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What is Bitcoin and how does it work? 2022

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What is Bitcoin and how does it work?

Over 10 years ago, the world was a very different place. In 2009, Apple launched the iPhone 3S, and social media was just starting to take off. However, there was a major contribution to the fintech world that was created, and not many people knew about it at that time. At the cusp of a new decade, around December 2008 or January 2009, Bitcoin was introduced.

Here’s a beginner’s guide to the ins and outs of Bitcoin, its history, and how it’s shaped the world of finance.

What is Bitcoin (BTC)?

Bitcoin (BTC) has been the leading cryptocurrency since 2009. It’s a newer currency developed and introduced by the mysterious Satoshi Nakamoto. Nakamoto’s identity is currently unknown as it was never revealed—it could even be a single person or a group of crypto geniuses. To this day, no one still knows who created Bitcoin.

It was designed to be used in everyday life and for monetary transactions. However, Nakamoto understood the faults of traditional banking infrastructures given the 2008 financial crisis and Bitcoin was meant to be the solution for those liabilities.

Since Bitcoin’s creation in early 2009, it has boomed and entered the mainstream markets. At this time, Bitcoin is still relatively new and volatile. Despite that, it continues to gain more popularity as well as scrutiny every day.

What makes Bitcoin valuable?

There are many reasons why Bitcoin is seen as valuable. Typically all successful currencies whether digital or otherwise must have the following criteria: scarcitydivisibilityutilitytransferability, and the inability to be counterfeited, Bitcoin meets many of these criteria and therefore is seen as valuable. 

How is Bitcoin measured?

Bitcoin is divisible by eight decimal places, which means it’s possible to buy fractions of it. The smallest unit is called a Satoshi, named after its creator. One satoshi is equivalent to 0.00000001 BTC. 

How does Bitcoin work?

Since BTC is a digital currency, it works solely with a robust and new technology called a blockchain. It’s a shared public ledger that records all confirmed Bitcoin transactions. Think of the blockchain as a digital passbook from a traditional bank where your account balance and transactions are tracked and recorded.

The main difference is that transactions on the Bitcoin blockchain are available and accessible to everyone on the network. This shared public ledger paves the way for high transparency levels since anyone on the network can view a BTC transaction’s source and destination address. 

Can BTC transactions be traced?

While the information about a transaction and the people involved in it are kept private and secured, the public can still see that someone on the network is sending an amount to someone else.

To keep a transaction from being linked to a specific owner, Bitcoin’s privacy model uses a new key pair. However, with many transactions entering the network, linking is sometimes unavoidable and can reveal that the inputs or transactions were owned and made by the same owner.

Bitcoin’s whitepaper reads, “The risk is that if the owner of a key is revealed, linking could reveal other transactions that belonged to the same owner.” With this, we can assume that Bitcoin is not anonymous, but rather pseudonymous.

Another notable fact about the network is that it’s decentralized. Unlike commercial banks, other financial institutions, and government-issued money regulated and monitored by central banks and other government agencies, BTC and the Bitcoin network operate independently. 

Bitcoin doesn’t need an agency or governing body to run its systems and processes. It doesn’t have a central authority. Instead, it works via peer-to-peer (P2P) transactions. 

Transactions and private keys

A Bitcoin transaction is defined as “a transfer of value between crypto wallets.” When you withdraw cash from ATMs or cash out via mobile apps, you confirm cash release by inputting your PIN. It’s the same with BTC transactions, but instead of a PIN, you’ll be asked to provide your private keys.

Just like your bank account’s PIN, a private key is a confidential piece of information that you shouldn’t share with anyone. It’ll give access to your Bitcoin wallet and allow your funds to be spent, so be extra careful for it not to fall into the wrong hands. Private keys are stored either on a personal computer or remote servers, depending on the type of wallet you’re using.

How can I get Bitcoin?

There are many ways to get your first fractions of Bitcoin. Your options include mining, buying on cryptocurrency marketplaces online, and more. Let’s explore and learn about these two.

Bitcoin mining

Like the precious metal and highly-valued commodity known as gold, Bitcoin is also acquired through a process called mining. However, Bitcoin mining, just like its signature coin, is a fully digital process. Instead of using heavy-duty equipment and chemicals, Bitcoin miners use high-powered computers, specialized software, a reliable and robust Internet connection, and high electricity levels.

Bitcoin mining is deemed to be one of—if not—the most expensive processes of acquiring Bitcoin. It also uses very complex algorithms, which are solved by miners. The mathematical problems are complicated and can’t be solved mentally, making the process expensive and intricate.

Miners get paid for every block they solve or confirm on the blockchain, but the competition starts to get tighter as more and more aspiring crypto miners are entering BTC’s digital cave. If you’re up to do some BTC digging, be sure to take note of the needed mining resources we mentioned earlier. Bring out not only your funds for top-of-the-line equipment but also set up your mining operation in an ideal country, have a handful of patience, and competitive spirit in the mining market!

Bitcoin mining pool

When mining Bitcoin, there’s a possibility to mine in groups also. This is known as a Bitcoin miners’ pool. A Bitcoin miners’ pool is when a group of miners work together so they can increase their chances of finding and mining a block. When miners pool their efforts it allows for them to work faster and allows for higher chances to find Bitcoin. 

However, the downside to a mining pool is that the payment you receive when finding Bitcoin is split among the group. This means miners who mine in groups earn less than if they were mining alone. 

Bitcoin halving

After miners successfully verify transactions, they will receive Bitcoin. Throughout the process of mining, there’s an anticipated event called the Bitcoin halving. Halving is when the rewards gained by all miners are halved. This occurs around every four years and occurs after 210,000 blocks are mined. 

Cryptocurrency marketplaces

If you don’t want to dip your toes into the Bitcoin miners’ pool, there are thousands of cryptocurrency marketplaces online where you can buy BTC. Among the things you need to bear in mind when scouting for a reliable exchange includes the following:

  • Reliable security features – it’s better to look for a platform that enables layers of security features like two-factor authentication (2FA), for example.
  • Geographical limitations – Some countries and jurisdictions are still struggling to embrace the uses of Bitcoin and thus its limitations. Find a platform that will allow you to maximize your digital asset.
  • Liquidity of assets – Look for an exchange platform that will let you convert your BTC into your desired fiat currency without breaking a sweat. You’ll find lots of those on the web.
  • Transaction charges – Fees for buying, selling, depositing, or withdrawing BTC vary per exchange, so try to compare them to find out which ones have lower fees.
  • Platform authenticity and reputation – Do your research and verify whether the company is legitimate or not. You can search on the web and reach the company via email or a call.

This might seem like a lot of work, but these are the most crucial factors you’ll need to consider before entering a crypto market. Trust us, you won’t regret this. In fact, you’ll even thank yourself later.

What are Bitcoin forks?

In the simplest terms, Bitcoin forks are when the protocol to the blockchain changes and is upgraded. It occurs when enough miners adopt a new rule for the network. There are two types of forkshard forks and soft forks.

  • Hard forks are when the previous blockchain protocol and the new blockchain protocol split from one another. When there is a hard fork, the old blockchain version gets left behind, and any transactions made with the upgraded blockchain can’t be read by the previous blockchain version. With hard forks, miners can decide which one to use as there are now two cryptocurrencies in play.
  • Soft forks are similar to hard forks in that with soft forks there is a new blockchain protocol that is being utilized. However, unlike hard forks, soft forks allow for the new blockchain protocol and the older protocol to coexist. Nodes, which make up the infrastructure of a blockchain, will eventually update to work with the new blockchain protocol. Transactions made using older blockchain nodes can still process transactions and push new blocks using the new protocol to the blockchain. 

Examples of hard forks include: 

  • Bitcoin Cash (BCH): This is one of the most successful hard forks. It was made August 2017, and allows for blocks of eight megabytes, and does not follow SegWit (Segregated Witness)
  • Bitcoin Gold (BTG)This is a hard fork that was created in October 2017 to restore previous mining functionality. Mining BTG means using graphics processing units (GPUs) instead of using specific hardware and equipment known as application-specific integrated circuits (ASICs). Essentially, it means that miners can mine BTG at home without needing extensive equipment. 
  • LiteCoin (LTC): This fork uses a different type of algorithm than the original Bitcoin algorithm, SHA-256. LTC transactions are said to confirm faster and have lower fees than traditional Bitcoin. 

Who makes decisions about forks?

There are three groups of people that make most of the decisions about forks:

  • Developers: This group creates and updates the code. If you’re a developer, you can suggest changes that other developers can review. Developers fix any bugs in the system and add any software or feature changes.
  • Miners: This group adds new blocks to the blockchain and runs the code system. Miners ensure the blockchain’s security and keep the system running.
  • Full node users: These users send, receive, and validate blocks on the blockchain. They are considered a main component of the blockchain and help the system continue to run.

Where can I store Bitcoin?

BTC is digital money. It has no physical representation and exists solely with the use of technology. There are no BTC bills to fold and no coins to hold inside your physical purses or wallets, but instead uses a storage known as a Bitcoin wallet.

A Bitcoin wallet or digital wallet is a unique and secure means of storage. It also uses the blockchain, the smart technology behind the cryptocurrency network. What makes it more fascinating is that you can do a bunch of things with it. If you use a mobile Bitcoin wallet, you can also receive BTC from other wallets, send funds or complete payments, and check your balance in real-time.

There are many types of cryptocurrency wallets, but most of them fall under two main categories:

  • Hot wallets – storage accessible through an Internet connection. These include web and mobile wallets. 
  • Cold wallets – physical devices that don’t need Internet access. Examples are hardware wallets, desktop wallets, and paper wallets

Some peer-to-peer marketplaces and online exchanges, like Paxful, offer a free Bitcoin wallet after creating an account. 

If you sign with a pen and paper when completing transactions in banks and other financial institutions, Bitcoin transactions, on the other hand, use a digital signature. It’s cryptographic and “mathematical proof” that the BTC came from the wallet’s owner and not from anywhere and anyone else. A digital signature also allows you to know whether the BTC has been sent to someone else.

While everyone on the network can see that your signature matches a particular Bitcoin transaction, there’s no way for anyone to figure out your private key. Bitcoin uses very complex processes and features that are hard to compromise, so there’s no need to worry about getting your hard-earned funds stolen—that is as long as only you have access to your private keys!

Trading Bitcoin

Like any other currency, Bitcoin can be held and traded for other currencies or goods. However, there are some popular strategies that crypto enthusiasts have been using, and with any strategy, there are some pros and cons to trading Bitcoin and crypto. We’ll dive into some of the strategies Bitcoin traders use to make the most out of their crypto holdings. 

What is HODL?

HODLing or “hold[ing] on for dear life” is a long-term strategy that investors use when the market is down. Even when the market is down, investors who HODL do not sell their crypto in hopes that the price will rise again in the long term. This is different from day trading which is a more short-term investment strategy that we’ll discuss later. Investors who HODL are not as interested in the short-term profits of Bitcoin or crypto. It’s more about improving the adaptability of Bitcoin and making fiat currencies less powerful compared to crypto. 

What is swing trading?

Swing trading is a practice that can be used for crypto trading, forex, and the stock market. Investors trade when the market is in swing (or at a low or high) over the course of a few days to even a few weeks or months. When traders and investors swing trade they are hoping to take advantage of potential price changes. Traders look at the risk to reward ratio. They try to buy assets when the risk is low and the reward will be high based on their analysis of the market. This can be a very volatile trading strategy.

There are two methods to swing trading. Traders can use technical analysis, fundamental analysis, or a combination of both analyses. 

Technical analysis is when traders look at past market data of certain assets. Traders can look at market trends and patterns to predict future market behaviors. These predictions then impact their trading habits.

Fundamental analysis is when traders study an asset’s value by looking at certain economic and financial variables related to the asset. 

The difference between analysis styles: A major difference between these two analyses is that technical analysis uses future predictions while fundamental analysis tries to understand and predict how valued or undervalued an asset is.

What is day trading?

Day trading is a short-term strategy that involves making many trades within a day to maximize the swings within a market. Traders will typically buy an asset at a certain price and wait for the value of the asset to increase. Once (and if) the value of the asset increases, they will sell at that higher price, and the traders will make a profit. The goal is to make smaller profits off of many trades that have a positive margin and offset the number of trades with a negative margin. 

There are risks to day trading as trading of this kind moves quickly and involves a lot of oversight. Day trading is a full-time job as traders need to keep a constant eye on market changes. Day traders must also analyze the market extensively as it relies on short-term market fluctuations.

There are several other crypto trading strategies that investors can use. Some of these strategies include:

  • Dollar-Cost Averaging (DCA)
  • Golden Cross/Death Cross
  • Relative Strength Index (RSI) Trading
  • Trend Trading
  • Scalping

What is Bitcoin used for?

Initially, Bitcoin was known only for making direct, cheap, and borderless payments. But as its adoption rate increases, people from around the world and different industries are starting to discover Bitcoin’s remarkable uses. These include:

You can do all these things with just a few clicks on your mobile Bitcoin wallet anytime and anywhere you want. 

Bitcoin vs. Ethereum (ETH):

Ethereum was created by, Vitalik Buterin, in 2015, and it is considered by some to be the second most popular cryptocurrency (behind Bitcoin). 

How are they similar? 

They are both very similar, Ethereum and Bitcoin are both digital currencies that are traded online. They also are decentralized and use blockchain technology. 

How are they different?

Ethereum uses blockchain technology to not only run and maintain its network, it uses blockchain to store computer code. Ethereum also uses its own code on the blockchain, and unlike Bitcoin, it was not created to be an alternative to fiat currencies. Ethereum transactions are also confirmed in seconds rather than the minutes it takes Bitcoin to confirm a transaction.

Bitcoin vs Tether (USDT):

Tether is a stablecoin that is pegged to the US Dollar. One of Tether’s goals is to avoid the volatility that other cryptocurrencies are typically known for.

How are they similar?

Both Bitcoin and Tether use blockchain and are considered cryptocurrencies. 

How are they different?

Unlike Bitcoin and Ethereum, Tether is a stablecoin, which means that it is tied to an asset that can be a fiat currency, precious metals, or another cryptocurrency. This is incredibly different from Bitcoin which is not tied to any other currency. In fact, Bitcoin strives to be an alternative to fiat currencies. Because Tether and other stablecoins are tied to an asset, it means that it is less volatile than Bitcoin. 

To buy or not to buy

After all the great stuff we’ve discovered—from what Bitcoins are to how they work—we’re pretty sure you’re itching to experience what other wonders it can bring about. Just a friendly note, this chunk of information is only one page from the many galaxies in the cryptocurrency universe. There are still lots of things to discover and explore in the crypto space!

Are you ready to take on the adventure? Buy Bitcoin today and let your crypto journey begin!

Steven Madden

Steven Madden

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