What is Bitcoin and how does it work?
Definition: Bitcoin is a cryptocurrency, a form of electronic money. It is a decentralized digital currency without is independent of banks and can be sent from user to user on the peer-to-peer bitcoin blockchain network without the need for intermediaries.
Updated April 2019
If you want to know what is Bitcoin, how you can get it, and how it can help you, without floundering into technical details, this guide is for you. It will explain how the system works, how you can use it for your profit, which scams to avoid. It will also direct you to resources that will help you store and use your first pieces of digital currency. If you are looking for something even more in detail please check out our blockchain courses on bitcoin.
What is a Bitcoin and how does it work?
Small wonder that Bitcoin emerged in 2008 just after Occupy Wall Street accused big banks of misusing borrowers’ money, duping clients, rigging the system, and charging boggling fees. Bitcoin pioneers wanted to put the seller in charge, eliminate the middleman, cancel interest fees, and make transactions transparent, to hack corruption, create organic network value, and cut fees. They created a decentralized system, where you could control your money and know what was going on without depending on banks.
Bitcoin has come far in a relatively short time. All over the world, companies, from REEDS Jewelers, a large jewelry chain in the US, to a private hospital in Warsaw, Poland, accept its currency. Billion dollar businesses such as Dell, Expedia, PayPal, and Microsoft do, too. Websites promote it, publications such as Bitcoin Magazine publish its news and price actions, forums discuss cryptocurrency and trade its coins. It has its application programming interface (API), price index, and exchange rate.
Problems include thieves hacking accounts, high volatility, and transaction delays. On the other hand, people in third world countries may find Bitcoin their most reliable channel yet for giving or receiving money.
Understanding Bitcoin – What is Bitcoin in-depth?
At its simplest, Bitcoin is either virtual currency or reference to the technology. You can make transactions by check, wiring, or cash. You can also use Bitcoin (or BTC), where you refer the purchaser to your signature, which is a long line of security code encrypted with 16 distinct symbols. The purchaser decodes the code with his smartphone to get your cryptocurrency. Put another way; cryptocurrency is an exchange of digital information that allows you to buy or sell goods and services. The transaction gains its security and trust by running on a peer-to-peer computer network that is similar to Skype, or BitTorrent, a file-sharing system. Satoshi Nakamoto leveraged blockchain technology to allow bitcoin to gain decentralization, complete transparency, and immutability.
Bitcoin Transactional properties:
1.) Irreversible: After confirmation, a transaction can‘t be reversed. By nobody. And nobody means nobody. Not you, not your banks, not the president of the US, not Satoshi, not your miner. Nobody. If you send money, you send it. Period. No one can help you, if you sent your funds to a scammer or if a hacker stole them from your computer. There is no safety net.
2.) Pseudonymous: Neither transactions or accounts are connected to real-world identities. You receive Bitcoins on so-called addresses, which are randomly seeming chains of around 30 characters. While it is usually possible to analyze the transaction flow, it is not necessarily possible to connect the real-world identity of users with those addresses.
3.) Fast and global: Transaction is propagated nearly instantly in the network and are confirmed in a couple of minutes. Since they happen in a global network of computers they are completely indifferent to your physical location. It doesn‘t matter if I send Bitcoin to my neighbor or to someone on the other side of the world.
4.) Secure: Bitcoin funds are locked in a public key cryptography system. Only the owner of the private key can send cryptocurrency. Strong cryptographic technology and the magic of big numbers make it impossible to break this scheme. A Bitcoin address is more secure than Fort Knox.
5.) Permissionless: You don‘t have to ask anybody to use cryptocurrency. It‘s just a software that everybody can download for free. After you installed it, you can receive and send Bitcoins or other cryptocurrencies. No one can prevent you from transacting with your own money. There is no gatekeeper.
Where can I find Bitcoins?
First, we would recommend you read this in-depth guide for buying Bitcoin.
You can get your first bitcoins from any of these four places.
A cryptocurrency exchange where you can exchange ‘regular’ coins for bitcoins, or for satoshis, which are like the BTC-type of cents. Resources: Coinbase and Coinsquare in the US & Canada, and BitBargain UK and Bittylicious in the UK.
A Bitcoin ATM (or cryptocurrency exchange) where you can change bitcoins or cash for another cryptocurrency. Resources: Your best bets are BTER and CoinCorner
A classified service where you can find a seller who will help you trade bitcoins for cash. Resources: The definitive site is LocalBitcoins.
You could sell a product or service for bitcoins. Resources: Sites like Purse.
Caution! Bitcoin is notorious for scams, so before using any service look for reviews from previous customers or post your questions on the Bitcoin forum.
How does Bitcoin work?
Without getting into the technical details, Bitcoin works on a vast public ledger, also called a blockchain, where all confirmed transactions are included as so-called ‘blocks.’ As each block enters the system, it is broadcast to the peer-to-peer computer network of users for validation. In this way, all users are aware of each transaction, which prevents stealing and double-spending, where someone spends the same currency twice. The process also helps blockchain users trust the system.
“Unlike traditional currencies, which are issued by central banks, Bitcoin has no central monetary authority. Instead it is underpinned by a peer-to-peer computer network made up of its users’ machines, akin to the networks that underpin BitTorrent, a file-sharing system, and Skype, an audio, video and chat service. Bitcoins are mathematically generated as the computers in this network execute difficult number-crunching tasks, a procedure known as Bitcoin “mining”. The mathematics of the Bitcoin system were set up so that it becomes progressively more difficult to “mine” Bitcoins over time, and the total number that can ever be mined is limited to around 21 million. There is therefore no way for a central bank to issue a flood of new Bitcoins and devalue those already in circulation.”
Is Bitcoin safe and legal?
To see how the system works, imagine someone called Alice who’s trying out Bitcoins. She’d sign up for a cryptocurrency wallet to put her bitcoins in.
The Bitcoin Wallets
There are three different applications that Alice could use.
Full client – This is like a standalone email server that handles all aspects of the process without relying on third-party servers. Alice would control her whole transaction from beginning to end by herself. Understandably, this is not for beginners.
Lightweight client – This is a standalone email client that connects to a mail server for access to a mailbox. It would store Alice’s bitcoins, but it needs a third-party-owned server to access the network and make the transaction.
Web client – This is the opposite of “full client” and resembles webmail in that it totally relies on a third-party server. The third party replaces Alice and operates her entire transaction.
You’ll find wallet technology that comes in five main types: Desktop, mobile, web, paper and hardware. Each of these have its advantages and disadvantages.
Bonus: The Most Comprehensive Digital Wallet Guide: Step-by-Step Examples
How do I buy and sell stuff with Bitcoins?
Here’s the funny thing with Bitcoins: there are no physical traces of them as of dollars. All you have are only records of transactions between different addresses, with balances that increase and decrease in their records that are stored on the blockchain.
To see how the process works, let’s return to Alice.
Example of a Bitcoin transaction
Alice wants to use her Bitcoin to buy pizza from Bob. She’ll send the bitcoin to Bob’s public address, which is like his bitcoin bank account. She signs off the transaction with her private key to verify that she is indeed the sender of the digital currency. Once the miners have verified the validity of her transaction, the bitcoin get sent to Bob’s public address. Bob can now unlock the bitcoin with her private key. At the same time, Alice’s transaction is broadcast to all the other network participants (called “nodes”) on the bitcoin blockchain and, approximately, ten minutes later, is confirmed, through a process of certain technical and business rules called “mining.” This “mining” process gives Bob a score to know whether or not to proceed with Alice’s transaction.
What is Bitcoin Mining?
Mining, or processing, keep the Bitcoin process secure by chronologically adding new transactions (or blocks) to the chain and keeping them in the queue. Blocks are chopped off as each transaction is finalized, codes decoded, and bitcoins passed or exchanged.
Miners can also generate new bitcoins by using special software technology to solve cryptographic problems. This provides a smart way to issue the currency and also provides an incentive for people to mine.
The reward is agreed-upon by everyone in the network but is generally 12.5 bitcoins as well as the fees paid by users sending transactions. To prevent inflation and to keep the system manageable, there can be no more than a fixed total number of 21 million bitcoins (or BTCs) in circulation by the year 2040, so the “puzzle” gets increasingly harder to solve.
So to summarize the Bitcoin mining process:
Bitcoin miners are nodes in the Bitcoin network that possess specialized software technology called ASICs.
The Bitcoin miners constantly solve cryptographically hard puzzles.
If successful, they get to add a block to the Bitcoin blockchain and get a reward, in return.
Currently, the bitcoin block reward is around 12.5 BTC.
There are a few more key things to remember about bitcoin mining or proof-of-work are as follows:
It’s extremely difficult to do. Miners often need to spend a lot of money and computing power to successfully mine a Bitcoin. In fact, mining is now so difficult to do that it is impossible for a lone miner to do it on their own. This is why miners often join forces to create mining pools.
The metric which defines the degree of toughness of mining is known as “difficulty.”
Difficulty is directly proportional to network hashrate. Hashrate is a value that calculates the rate in which miners are executing operations within the ecosystem. Higher the network hashrate, higher the speed and security of the network.
When bitcoin hashrate increases, the difficulty increases as well to keep mining under control and maintain a consistent bitcoin block time of 10 mins.
What do I need to know to protect my Bitcoins?
Here are four pieces of advice that will help your bitcoins go further.
As you’d do with a regular wallet, only store small amounts of bitcoins on your computer, mobile, or server for everyday uses, and keep the remaining part of your funds in a safer environment.
Backup your wallet on a regular basis and encrypt your wallet or smartphone with a strong password to protect it from thieves (although, unfortunately, not against keylogging hardware or software).
Store some of your bitcoins in an offline bitcoin wallet disconnected from your network for added security. Think of them as your bank accounts, while you, generally, keep only some of your money in your wallet.
Don’t store your cryptocurrency in bitcoin exchanges or any third-party storage place for that matter.
Update your bitcoin software. For added protection, use Bitcoins’ multi-signature feature that allows a transaction to require multiple independent approvals to be spent.
Spending some time on these steps can save you money.
We recommend the Nano Ledger S – Hardware Wallet
Nano Ledger X is just as secure as the other two hardware wallets. It is popular because of its relatively low price of $65 compared to its competitors. Being smaller than KeepKey, it is more portable and easier to carry around. It is a hardware wallet that comes at a very competitive price and is backed by top-class technology.
What are the disadvantages of Bitcoin?
In the beginning, a lot of people were skeptical about bitcoin since nobody knows the identity of its founder- Satoshi Nakamoto. In fact, we don’t even know if Satoshi Nakamoto is a man, woman, or a group of people.
Regarding more practical concerns, hacking and scams are the norms. They happen at least once a week and are getting more sophisticated. Bitcoin’s software complexity and the volatility of its currency dissuade many people from using its payment system, while its transactions can be frustratingly slow. You’ll have to wait at least ten minutes for your network to approve the transaction. Recently, some Reddit users reported waiting more than one hour for their transactions to be confirmed.
Scams to watch out for
The four most typical Bitcoin scams are Ponzi schemes, mining scams, scam wallets, and fraudulent exchanges.
Ponzi Scams: Ponzi scams, or high-yield investment programs, hook you with higher interest than the prevailing market rate (e.g. 1-2% interest per day) while redirecting your money to the thief’s wallet. They also tend to duck and emerge under different names in order to protect themselves. Keep away from companies that give you Bitcoin addresses for incoming payments rather than the common payment processors such as BitPay or Coinbase.
Bitcoin Mining Scams: These companies will offer to mine outrageous amounts of bitcoin for you. You’ll have to pay them. That’s the last you’ll see of your money (with no bitcoins to show for it, either).
Bitcoin Exchange Scams: Bitcoin Exchange Scams offer features that the typical bitcoin wallets don’t offer, such as PayPal/Credit Card processing, or better exchange rates. Needless to say, these scams leave you in the hang while they siphon your dollars.
Bitcoin Wallet Scams: Bitcoin scam wallets are similar to online wallets – with a difference. They’ll ask you for your money. If robbers like the amount, that’s the last you’ll see of your deposit. The address, in other words, leads to them, rather than to you.
Of all of these, wallet scams are the most popular with scammers managing to pinch millions.
What are the advantages of Bitcoin?
The best thing about Bitcoin is that it is decentralized, which means that you have a payment system that can settle international deals without messing around with exchange rates and extra charges. Plus, you don’t need to go through a third party like a bank to conduct your transactions. Bitcoin is free from government interference and manipulation, so there’s no Federal Reserve System to hike interest rates. It is also transparent, so you know what is happening with your money. You can start accepting bitcoins instantly, without investing money and energy into details, such as setting up a merchant account or buying credit card processing hardware. Bitcoins cannot be forged, nor can your client demand a refund.
It’s a small wonder that users call Bitcoin “Money 2.0” or that Bill Gates called it “a techno tour de force.”
What is Bitcoin: Conclusion
Other coins like Bitcoin
While Bitcoin is THE big coin in the crypto space, it does have some shortcomings when it comes to scalability and privacy. This is why many projects have simply forked off the main bitcoin protocol to create their own currencies. Some of the more well-known bitcoin forks are:
Litecoin: Positioning themselves as silver to bitcoin’s gold, Litecoin can be considered a lighter and faster version of bitcoin.
Bitcoin Cash: A fork of the bitcoin protocol that has an 8 MB block size as opposed to 1 MB.
Zcash: Utilizes zk-SNARKS with the underlying bitcoin protocol to create a unique privacy coin.
Dash: A bitcoin fork that provides a payment system that’s both private and scalable.
What is Bitcoin: Conclusion
Where do I go from here?
Here are various resources that will direct you to best places for finding wallets, stores that accept bitcoins, exchanges for trading Bitcoin, and Bitcoin news, prices, charts, guides, and analysis among other information.
Bitcoin has been through several obstacles recently with the Bitcoin Cash fork and SegWit implementation. Bitcoin, over the last 11 years, has truly disrupted the world’s economy and financial systems by providing a payment system that is ahead of its time. The idea of you being your own bank and owning your own bank account as opposed to storing your money in third party financial institution or payment processor is revolutionary. Having said that, this is just the beginning. The Bitcoin revolution still has a lot of miles to go. It is going to super exciting to see where we are going to go on from here.
Blockchain.info – Blockchain info is the go-to place for checking transactions on the ledger. You can check how much money your wallet contains, or, for that matter, how much BTC is stored at any particular wallet address.
Bitnodes – Run by the Bitcoin Foundation, Bitnodes estimates and visualizes the size of the bitcoin network.
Wizbit – Wizbit shows all transactions and newly mined blocks in real-time on an eye-catching spinning globe.
We Use Coins – Weusecoins.com is a list of credible exchanges for trading Bitcoins worldwide or in the U.S.
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