Before you start dealing with crypto, you should know the answer to the question “What is Bitcoin?” It’s the first and most important cryptocurrency that paved the way for hundreds of altcoins, both good and worthless. In this article, we will explain what Bitcoin is based on, how it works, where you can buy it, and more.
TABLE OF CONTENTS
What Is Bitcoin And How Does It Work
Let’s start with what Bitcoin is, explained in simple terms.
What Is BTC: Definition And Basic Attributes
The basic Bitcoin definition would be: “It’s a decentralized, peer-to-peer, and 100% digital money based on the blockchain technology”.
Let’s see what each of these attributes stands for.
Decentralized. It means that Bitcoin does not depend on any central body. No government or bank can issue or control it. Instead, it’s issued utilizing a special mechanism called ‘mining’.
100% digital. This currency has no material representation, except for some collectible coins of gold and silver that no one would accept as payment. This feature makes BTC different from fiat money can be both digital (credit cards) and material (cash).
Peer-to-peer (P2P). To send and receive bitcoins, you don’t need any bank (or a similar centralized system) to manage the process. The money moves directly from one user to another. There’s no ‘trusted third party’: the BTC network ensures this trust using miners.
Blockchain-based. Blockchain or the Distributed Ledger Technology (DLT) is probably the biggest modern invention after the Internet. A blockchain network is a distributed database with all the records stored on many individual computers, and not in one place.
These were the basics to keep in mind. But to understand what Bitcoin is, exactly, we should explore how it applies to real life.
How Bitcoin works
As we mentioned earlier, Bitcoin transactions are P2P. You can send some digital money to another BTC network member directly. It may be a person you know or a complete stranger. The typical question from a beginner is “How I can trust the system and the sender/receiver if there is no central authority to control the process?”
It sounds logical. If you send money through a bank or a payment system like Western Union, this institution performs the procedure for you and charges a fee. A bank keeps all the transaction records and makes sure that your balance is correct. For instance, when you have bought something online for $100, the amount spent becomes unavailable to you even if the retailer hasn’t received the payment yet. How does the Bitcoin network deal with this problem? It seems that, if there’s no central body to control your financial activity, you can send the same bitcoins as many times as you want. Or, you can spend the money you don’t possess, can’t you?
To prevent the problem of ‘double spending’ the network uses a special mechanism. To understand how it functions, we will consider a typical cryptocurrency transaction step by step.
What Is Bitcoin Exactly: Real-Life Examples
Okay, you promised to send 1 BTC to your friend Alice. What would be your actions?
- You open your wallet, enter Alice’s address and the amount you are sending (1 BTC).
- Now, you have requested a transaction. Every computer in the BTC network (they are called nodes) gets aware of it.
- The miners validate your transaction through the Proof-of-Work mechanism the BTC network uses for this purpose. Their task is to confirm that you possess the amount you are sending and this money does not participate in another transaction.
- If your transaction meets these criteria, miners validate it. Then the transaction becomes a part of the next block in the chain. From now on, nobody can change or cancel it. Alice receives her money and you cannot undo it.
At this stage, you are probably wondering what mining and Proof-of-Work looks like. No worries, we will deal with these topics later in the article. Before it, we will have a closer look at a Bitcoin history.
What is Bitcoin and where it comes from? Here are some milestones:
- 2008: Satoshi Nakamoto, the anonymous creator of Bitcoin, publishes his White Paper. No one really knows who he was, but there are various versions. Among the favorites are Craig Wright, Gavin Anderson, Nick Szabo, and Dorian Prentice. All of them were involved with BTC at the early stages of its development. Satoshi was around for a couple of years after the BTC emerged, then he disappeared. His BTC stash (1/13 of the whole BTC inventory) remains untouched.
- 2009: Mining of the first (Genesis) block happens. It means the network starts to process transactions. Few people know about it, so it is a good chance to make some easy coins.
- 2010: The market cap reaches $1,000,000. Compare it with $160 billion today.
- 2011: Charlie Lee creates Litecoin (LTC), the first Bitcoin fork ever. The coin should become a lighter version of BTC, convenient for moving smaller amounts of money.
- 2012. Coinbase, one of the pioneer crypto exchanges is born.
- 2014. Tokyo-based crypto exchange Mt. Gox suffers the famous hack. The company declares it has lost over 850,000 BTC, around 6% of all coins in circulation.
- 2017: BTC and crypto become hype. Many people see investing in cryptocurrency as a get-rich-fast scheme. There are many ICOs (Initial Coin Offerings), using this fact to raise money for blockchain startups. Most of them are scam projects.
- 2018: The price of BTC plummets in September, 2 months after it reached its all-time high in June 2018. Crypto haters celebrate the fact that ‘the bubble’ has burst. it’s the 10th anniversary of Bitcoin.
- Recent times. Bitcoin price has been growing again. At the time of writing it costs around $9,073.
Understanding Bitcoin: The Basic Concepts
There are several important concepts and terms you should be familiar with if you seek to understand Bitcoin. They are private/public keys and BTC address. Here is what these things mean, in a nutshell.
- What is Bitcoin private key
At a glance, it’s a meaningless piece of code, consisting of many letters and numbers. The software you use to manage your crypto creates this code in a random manner. It applies a complicated encryption algorithm, so the probability of creating 2 identical codes is practically zero.
You need a private key to be able to receive money. It’s the thing that makes your funds yours. We may compare it to an email password or CVC.
- What is Bitcoin public key
A public key is a piece of code that your wallet creates together with the private key, using encryption. It’s a hash (product of SH256 cryptographic function) of your private key, so these two codes are a match. As the name suggests, you can give your public key to anyone.
- What is Bitcoin public address
A public address is a hash of your public key. You can see it as a version of your public key, but shorter and thus more convenient to use. If you want someone to send you money, you provide them with your public address. To make our financial activity harder to trace, we generate a new public address for every single transaction.
Bitcoin Transaction Properties
In this part, we will talk about the properties of BTC transactions. It will help you see the difference between the ways digital and fiat currencies work.
Any transaction in the Bitcoin network is:
- Irreversible, meaning it cannot be canceled.
As soon as miners add your transaction to the next block, it is carved in stone. And no one, including yourself, can un-carve it. In the case of traditional money, things are more flexible, especially if you deal with a credit card. In case you send your bitcoins to a scammer, there is no way to get them back.
- Pseudo-anonymous, meaning it is hard (but still possible) to trace your transaction to your real-life identity.
Bitcoin and other cryptocurrencies have a reputation of being ‘private’, but it’s not exactly the case. Some guys who used them for illegal darknet activities are now are serving time in prison. (There is a coin called Bitcoin Private (BTCP) to solve this issue. It’s a hard fork seeking to combine the best features of Bitcoin Core and Zclassic, one of the top-private cryptos).
As we said, you receive BTC on your public address, which everyone can view. Sometimes it’s possible to analyze this activity and make conclusions about who you are. Especially, if you don’t generate a unique address for every transaction.
If you don’t share your private keys with everyone and take some safety measures, you remain the only owner of your funds. Due to the sophisticated cryptography methods, no hacker can guess this key.
- Global and direct
You can send your Bitcoins to any other person who has a crypto wallet. It does not matter where in the world the receiver and sender are located. It makes crypto transactions cheap and fast. There any no banks and payment systems in between, so you skip their activity that costs you time and money. You only pay a small fee for processing your transaction, and it doesn’t depend on the amount you send.
Where Do I Buy Bitcoins
What is Bitcoin investment is and where can you buy this crypto? There are several ways for you to do it:
- Use a cryptocurrency exchange
There are many platforms where you can exchange ‘normal’ coins for digital ones. The most popular marketplaces are Coinbase, Binance, Huobi, Bittrex, Bitfinex, and some others.
- Install a Bitcoin wallet
A cryptocurrency wallet is a piece of software that allows managing your crypto. Visually, it’s similar to your banking app. Using such a wallet, you can buy BTC with crypto or fiat money from your PC or mobile.
- Find a Bitcoin ATM
The number of BTC AMT is increasing with every year. Here is a map to help you find one nearby.
A BTC ATM is easy to use: you have to scan the QR code of your Bitcoin address, insert some cash and press Send.
- Use an exchanger service
There is no multi-tier identity verification: It’s enough to provide a valid email and phone number. On an exchanger website, select BTC, enter the amount needed, see the price and payment options. Normally, such services apply less favorable exchange rates and charge higher commissions. Convenience and speed come with a price.
- Use a P2P exchange
Unlike a regular crypto exchange, a P2P one acts as a marketplace or dating website connecting individual users. Here, you can find a seller who offers bitcoins for an acceptable price and agrees to your type of payment. It may be PayPal, credit card or even hard cash. The exchange takes its fee for ‘match-making’, but it doesn’t guarantee you will be happy. Thus, we recommend you to be careful, especially if the seller insists on meeting offline. Some examples of P2P Bitcoin exchanges are Xcoins and LocalBitCoins.
Where Do I Store Bitcoin
Once you’ve bought some bitcoins using any of the methods above, it’s time to decide where you will be storing them.
You can store your Bitcoin using a wallet. There are various types of crypto wallets with their pros and cons. Cons don’t always mean that a wallet is bad, they may naturally result from the structure and purpose of this device/software.
Long story short, we may divide all the wallets into 2 big categories — hot and cold. Hot wallets have a connection to the Internet, and cold wallets are isolated from it. It makes them perfect storages for your bitcoins, especially if you deal with big amounts. Therefore, we will focus on this type below.
Dealing With Cold Wallets
Cold wallets fall into 2 categories — hardware and paper wallets. In the first case, it’s a sturdy device that resembles a USB drive (Ledger Nano S) or a keychain gadget (Trezor One). Most of the time they rest in a safe place. When you want to make a transaction, you connect the device to your PC and enter a PIN-code to get them matched. If the code is ok, you send the coins from your hardware wallet and then disconnect it. This storage is 99,99% secure. Your money and sensitive info stay out of reach of hackers even if your computer is infected by Bitcoin-specific malware.
Paper wallets look like pieces of paper (and they are). This is a printout with your private and public keys and QR codes representing them. Unless it gets destroyed, or damaged, or stolen, or eaten by your pet, you can always take it out of a bank vault and recover access to your BTCs. Security experts insist you should have several well-hidden copies — just in case.
Diversifying Your Funds
It would be a good idea to diversify your digital funds across different wallets. Keep the amount you need daily in a mobile wallet, so you could reach it easily. Store the bulk of your BTC fortune in a hardware wallet like Trezor, Ledger or KeepKey. If you are an active trader, get a wallet provided by a secure exchange.
Also, take all the necessary security measures — we will discuss them after we have done with the mining topic.
What Is Bitcoin Mining
Simply explained, mining is the process of adding blocks to the chain. Block is a data unit that stores a certain number of transactions. The number of transactions depends on the block size — the bigger is the block, the more information it contains. You can see a block as a page in a distributed ledger: if you rip it off, the whole story will fall apart. It’s because every new block contains a hash of the previous one, down to the genesis block.
BTC Mining Explained
So, who adds new pages to this record book? It’s done by miners. They are network nodes that use special soft- and hardware to solve extremely difficult math puzzles that come with each new block. This process if necessary to validate the transaction and make it an immutable part of the blockchain.
Solving the task requires a lot of computing resources. When a blockchain network is still young and contains few blocks, you can do mining with your PC or smartphone. As the network grows popular and more blocks join the chain, its mining difficulty increases. For instance, if you want to do mining in the BTC network that has been around for 10 years, you need to invest in powerful and rather expensive hardware. It consumes a huge amount of electricity that costs money, too. Besides, you need cooling equipment to avoid overheating and some room for all this machinery.
The question is, why miners spend their time and money to solve these puzzles? They do it to get a reward and a transaction fee. The first miner to solve the puzzle adds the new block and receives some newly-issued Bitcoins. Normally, a lucky winner sells these coins immediately to cover his mining expenses and grab some profit. That’s how new BTCs enter the market.
Proof-Of-Work Mechanism (PoW)
The Bitcoin network relies on the so-called proof-of-Work (PoW) consensus mechanism. ‘Work’ refers to the calculations miners do to solve the puzzle. When any of them comes up with the right guess, he gets rewarded. It means other competitors have wasted their resources.
To outcompete other miners, you need to buy and regularly upgrade your mining hardware. As we said, these machines are expensive and require a lot of wattages. Thus, the barrier to entry becomes too high for a solo miner. Right now, it makes more sense to enter one of the major mining pools that control the market. In a pool, miners join their resources to do the math. When someone solves the puzzle, the reward is split proportionately between the participants.
What Is Bitcoin Halving 2020
Another thing that makes Bitcoin mining less profitable with time is halving. It means the reward per block reduces by half.
It happens every 210,000 blocks or approximately every 4 years. Therefore, the next halving should happen on May 18, 2020. Usually, this event positively affects the BTC price, so many investors look forward to it. Miners are not so excited about the halving, though if the price of the coin grows it may partly compensate for their loss.
Halving is necessary to curb inflation and keep the value of the coin. Unlike traditional currencies, Bitcoin has a limited maximum supply that is 21,000,000 BTC. This number is determined by the coin protocol and cannot be increased.
Halving is an in-built mechanism that helps control the mining activity in the network. It slows down the release of new coins and thus makes them more scarce and wanted. When something good is also rare, it goes up in price. If you want to know more about how this thing works, read our article about halving.
Is Bitcoin Safe And Legal
The major users’ concerns related to Bitcoin are:
- Safety of use.
We will deal with each issue separately.
Bitcoin and other cryptos lack consistent and clear regulation. Therefore, some people avoid dealing with it as they don’t want any problems with the national tax service.
In general, taxation depends on the country and its laws. Cryptocurrency may have a status of legal tender (means of payment), or commodity, or ‘value represented in digital form’, or ‘financial instrument’. According to their status, different taxes may apply to your crypto transfers and mining profits. So, it would be a good idea to consult a tax advisor before converting your BTC holdings into fiat money or buying a house with them.
Is Bitcoin legal to use and could it lead to some problems with the law? Again, it depends on where you live and do business. Some states have developed a clear legal framework to attract blockchain startups. They are Japan, France, Malta, Estonia. Recently, China decided to follow this path, too.
The countries like Finland, Germany, UK, Switzerland have flexible regulations but are rather crypto-friendly in general.
Finally, there are some places where crypto is illegal. Some examples are Vietnam, Bolivia, Qatar, Afghanistan, Bangladesh, Saudi Arabia, Pakistan.
Safety Of Use
Many people lack understanding of cryptocurrency and blockchain. They see it as fiat money with benefits — faster and cheaper to transfer and easier to deal with.
What these people don’t understand is that all benefits have their price. Decentralization is a double-edged sword: it gives you independence from central authorities but requires you to be more responsible and better educated on the subject.
If you want your digital funds to be safe, you should:
- have some knowledge about how cryptocurrency works
- be aware it’s different from conventional money;
- follow some simple security rules.
Keep reading to get familiar with these rules.
What Do You Need To Know To Protect Your Bitcoins
There are many ways to lose your digital coins. Below are some mistakes BTC users regularly make.
- Losing or forgetting their private keys;
- Sharing these keys with other people;
- Ignoring basic safety measures;
- Keeping money on an exchange that ignores basic security measures or just cannot afford a strong cybersecurity team;
- Falling victims to online scammers;
- Taking part in scam ICOs.
How To Protect Your Funds
Though all these things can never happen to you, let’s see what precautions you should take — just in case.
- Apply all the recommended security measures. For instance, if you create an account on a crypto exchange, set up a strong password for it. Also, implement 2-Factor Authentication (2AF) and use a brand new email no one knows about.
- Install paid anti-virus software by a reliable developer. It will help keep your computer protected from malware, including crypto-specific viruses.
- Keep the bulk of your BTC fortune in cold storage. Keep the storage device itself in a safe place. Make sure you have a recovery phrase well-hidden, too.
- Backup your private key. If you forget or lose them, this is the end of your ownership. Create a backup of your wallet file and download it to a safe place, like a disconnected USB device. Or print it out and hide the paper copy well.
- Before depositing your crypto to an exchange, check if it can be trusted. Ask the community about their experience, see what security measures the platform offers, search for the history of successful hacks.
- Don’t talk about your crypto with strangers. Many people associate Bitcoin with Lambos, so you may attract unwanted attention to criminals or fraudsters.
- Be aware of the main traps scammers use to rob crypto users. Also, get updated on the most popular types of hacker attacks.
What Are The Pros And Cons Of Bitcoin
Like everything, Bitcoin has its pros and cons. We have already outlined some of them, but let’s sum it all up, starting with the pros.
Here are the reasons why we love Bitcoin:
- It’s decentralized and free from the whims of any government or central bank. In times of political or economic turbulence, the Bitcoin price tends to grow.
- It’s cheaper to transfer. You don’t have to pay huge and often hidden fees and agree to the exchange rates the banks apply to earn more. Instead, you pay a small operational fee. It does not depend on the amount of money your send.
- It’s fast. Sometimes you have to wait until your BTC transaction is processed and added to a new block. But due to the absence of intermediaries (banks, payment systems), Bitcoin still travels very fast. Besides, when you are in a hurry, you can entice miners with a bigger fee and they will make your transaction a priority.
- Bitcoins ensure more privacy and transparency than conventional currencies. Everyone can see the list of transactions but nobody knows who you are.
- It’s perfect for cross-border transfers. Bitcoin does not care where in the world the transaction participants (peers) are located. It affects neither the price nor the speed of a transfer.
Now, meet the cons of the first cryptocurrency.
- Technical complexity scares people away. For a layman, Bitcoin remains a sophisticated hi-tech financial tool. Many people heard the term, but they cannot explain what it means and how it works. They are worried about the fact that crypto has no cash version. This absence of any material form leads them to believe crypto haters who say digital money is a bubble and has nothing behind it.
- BTC is rather slow, compared to other cryptos. Normally, it takes 10 min to solve a block, but unless you offer a higher than average transaction fee, you have to wait your turn. the BTC network is rather popular, so it’s busy. Your waiting time depends on how many transactions miners have to process right now. It may be anything between 30 min to 16 hours. Not bad compared to several business days for bank transfers, but it still makes many users unhappy.
- Scammers. We see a lot of scam activity around Bitcoin. There are schemes that use your computer for secret mining, there are fake wallets, phishing websites, ads with malicious links, etc. Many are easy to detect, but some projects are rather sophisticated, especially if they target a high-profile victim.
- Controversial image. Scam ICO that were mushrooming in 2017 — 2018, resulted in many investors losing their money. Most of these crowdfunding campaigns promised to develop ‘a next bitcoin’. Instead, they escaped with the funds. Unfairly, but though no one remembers the names of shitcoins, Bitcoin has come to be associated with fraud and deception.
Bitcoin vs Bitcoin Cash
You have probably heard about Bitcoin Cash and wondered what it stands for. Bitcoin Cash, as well as many other altcoins with the same ‘family name’ is a BTC hard fork.
In short, a hard fork means a split in a blockchain network. It happens when its users radically disagree on the way the blockchain should follow. As a result, two separate chains appear, each having its coin.
Ok, and what is Bitcoin cash vs Bitcoin Core, its father?
BCH And BTC: What Makes Them Different
- Bitcoin Cash is younger and faster than its parent. Bitcoin block size is 1Mb, versus 8Mb for BCH. So, it can contain more transactions, and it makes things faster for a user.
- Bitcoin Cash was started by BTC miners and developers, who were unhappy with the scalability of the existing network. Scalability refers to the ability of a system to cope with an increasing workload.
- Transaction processing fees in the Bitcoin Cash system are lower.
Despite all this, Bitcoin remains the biggest and most important cryptocurrency and so far has no rivals in terms of market cap.
Bitcoin And The Lightning Network
We mentioned scalability as the biggest challenge the BTC network is facing today. The oldest blockchain network was not designed for such a workload. In the future, when Bitcoin goes mainstream, the problem will become even more serious.
These days, BTC transactions are rather slow already, compared to many other networks. It urges users to offer bigger processing fees to move their transactions up in the miners’ waiting list. Naturally, it increases the average cost of a Bitcoin transaction processing. Besides, as soon as all the coins are mined up, the network will have to increase transaction fees because miners will stop receiving rewards for solving new blocks.
When it happens, many people, especially in poor countries, won’t be able to afford to use BTC. Luckily, there is a solution called the ‘lightning network’.
How the Lightning Network Functions
Imagine, you have a trusted friend in another country. For some reason, you regularly send and receive to each other small amounts of money. It makes no sense to pay big transaction fees to miners and wait in line.
So, you can facilitate the process by using a special 2-way payment channel. It allows you to make transactions off the blockchain, bypassing the usual procedure and thus avoiding unnecessary costs. A payment channel is a sealed part of the BTC blockchain, protected by multi-signature. It allows 2 peers to conduct microtransactions between themselves without miners’ participation. At a certain point, this channel closes up, and the last set of transactions becomes part of the main blockchain.
The process looks like this:
- You and your friend Alice open a channel and deposit $50 in special storage. To get access to this ‘locker’ you need two matching halves of the code.
- There is a record about the balance each of you has (Alice has $25, and you also have $25). Each of you holds his/her half of the access code.
- If you send $10 to your partner, the balance is corrected. Now, you have $15 and A has $35.
- After a certain period of time you pre-agreed upon, the channel closes up. Also, it may happen after a certain number of transactions take place.
As you can see, it looks more like a real-life interaction between good friends. You use the advantages of BTC blockchain for keeping tabs but pay much less than if you were using the regular path.
Bitcoin Questions & Answers
What is bitcoin blockchain?
Bitcoin blockchain refers to the BTC network that allows users make transactions in a peer-to-peer manner. It’s a distributed ledger stored on multiple computers (nodes).
What is Bitcoin currency?
It’s the unit of value that the BTC network users send and receive between them. This currency is purely digital and does not exist in any material form.
What is Bitcoin’s value based on?
The value of Bitcoin is supported by the law of demand and supply. The total supply of BTC is limited. Thus, as more people want to use this coin, the demand for it and its value will grow, and vice versa.
What is a Bitcoin account?
It’s similar to a bank account and serves for managing your BTC funds. You get yourself a wallet (an analog of a banking app) and create an account for dealing with crypto funds.
What is Bitcoin Private?
BTCP is a fork of two popular coins — Bitcoin and Zclassic. The goal of the developers was to create a coin that would be as good as Bitcoin, but also 100% private.
What is Bitcoin’s future?
The future of Bitcoin depends on many things, including regulation. It has the potential for growth, but there are also some challenges. The biggest of them is the network scalability.