual wallet.
5. If you want to transfer money from your wallet to a bank account after selling your bitcoin, the Coinbase app makes it as easy as transferring funds from one bank to another. Similar to conventional bank transfers or ATM withdrawals, exchanges like Coinbase set a daily limit, and it may take between a few days and a week for the transaction to be completed.
What is the purpose of bitcoin?
Bitcoin was created as a way for people to send money over the internet. The digital currency was intended to provide an alternative payment system that would operate free of central control but otherwise be used just like traditional currencies.
Are bitcoins safe?
The cryptography behind bitcoin is based on the SHA-256 algorithm designed by the US National Security Agency. Cracking this is, for all intents and purposes, impossible as there are more possible private keys that would have to be tested (2256) than there are atoms in the universe.
There have been several high profile cases of bitcoin exchanges being hacked and funds being stolen, but these services invariably stored the digital currency on behalf of customers. What was hacked in these cases was the website and not the bitcoin network.
In theory if an attacker could control more than half of all the bitcoin nodes in existence then they could create a consensus that they owned all bitcoin, and embed that into the blockchain. But as the number of nodes grows this becomes less practical.
How To Use Bitcoin:
Bitcoin was initially designed and released as a peer-to-peer payment method. However, its use cases are growing due to its increasing value, competition from other blockchains and cryptocurrencies, and developments on blockchains that process information for the Bitcoin blockchain.
Risks of Investing in Bitcoin:
Bitcoin had a price of $7,167.52 on Dec. 31, 2019, and a year later, it had appreciated more than 300% to $28,984.98. It continued to surge in the first half of 2021, trading at a record high of $69,000 in November 2021. It then fell over the next few months to hover around $40,000 and rose with increasing speed in 2024 to more than $100,000.10
As a result of such price movements, many people purchase Bitcoin for its investment value rather than its ability to act as a medium of exchange. However, the lack of guaranteed value and its digital nature means its purchase and use carry several inherent risks.
Here are some of the risks that you're exposed to when trading or investing in Bitcoin:
Regulatory risk: The continuous battle between cryptocurrency-related projects and regulators makes longevity and liquidity an unknown. As of December 2024, Bitcoin is not considered a security by the authorities, but that stance could change in the future.
Security risk: Most individuals who own and use Bitcoin have not acquired their tokens through mining operations. Rather, they buy and sell Bitcoin and other digital currencies on popular cryptocurrency exchanges. These exchanges are entirely digital and are at risk from hackers, malware, and operational glitches.
Insurance risk: Bitcoin and other cryptocurrencies are not insured by the Securities Investor Protection Corporation (SIPC) or the Federal Deposit Insurance Corporation (FDIC). However, some exchanges provide insurance through third parties. For instance, Gemini and Coinbase offer cryptocurrency insurance, but only for failures in their systems or cybersecurity breaches. Any cash deposits you've made at either exchange might be eligible for "pass-through" FDIC coverage.111213
Fraud risk: Even with the security measures inherent within a blockchain, there are still opportunities for fraudulent activity.
Market risk: As with any investment, Bitcoin values can fluctuate. Indeed, the currency's value has seen wild price swings over its short existence. Subject to high volume buying and selling on exchanges, it is highly sensitive to any news events related to it.
How do you store Bitcoin?
Bitcoin, like all other cryptocurrencies, exists purely in digital form. To store these assets, holders need specialized Bitcoin wallets. Many Bitcoin startups focus on providing secure storage solutions for users.
How does Bitcoin make money?
New Bitcoins are created as part of the Bitcoin mining process, in which they are offered as a lucrative reward to people who operate computer systems that help to validate transactions. Bitcoin miners — also known as "nodes" — are the owners of high speed computers which independently confirm each transaction, and add a completed "block" of transactions to the ever-growing "chain." The resulting blockchain is a complete, public and permanent record of every Bitcoin transaction.
Miners are then paid in Bitcoin for their efforts, which incentivizes the decentralized network to independently verify each transaction. This independent network of miners also decreases the chance for fraud or false information to be recorded, as the majority of miners need to confirm the authenticity of each block of data before it's added to the blockchain in a process known as proof-of-work.
How is Bitcoin taxed?
Like other cryptocurrencies, sales of Bitcoin are subject to short-term capital gains tax rates if the Bitcoin was held for a year or less, or long-term capital gains tax rates if the Bitcoin was held for more than a year.
