What is Bitcoin and how does it work?

Not only is Bitcoin the first cryptocurrency, but it is also the most well-known of the more than 5,000 cryptocurrencies available today. Financial media eagerly covers every new dramatic downturn, making Bitcoin an inevitable part of the landscape.

While the wild volatility can make headlines, it hardly makes Bitcoin the best choice for beginners or people looking for a stable value store. Understanding the stakes can be tricky – let’s take a closer look at how Bitcoin works.

What is Bitcoin?

Bitcoin is a decentralized digital currency that you can buy, sell and exchange directly without an intermediary like a bank. Bitcoin’s creator, Satoshi Nakamoto, originally described the need for “an electronic payment system based on cryptographic proof instead of trust.”

Every Bitcoin transaction ever made exists on a public ledger that is accessible to everyone, making transactions difficult to reverse and difficult to counterfeit. It’s by design: the core of their decentralized nature is not supported by Bitcoins by the government or any issuing institution, and there is no guarantee of their value except the proof at the heart of the system.

“The reason it’s worth money is simply because we humans decided it had value – the same as gold,” said Anton Mozgovoy, co-founder and CEO of the digital financial services company Holyheld.

Since its public launch in 2009, Bitcoin has risen dramatically in value. Even though it was once sold for under $ 150 per coin, a Bitcoin is now being sold from March 1, 2021 for almost $ 50,000. As supply is limited to 21 million coins, many expect the price to continue to rise over time, especially as more large institutional investors begin to treat it as a kind of digital gold to secure against the market. volatility and inflation.

How does Bitcoin work?

Bitcoin is based on a distributed digital record called blockchain. As the name suggests, blockchain is a linked data component consisting of units called blocks that contain information about each transaction, including date and time, total value, buyers and sellers, and a unique identification code for each exchange. The posts are joined in chronological order and create a digital chain of blocks.

“Once a block is added to the blockchain, it becomes available to anyone who wants to see it, and acts as a public ledger for cryptocurrency transactions,” said Stacey Harris, consultant for Pelicoin, a network of cryptocurrency ATMs.

Blockchain is decentralized, which means that it is not controlled by any organization. “It’s like a Google Doc that anyone can work with,” said Buchi Okoro, CEO and co-founder of African cryptocurrency exchange Quidax. Nobody owns it, but anyone who has a link can contribute to it. And when different people update it, your copy is also updated. ”

While the prospect that anyone can edit the blockchain may sound very risky, it is actually the core of what makes Bitcoin secure. To begin with, in order for a transaction block to be added to the Bitcoin blockchain, it must be verified by the majority of all Bitcoin holders, and the unique codes used to recognize users’ wallets and transactions must conform to the correct encryption pattern.

These codes are long, random numbers, making them incredibly difficult to deceive. In fact, a fraudster who guesses the key code in your Bitcoin wallet has about the same odds as someone who wins a Powerball lottery nine times in a row, according to Bryan Lotti of Crypto Aquarium. This level of statistical random blockchain verification codes, required for each transaction, significantly reduces the risk of someone making fake Bitcoin transactions.

How does Bitcoin Mining work?

Bitcoin mining is the process of adding new transactions to the Bitcoin blockchain. It’s a tough job. People who choose to break Bitcoin use a process called proof of work and distribute computers in a race to solve mathematical puzzles that verify transactions.

To entice miners to continue competing to solve puzzles and support the overall system, the Bitcoin Code rewards miners with new Bitcoins. “This is how new coins are created” and new transactions are added to the blockchain, says Okoro.

In the beginning, it was possible for the average person to break Bitcoin, but that is no longer the case. The Bitcoin code is written to make solving their puzzles more and more challenging over time, requiring more and more computer resources. Today, Bitcoin mining requires powerful computers and access to large amounts of cheap electricity to succeed.

Bitcoin mining also pays less than before, making it even harder to recoup the rising computational and electrical costs. “In 2009, when this technology first came out, you got a much larger amount of Bitcoin than you do today,” said Flori Marquez, co-founder of BlockFi, a cryptocurrency company. “There are more and more transactions [now, so] The amount you get paid for each stamp is smaller and smaller. In 2140, all Bitcoins are estimated to have gone into circulation, which means that mining does not release any new coins, and miners may instead have to rely on transaction fees.

How to use Bitcoin

In the United States, people generally use Bitcoin as an alternative investment, which helps diversify a portfolio in addition stock and bonds. You can also use Bitcoin to make purchases, but the number of providers that accept cryptocurrency is still limited.

Major companies that accept Bitcoin include Overstock, AT&T and Twitch. You may also think that some small local retailers or websites take Bitcoin, but you need to dig a little deeper.

As said PayPal has announced that it will enable cryptocurrency as a source of financing for purchases this year, finance purchases by automatically converting crypto holdings to fiat currency for users.

“They have 346 million users and they are connected to 26 million merchants,” said Spencer Montgomery, founder of Uinta Crypto Consulting. “Its huge.”

You can also use a service that allows you to connect a debit card to your crypto account, which means that you can use Bitcoin in the same way as you use a credit card. This generally also means that a financial provider immediately converts your Bitcoin into dollars. “Crypto.com and CoinZoom are two services regulated in the United States,” says Montgomery.

In other countries – especially those with less stable currencies – people sometimes use cryptocurrency instead of their own currency.

“Bitcoin allows people to store value without relying on a government-backed currency,” says Montgomery. “It gives people the opportunity to secure for a worst case. You already see people in countries like Venezuela, Argentina, Zimbabwe – in countries that are highly indebted, Bitcoin gets a huge traction. ”

That said, when using Bitcoin as a currency, not an investment, in the United States, you need to be aware of some tax consequences.

How to buy Bitcoin

Most people buy Bitcoin through exchanges, for example Coinbase. Exchanges allow you to buy, sell and hold cryptocurrencies, and creating an account is similar to opening a broker account—You must verify your identity and provide some form of funding, e.g. a bank account or bank card.

Major exchanges include Coinbase, Kraken and Gemini. You can also buy Bitcoin from a broker like Robinhood.

No matter where you buy your Bitcoin, you need a digital wallet where you can store it. This can be what is called a hot wallet or a cold wallet. A hot wallet (also called an online wallet) is stored by an exchange or a provider in the cloud. Online wallet providers include Exodus, Electrum and Mycelium. A cold wallet (or mobile wallet) is an offline device used to store Bitcoin and is not connected to the Internet. Some mobile wallet options include Trezor and Ledger.

Some Important Notes on Buying Bitcoin: Although Bitcoin is expensive, you can buy fractional Bitcoin from some providers. You also need to watch out for fees, which are generally small percentages of your crypto transaction amount, but which can really add up to purchases in small dollars. Finally, be aware that Bitcoin purchases are not immediate as many other stock purchases seem to be. Because Bitcoin transactions must be verified by miners, it can take at least 10-20 minutes to see your Bitcoin purchase in your account.

How to invest in Bitcoin

As a stock, you can buy and hold Bitcoin as an investment. You can also do it now in special pension accounts called Bitcoin IRA.

No matter where you choose to hold your Bitcoin, people’s philosophies about how to invest it vary: Some buy and hold in the long run, others buy and aim to sell after a price rally, and others bet that the price drops. Bitcoin’s price over time has experienced large price fluctuations, as low as $ 5,165 and as high as $ 28,990 in 2020 alone.

“I think some places can use Bitcoin to pay for things, but the truth is that it is an asset that looks like it will increase in value relatively quickly over time,” Marquez said. “So why would you sell something that will be worth so much more next year than it is today? The majority of people who own it are long-term investors. ”

Consumers can also invest in a Bitcoin fund by buying shares in the Grayscale Bitcoin Trust (GBTC), but it is currently only open to accredited investors who earn at least $ 200,000 or have a net worth of at least $ 1 million. This means that the majority of Americans cannot buy it. In Canada, however, diversified Bitcoin investment is becoming more available. In February 2021, the Purpose Bitcoin ETF (BTCC) began trading as the world’s first Bitcoin ETF and the Evolve Bitcoin ETF (EBIT) has also been approved by the Ontario Securities Commission. US investors looking for Bitcoin or Bitcoin-like exposure may consider blockchain ETFs that invest in the technology underlying cryptocurrencies.

An important note, however: Although crypto-based funds can add diversification to crypto holdings and reduce risk somewhat, they still have significantly more risk and charge much higher fees than broad-based ones. index fund with stories of steady returns. Investors who want to grow wealth steadily can choose index-based mutual and exchange traded funds (ETFs).

Are you going to buy Bitcoin?

In general, many financial experts support their clients’ desire to buy cryptocurrency, but they do not recommend it unless clients express interest. “The biggest problem for us is if someone wants to invest in crypto and the investment they choose is not going well, and suddenly they can not send their children to college,” said Ian Harvey, a certified financial planner (CFP) in New York City. “Then it was not worth the risk.”

The speculative nature of cryptocurrency causes some planners to recommend it for customers’ “side investments”. “Some call it a Vegas account,” said Scott Hammel, CFP of Dallas. “Let’s keep this away from our real long-term perspective, make sure it does not become too large a part of your portfolio.”

In a very real sense, Bitcoin is like a single stock, and advisors would not recommend that you invest a significant portion of your portfolio in a company. At most, planners suggest that you do not put more than 1% to 10% in Bitcoin if you are passionate about it. “If it were a stock, you would never allocate any significant part of your portfolio to it,” says Hammel.