What Is Bitcoin?

Author: Tim Harrison
Last Updated: May 2020

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bitcoin
bitcoin

Bitcoin (BTC)

Price
$ 8,830.59

 

Bitcoin (BTC) is an international digital currency, the first of its kind, which can be exchanged on a decentralized peer-to-peer network called blockchain. This means that Bitcoin isn’t owned by an institution or a specific country and can be used without the need for intermediaries. The cryptocurrency is created and stored online and it doesn’t have a physical existence outside the network.

It wouldn’t be an overstatement to say that Bitcoin has been the talk of the decade, ever since its official release in 2009. What makes this currency sought-for and popular are its unique features such as complex cryptographic protection, and the advantage of being decentralized, private, portable, and cost-effective.

Many world-leading companies such as Microsoft, Expedia, Dell, and most recently Amazon (indirectly!), have finally started accepting Bitcoin as a payment method, while the state of Ohio even lets you pay your taxes with bitcoins since 2018. Its growing popularity has resulted in the emergence of a great number of other cryptocurrencies on the market competing in the race for the largest trading volume.

Even though digital currencies are becoming more and more recognized as a means of payment, there are still those who regard them with suspicion. Common accusations coming from these skeptics are the questionable legal status of Bitcoin and the lack of sufficient regulations, as well as the existing technical challenges.

If this introduction was enough to grab your attention and you’re interested to find out more about Bitcoin, keep reading our detailed guide. Although the explanations are primarily aimed at Bitcoin beginners, even experts in trading with this life-changing coin can benefit from the in-depth analysis, the history part, performance charts, and future prospects. You’ll learn how the network works and “mines” the coins, how you can get them, where to store them, and how to use them risk-free.

The History of Bitcoin

What’s Wrong With Fiat Currencies?

Paper money eventually returns to its intrinsic value – zero. – Voltaire, 1729

For centuries now, it has been the practice of governments to declare a certain currency as a legal tender. These are known as fiat currencies, state-issued money that have no intrinsic value themselves apart from the value determined and maintained by the government. This status, coupled with the fact that they’re physical tangible objects, makes them seem trustworthy in the eyes of the people.

However, history has shown us time and time again, how the rise of a fiat currency is followed by its inevitable collapse, most often as a result of devaluation. At the start, paper money spur the economy into which they’re introduced until they become overprinted, inflation occurs, and they lose their value, bringing down the economy as well.

You’ve probably heard of what happened to Papiermark, the German currency during and after World War 1. When the war was over, Germany had to pay war reparations set forth by the Treaty of Versailles. Since the country didn’t have enough money to pay the debt, the government couldn’t think of any other way out but to print extra cash. They had printed so much money, causing hyperinflation which rendered them worthless. The only thing left for people to do with the money was to burn the currency instead of firewood or make dresses for themselves.

This is just one example among many others that have made people see the faults with fiat currencies. It’s one of the main reasons why they started thinking about alternatives. They didn’t want a currency that allowed governments to have the upper hand and corrupt leaders to loot the state’s wealth. What they needed was a decentralized currency that belonged to the people.

Digital Currencies

In the 1960s and ‘70s, about two decades before the idea for decentralized digital currencies was brought to the table, the general public started using the credit card for purchases. The vision behind credit card transactions was to store existing money in the form of digital-electronic data and verify the transaction via different communication channels.

Early research and projects on e-cash such as David Chaum’s DigiCash for example, still focused on changing the format of centralized physical currency into a temporary digital version. However, with the advances in technology, software engineers and cryptographers came up with some more ambitious propositions and ideas. Why not use a series of computational processes to create a digital currency instead?

It took two more decades for Bitcoin software to be released as open-source code. The technology didn’t materialize out of thin air, and it wasn’t the work of a single brain. It was a patchwork that brought together the hard work of many computer scientists who had been working on the same problems for years. Some of these problems included operating a peer-to-peer network, timestamping data, digital pseudonyms, encryption, etc.

One of the most notable projects was Wei Dai’s B-Money payment system, which succeeded in having users convey their transactions under digital pseudonyms to keep their privacy. Dai suggested two verification protocols but failed to solve the double-spend problem of using the same digital assets for more than one service.

The White Paper

The revolution began at the nadir of the global financial crisis that culminated with the great stock market crash in the US in 2008. On Halloween night, October 31st, 2008, an individual or a group of individuals under the name of Satoshi Nakamoto published the famous white paper Bitcoin: A Peer-to-Peer Electronic Cash System. The paper describes the first completely decentralized payment system that wasn’t based on trust in an institutional or individual authority but trust in the peer-to-peer network itself.

“The root problem with conventional currency is all the trust that’s required to make it work”, Satoshi will remark in an online discussion a year later. According to him (her? them?), this network was going to solve the problem of double-spending on its own, without the interference of a financial institution. “The result is a distributed system with no single point of failure.”

The Beginnings of Bitcoin

In his paper, Satoshi used the name ‘Bitcoin’ to refer to the new electronic payment system that he was developing. The technology was to serve primarily as a digital ledger that would store data in “blocks” and “chain” them together by means of a hash function. The ledger keeps track of every transaction, which is timestamped, and while new data is continually added to it, no one can remove or alter what has already been recorded.

Satoshi Nakamoto released the software in 2009 when he mined the first Bitcoin block (Block 0) on the network on January 3rd. This block is known as the Genesis Block and contains the following message: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks” referring to the massive bailout of financial institutions after the stock market crash that was financed with tax money.

The raw hex version of the Genesis Block looked like this:

crypto genesis block

Source: Block Explorer 

The first bitcoin transaction took place on October 12th, 2009 when Satoshi sent 10 BTC to another cryptographer and fellow supporter Hal Finney. They were in direct correspondence since the day Satoshi released the Bitcoin paper, and it was actually Finney who started referring to the data structure as a “block chain” (two words).

Over the years, blockchain became the official term for the digital ledger and the technology that drives it. Bitcoin, written in capital letters, is still used to refer to the cash system and trading platform, but ‘bitcoin’ written in lowercase, denotes the name of the first digital coin and it’s commonly abbreviated to BTC.

Bitcoin Explained

Now that we know a little bit more about the history of this digital coin, let’s discuss how it works and what makes it so special in more depth.

Mining Bitcoins

Since bitcoins don’t take a physical form and exist on an online network only, they are “mined” digitally. The mining is done on the blockchain network that we’ve already mentioned and it includes solving a very complex cryptographic problem. To make it easier for you to understand how the mining works we’ll try to explain this process in a simpler way.

The blockchain network consists of thousands of computers around the world that belong to users who have joined the network voluntarily and can access a copy of the ledger. These are the so-called full nodes, and “miners” use their computational power to verify Bitcoin transactions. Again, there’s no central authority in charge, so it all depends on the collective work of the miners who try hard to solve the mathematical algorithm by running a hash function.

You might wonder why would anyone spend so much time and energy, not to mention computational power, to mine virtual coins online? In the white paper, Satoshi stated that:

By convention, the first transaction in a block is a special transaction that starts a new coin owned by the creator of the block. This adds an incentive for nodes to support the network, and provides a way to initially distribute coins into circulation, since there is no central authority to issue them. The steady addition of a constant of amount of new coins is analogous to gold miners expending resources to add gold to circulation. In our case, it is CPU time and electricity that is expended.

When Alice wants to send bitcoins to Bob, her transaction is broadcasted to all the nodes on the network, and all of the miners get down to work and look for the solution of the complex maths problem. Whoever finds it first, sends it to the others who need to accept it, and in doing so validate the transaction, which goes into the next block. The node that had solved the proof-of-work challenge (another term for the maths problem) initially claimed fifty new bitcoins for itself plus a transaction fee.

BTC mining

Where to Find Bitcoins

There are several ways in which you can purchase your first bitcoins. Before you choose one, you need to think about how much personal information you’re willing to disclose, what’s your preferred payment method, and what’s your place of residence. Different countries have imposed different regulations on BTC, so be sure to double-check that.

Cryptocurrency Exchanges

Cryptocurrency exchanges are the most popular way to buy bitcoins, especially if you’re considering to purchase a large amount or trade them with other cryptocurrencies later on. There are two main types of platforms: centralized and decentralized. The first ones are more common since decentralized exchanges are hard to maintain and protect. On the other hand, centralized exchanges have stricter regulations, anti-money laundering policy, and KYC checkups but at least your coins are safely stored and protected.

Some of these platforms have a wider range of coins but don’t offer fiat to crypto exchanges, while some are just the opposite – scarcity of choice but great fiat-to-crypto trading pairs. You should check our detailed single and comparative guides on the most respectable exchanges in the crypto world and decide which one works best for your investment plan.

Use a Bitcoin ATM

Using a Bitcoin ATM is probably one of the quickest and most private options to purchase bitcoins. To locate an ATM machine in your vicinity, go to the Coin ATM Radar service and search on their map. The good thing is that you don’t need to disclose your identity. It’s pretty rare for an ATM to ask for your ID or apply KYC regulations, and it only happens if you’re purchasing a larger amount of BTC.

The ATMs can be used either to buy or sell bitcoins since a two-way ATM is very hard to find. You can exchange bitcoins for cash or other currencies or buy them with cash directly. Unfortunately, ATMs have notoriously high fees of 3%-6% for their services.

Gift Card/ Voucher

There are many websites where you can purchase a Bitcoin gift card or voucher with a credit card, or visit a well-stocked nearby kiosk and buy the voucher with cash. Then, you go to one of the available online platforms to use the code that’s on your voucher and redeem your bitcoins. This is a popular option in countries like Austria, Mexico, and South Korea but the transaction fees can be pretty high as well.

Direct Commercial Brokers

What these sellers do is they buy bitcoins themselves through an online exchange platform, and then sell them to customers at a set price. All you need to do is find one of these websites, choose how you want to pay for the coins, make the payment and enjoy your bitcoins. To receive the coins you either need to have an online wallet or you can use one provided by the website. This is really fast and easy but the major downside is the processing fee for certain payment methods such as credit cards.

Peer-to-Peer Markets

These markets connect Bitcoin buyers and sellers and allow them to exchange coins at relatively low fees. Once you create an account and want to get started, set a price you’re willing to pay and then wait for someone to meet your offer and sell you some coins. This is a great purchasing option for high-volume traders. The most famous P2P markets are LocalBitcoins, the German Bitcoin.de, and Bitsquare among others.

bitcoin transactions
Cryptocurrency transaction technology isometric flowchart from request block creating verification adding to blockchain to completion vector illustration

Limited Number of Bitcoins

Another key thing about these digital coins is that the number of bitcoins that can be mined has been predetermined. “Once a predetermined number of coins have entered circulation, the incentive can transition entirely to transaction fees and be completely inflation free”, wrote Nakamoto in the original Bitcoin paper.

On the 8th of January 2009, in the official Bitcoin release, he announced that:

Total circulation will be 21,000,000 coins. It’ll be distributed to network nodes when they make blocks, with the amount cut in half every 4 years.

first 4 years: 10,500,000 coins

next 4 years: 5,250,000 coins

next 4 years: 2,625,000 coins

next 4 years: 1,312,000 coins

Etc…

So, what do you think? How many bitcoins have we mined so far? Well, it turns out that in just over one decade, we have mined around 18 million bitcoins! The good news is that crypto experts have estimated that the final bitcoin is unlikely to be mined before 2140. But how is this possible?

We’ve already learned that miners used to get 50 BTC as a reward for verifying a new transaction. However, their reward reduces over time, which is why in 2012 it halved to 25 BTC, and in 2016 it halved again to 12.5 BTC, and the same thing will happen again sometime next year, at which point the reward would be only 6.25 BTC.

What are the implications of the limited bitcoin supply? Well, for one thing, miners might stop doing their work once they stop getting the reward which has acted as their main incentive from the very beginning. This, in turn, might lead to a total centralization or collapse of the Bitcoin blockchain since miners are what keeps the peer-to-peer network running.

On the flip side, some crypto aficionados claim that miners will continue to validate new transactions because of the transaction fees. These fees remain quite small for now, but they’re bound to increase in the future as the demand for more coins goes up as well. Anyway, we still have a hundred years ahead of us to come up with a more satisfying scenario.

bitcoin supply

“Number of bitcoins in circulation.” Source: Statista 

Bitcoin Transactional Properties

So, what are the unique properties that distinguish transactions made with bitcoins from those made with regular fiat currencies?

Irreversible

Once Alice gets a confirmation that her Bitcoin transaction has been successfully approved by the nodes, she can’t reverse it. If Alice has a row with Bob and changes her mind, not wanting to send him the coins anymore, she won’t be able to cancel the transaction. Not only her, but nobody else can either. Not even the blockchain miners or Satoshi himself.

On the other hand, if Bob gets really mad and tries to hack Alice’s account to send himself a larger sum of BTC, his attempt is bound to fail as well. The nodes will notice the inconsistency and intervene.

Pseudonymous

People tend to think that the “crypto” part in “cryptocurrency” means “encrypted”, in the sense of being secretive and anonymous, coming from the Greek word “kryptos” which means hidden.

The fact that this was the initial Bitcoin promise makes this type of understanding partly true but it’s quite misleading for the most part. “Crypto” primarily stands for the computational processes needed to mine the digital coins. So, does that mean bitcoin transactions aren’t anonymous? Yes…and no. They’re actually pseudonymous.

Bitcoin transactions require no government-issued ID, no photo, no email address. The only thing you need is an electronic address on the digital ledger which is actually your cryptographic public key or a hashed code of that key to be more precise. This creates a false impression that the transactions are anonymous.

In reality, every transaction that you send from your digital address will be permanently recorded and stored on the ledger. This makes them public and traceable but only when someone discovers your digital pseudonym. If you’re careful enough, no one will be able to link the digital address to your identity.

Fast and global

If you send money the traditional way via banks, you might end up waiting for several days before the transfer is completed. This is largely due to regulations that differ between banks, especially if the transfer is international. Regardless of your location or the location of the person that you’re sending bitcoins to, the bitcoin transaction speed remains the same. It takes only a moment for it to be broadcast on the network, and it’s usually verified within minutes.

Secure

Bitcoin transactions are definitely safer than regular transactions where you place your trust in the hands of third parties (though there are a few unconfirmed transactions floating around).

First of all, there’s no room for the miners who verify your transactions to interfere or forge them since they’re being additionally checked by the rest of the network. If someone attempts to take control over the whole blockchain network it would take them an incredible amount of computational power to pull off such a scheme.

On top of that, we should take into account the fact that the difficulty of the proof-of-work algorithmic challenges that need to be solved is increasing over time.

Cost-Effective and Portable

Transaction fees are very important for financial institutions since this is how they capitalize on the services they offer. They use any chance they get to make you pay more. You’re charged when withdrawing money or sending them to someone else. If the transfer of funds is international, the fees jump even higher.

In comparison, transaction fees on the Bitcoin blockchain are incredibly low, only about 0.1% of the trade amount. This is awarded to the miners who are also paid with bitcoins for each mined block of data. This is why the transaction fees can stay low (at least for now). Another advantage is the option to send micropayments which is otherwise unviable. Trying to send very small payments via credit card will result in the transaction fees surpassing the payment itself!

Permissionless

The Bitcoin blockchain network is as software that anyone can download with no exceptions. You don’t need anyone’s permission to install it and buy bitcoins.

Related:

bitcoin wallet

How to Store Bitcoins

People keep their cash and cards in physical wallets but what about their virtual currencies? They use digital wallets, of course! These wallets can be based differently with different security levels. All of them, however, give users a private key without which they cannot access the funds they have stored. This means that at the end of the day, the responsibility is primarily yours to protect your key from cyber thieves.

Online Wallet

The first type of wallet is, of course, the online wallet that runs on the cloud. You can access it from your computer regardless of your location. There are also mobile wallets, accessed from a mobile app, that don’t necessarily have to be connected to the Internet.

Online wallets are definitely convenient but their major disadvantage is that they’re controlled by a third-party which stores your private key online. This, in turn, increases the possibility of phishing scams, hacking attacks, and stolen private keys since online platforms are liable to such fraudulent activities.

Desktop Wallet

Desktop wallets are one step up on the security ladder compared to online wallets. They’re disconnected from the Internet and are accessed only through your personal computer which guards the private key that unlocks your bitcoins. This is called the cold storage method. To avoid any risk, keep your device safe from malware infection that might steal your account key.

Hardware Wallet

Hardware wallets are external devices, similar to a USB stick, that are portable and accessible at any time. The best thing about them is that they aren’t linked to your computer, another device, or your address, hence your identity remains anonymous, eliminating the risk of data leakage. If you happen to lose the wallet, you can recover your bitcoins with a seed phrase.

Paper Wallet

The last type of wallet is the paper wallet, another secure invention that stores your bitcoins. It’s not exactly beginner-friendly, so you do need to know a thing or two about cryptocurrencies. Paper wallets generate a private key for your coins and then print it out. If you have already stored your bitcoins in an online wallet, you’ll just have to transfer them to the address shown on your paper wallet.

bitcoin safety

How to Protect Your Bitcoins

Bitcoins are experiencing another surge in popularity in 2019 which has also resulted in more attempts at hacking accounts and stealing funds. Therefore, it’s really important to be well-informed and up-to-date with the newest safeguarding platforms and technologies. Here’s some advice on how to do that:

  • Backup your bitcoin wallet.

Rule number one: make sure you do regular backups on wallet.dat files! You can’t allow being careless when it comes to storing sensitive data such as digital currencies. This might be your only chance to recover bitcoins. Plus: go the extra mile storing the backup on a USB, CD, or hard drive.

  • Offline storage.

What are you going to lose if you decide to keep some of your bitcoins offline, far from the greedy hands of Internet hackers? Hopefully not bitcoins! Always rely on offline storage for the majority of your funds and keep only a small percentage of bitcoins online for upcoming purchases.

  • Update your software.

A word of advice: software updates are crucial! Most of the updates are made to improve and enhance the security methods that your software uses so make sure you don’t miss the next one!

  • Multi-signature.

This method is quite practical if you have a group of friends or colleagues who are enthusiastic about bitcoins as much as you are. Basically, you make a list of people, ideally 3 to 5 individuals, whom you trust to verify any transaction that you wish to make. Later on, you will do the same thing for them, forming a little Bitcoin circle of your own. This way, if a hacker gains access to your bitcoins, they’ll still need the approval of the whole group to transfer your money.

The Challenges of Bitcoin

Volatility

It’s no secret that bitcoin has high volatility which means that the price of the coin changes frequently. This is because the crypto trading market it’s still in its infancy and the community that uses bitcoins is incomparable to the number of people using traditional currencies around the world. Most of the estimations regarding bitcoin are mere speculations because we need further proof of its performance.

So, on the one hand, merchants need to update their prices continually if they want to make a profit by accepting bitcoins as a payment method, and customers have to check daily how much their bitcoins are worth.

On the other hand, high volatility is not necessarily a bad thing per se. Investors who want stability above all might avoid the fluctuating prices on the crypto market. Otherwise, the more adventurous investors are drawn to bitcoins exactly because of that possibility for higher returns in the long run.

Lack of Trust

Bitcoin has a long way ahead in gaining customer trust and mainstream acceptance. In the past ten years, financial speculators made the biggest profit from digital currencies. They were bold enough to take the risk and most of them saw the bitcoins as a way to cheat the system by laundering money, evading taxes, and ending up ultra-rich in no time.

Therefore, it’s obvious why governments are reluctant to recognize cryptocurrencies as legal tender. They see the lack of central authority as the biggest problem because now there’s no one to monitor the transactions on the Bitcoin network. They distrust people’s intentions and fear an upcoming financial instability. Ten years later, there still aren’t universal regulations that govern the bitcoin industry.

Government Regulations Across the World

As it goes, different countries treat crypto trading differently. For example, since 2016, Japan recognizes cryptocurrencies as a type of money and issues licenses to deserving crypto exchanges, unlike China where residents are banned from using or mining crypto. Similar crypto-averse countries include Egypt, Morocco, Colombia, Ecuador, Nepal, Indonesia, and others.

Apart from Japan, other increasingly crypto-friendly countries are:

  • Switzerland

The country has passed several progressive laws regulating the crypto market. To illustrate how far they’ve gone, it’s enough to have in mind that you can purchase railway tickets with BTC. Zug, a town in central Switzerland, is even called “Crypto Valley”.

  • Malta

Malta is a real hub for crypto trading! Last year, the country passed three regulatory bills: the Digital Innovation Authority Act, the Innovative Technological Arrangement and Services Act, and the Virtual Financial Asset Act

  • Estonia
  • Barbados
  • Slovenia

In the UK, cryptos aren’t considered legal tender but residents are allowed to engage in crypto trading as long as the exchanges which they use have registered with the Financial Conduct Authority. In the US, the laws differ from state to state. For instance, Wyoming is probably the most crypto-friendly state and exempts cryptos from property taxation. Ohio was the first state to legalize Bitcoin as a payment method for taxes, with Arizona and Georgia to follow. The laws in New York are generally seen as more restrictive.

Bitcoin Charts

The following two Bitcoin charts are from Statista:

bitcoin market cap

The statistic presents the market capitalization of Bitcoin from the third quarter of 2013 to the third quarter of 2019. Market capitalization is calculated by multiplying the total number of Bitcoins in circulation by the Bitcoin price. The Bitcoin market capitalization increased from approximately 1.02 billion U.S. dollars in the second quarter of 2013 to peak at 238 billion U.S. dollars in the fourth quarter of 2017. It currently sits at 144.96 billion U.S. dollars.

crypto bitcoin price index

The Bitcoin price index represents an average of bitcoin prices across leading global exchanges.

The following chart comes from the paper An Analysis of Bitcoin’s Price Dynamics, published in 2018 by a group of researchers from the NTNU Business School at the Norwegian University of Science and Technology in Trondheim and the Nord University Business School in Bodø, Norway, showing weekly Google statistics on the search term “B/bitcoin”.

BTC price graph

The Future of Bitcoin

Bitcoin has always been the unparalleled number one cryptocurrency on the market! Although we can’t know for sure, experts predict that in the future, Bitcoin will continue to expand on the market and attract more and more customers. While the current surge of new cryptos won’t put Bitcoin in the shade, it will definitely heat up the competition.

Here’s what some renowned experts have to say on Bitcoin’s future:

Bitcoin is only just over 10 years old, but it has already attracted tens of millions of users and is growing faster than both the internet and personal computer. Looking ahead, there are a number of powerful drivers behind the growth of bitcoin and other cryptoassets. Today, owners of stablecoins can earn 10% annual interest on their savings through various Open Finance or DeFi (decentralized finance) platforms. This is far superior to the de minimis or even negative rates offered at many legacy banks. The development of decentralized Web 3.0 technologies, and the work to rearchitect the internet around “can’t be evil” blockchain infrastructure, is another longer-term driver of cryptoasset growth. (Garick Hilleman, Head of Research at Blockchain and Researcher at the London School of Economics)

While Bitcoin was quite revolutionary in 2009, in 2019 other projects are pushing forward and making innovative improvements over Bitcoin’s original design. (Steven Goldfeder, Postdoctoral Researcher at Cornell Tech/IC3, co-founder of Offchain Labs, and co-author of “Bitcoin and Cryptocurrency Technologies”)

When bitcoin currency is converted from currency into cash, that interface has to remain under some regulatory safeguards. I think the fact that within the bitcoin universe an algorithm replaces the function of the government …[that] is actually pretty cool. (Al Gore, Former Vice President of the US, quoted in “Learning Bitcoin” by Cichard Gaetano)

It is not a speculative investment even though it is being used as such by other people. As Bitcoin network grows the value of Bitcoin grows. As people move into Bitcoin for payments and receipts they stop using US Dollars, Euros and Chinese Yuan which in the long-term devalues these currencies. (John McAfee, founder of the software and anti-virus company McAfee, in his Youtube talk)

If you can’t get enough of BTC, check out our Bitcoin Statistics page.

About The Author

Tim Harrison

Tim has been working with Crypto Head since 2019 providing high quality guides and resources for our users. He's been an advisor on a number of ICO's and worked in the Cryptocurrency industry for almost 5 years. He has a wealth of knowledge to share and finds huge fulfillment with helping new people get into the industry.

Disclaimer: Digital currencies and cryptocurrencies are volatile and can involve a lot of risk. Their prices and performance is very unpredictable and past performance is no guarantee of future performance. Consult a financial advisor or obtain your own advice independent of this site before relying and acting on the information provided.

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