It’s hard to believe that Bitcoin has been around since 2009. In the grand scheme of things, it’s still a baby, but if you’re reading this article, you may just be starting your journey and be a Bitcoin baby yourself.
What is Bitcoin and how does it work? At the highest level, as stated in the original whitepaper “A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.”
How it works? keep reading to learn how it works and why Bitcoin is the future of finance.
What is Bitcoin?
Bitcoin is a decentralized digital currency that enables peer-to-peer transactions without the need for intermediaries like banks or governments. It was created in 2009 by an anonymous person or group of people using the pseudonym Satoshi Nakamoto.
KEY TAKEAWAYS
- Created in 2009, Bitcoin is the largest cryptocurrency by market cap.
- Running 24/7 on a decentralized network known as the blockchain, Bitcoin transactions can be executed directly between parties, in a trustless manner, without an intermediary.
- Bitcoin can be purchased on various exchanges to be used as a currency to transact, or as a store of value similar to gold.
- The Bitcoin network is secured by the number of participants on the network and the way it verifies and confirms each transaction.
- Bitcoin is a volatile asset and has had many ups and downs since its inception.
Why does Bitcoin exist?
In 2009, no such mechanism existed, that allowed two willing parties to transact with each other over a communications channel without going through a financial institution.
Until this time, the failure of digital money had been due to being unable to solve the problem of double-spending. This just means that a person could spend a coin twice or more by performing some shady antics and spoofing the blockchain.
What problem does Bitcoin solve?
Bitcoin solves many problems. Satoshi Nakamoto wanted to create a purely peer-to-peer version of electronic cash that would allow online payments to be sent directly from one party to another without going through a financial institution.
Additionally, here are some of the other key things that Bitcoin aims to solve:
- Decentralization – Traditional currencies are controlled by central banks and governments, leading to concerns about manipulation, inflation, and censorship. Bitcoin operates on a decentralized network, meaning no single entity controls it. This decentralization promotes transparency, reduces the risk of manipulation, and enhances financial sovereignty for individuals.
- Trustless Transactions: Traditional financial transactions often require trust in intermediaries such as banks, payment processors, and clearinghouses. Bitcoin transactions are trustless, meaning they can be executed directly between parties without the need for intermediaries. The blockchain technology ensures the integrity and security of transactions without relying on third parties.
- Financial Inclusion: Many people around the world lack access to traditional banking services due to factors such as geography, infrastructure, and documentation requirements. Bitcoin offers a borderless and inclusive financial system, enabling anyone with internet access to participate in the global economy, regardless of their location or background.
- Security and Privacy: Traditional financial systems are susceptible to fraud, identity theft, and data breaches. Bitcoin provides enhanced security and privacy through cryptographic techniques such as public-key cryptography and pseudonymity. Users have control over their funds and can transact with a level of privacy not always available in traditional banking systems.
- Inflation Hedge: Fiat currencies are subject to inflationary pressures caused by central bank policies such as quantitative easing and money printing. Bitcoin’s fixed supply of 21 million coins makes it resistant to inflation, providing a hedge against currency devaluation and preserving purchasing power over time.
- Cross-Border Payments: Traditional cross-border transactions (think Western Union) can be slow, expensive, and subject to intermediary fees and delays. Bitcoin enables fast and low-cost international payments without the need for currency conversion or intermediaries. This can be particularly beneficial for remittances and international trade.
How does Bitcoin work?
We’ve already covered what decentralization is, but what else makes the Bitcoin network work?
Blockchain technology is a distributed ledger that records all transactions that have ever been made using Bitcoin.
Each block within the blockchain houses a group of transactions that are linked together in chronological order, forming a chain.
This transparent ledger ensures the Bitcoin network stays secure and maintains integrity.
If you want to send Bitcoin to another person, you create a transaction.
The transaction includes the sender’s digital signature, a unique identifier of the recipient called a public address, and the amount of Bitcoin being transferred.
This transaction is broadcasted to the network which will be verified by miners.
Miners? Like mining for gold?
Kind of. Miners solve complex mathematical puzzles to validate and confirm transactions on the Bitcoin network, and for their efforts, they’re rewarded with newly minted Bitcoin and transaction fees.
However, instead of using picks and shovels, they use powerful computers known as mining rigs to solve these puzzles, and when successful they add a new block of transactions to the blockchain.
Earlier we talked about trust in a traditional financial system which is susceptible to fraud.
The Bitcoin network relies on a consensus mechanism called Proof of Work (PoW) to ensure the security and immutability of the blockchain.
Those miners we talked about earlier compete to solve puzzles, and the longest valid chain with the most accumulated computational work is considered the valid blockchain. This is what prevents double-spending and the aforementioned fraudulent activities.
Lastly, Bitcoin has a limited supply of only 21 million coins, which makes it a deflationary asset.
This scarcity is built into the protocol which is further enforced by the halving mechanism, which cuts the number of new bitcoins created in half approximately every four years.
Estimates suggest that around 6 million coins, or 30% of Bitcoin’s supply, have been irretrievably lost, so the real number of coins that can ever be mined is closer to 15 million.
Is Bitcoin actual money?
Well, that depends on who you ask, and what your perspective on money is. Bitcoin is not legal tender in most countries, so it’s not a valid form of payment for debts.
However, Bitcoin can be used as a medium of exchange to buy goods and services from merchants that accept it as payment. In this sense, Bitcoin functions similarly to traditional fiat currencies like the US dollar or the GBP.
Some people hold Bitcoin as a store of value, similar to gold. The limited supply of 21 million Bitcoin and its decentralized nature makes it attractive to some as a hedge against inflation and economic uncertainty.
Bitcoin is a volatile asset relative to fiat currencies, so using it as a unit of account is currently debatable.
The regulatory treatment of Bitcoin varies by country and jurisdiction. Some governments have embraced Bitcoin and enacted regulations to facilitate its use, while others have imposed restrictions or outright bans on its use.
How is Bitcoin used?
In addition to some of the ways we’ve covered earlier like peer-to-peer transactions, and as a store of value, here are a few more ways:
- Remittances: Bitcoin provides a low-cost and efficient solution for sending money across borders, particularly in regions where traditional remittance services are expensive or inaccessible. By using Bitcoin, individuals can send funds to family members or friends in other countries quickly and at lower fees compared to traditional remittance services.
- Investment: Some buy and hold Bitcoin as a long-term investment, speculating that its value will increase due to factors such as scarcity, increasing adoption, and growing institutional interest.
- Trading: Bitcoin can be traded on cryptocurrency exchanges, in exchange for fiat currencies or other cryptocurrencies known as altcoins. Traders speculate on Bitcoin’s daily price movements, aiming to make money from short-term price fluctuations.
- Micropayments: Bitcoin can facilitate micropayments, allowing users to make small transactions for digital content, online services, or pay-per-use products. This can encourage new business models and revenue streams for content creators and service providers.
These are just a few use cases, and as Bitcoin adoption grows and technology moves forward, with its decentralized nature, and programmability, many use cases will flourish for various financial, economic, and social applications.
Is Bitcoin safe?
Bitcoin’s underlying technology is very safe and secure, however, you must take individual precautions to protect your Bitcoin.
When you hear about Bitcoin being “hacked” in the news, it’s important to understand that the Bitcoin network isn’t being hacked, but rather an exchange or centralized entity has been compromised.
There is a saying, “Not your keys, not your money”. This simply means, that if you don’t control the private keys to access your Bitcoin, well it’s not your Bitcoin.
The beauty of the Bitcoin network is that it’s a decentralized network of client nodes where there is no single point of failure to apply pressure.
If a hacker wanted to steal one Bitcoin each from one million users hodling their private keys, they’d need to hack each hodler one at a time, which is nearly impossible.
If those same hodlers transferred their Bitcoin to a centralized exchange, the hacker would now only need to hack the exchange once to steal the same amount of Bitcoin.
On a personal level, risk can include loss of private keys, malware, phishing attacks, and the aforementioned exchange hacks.
It’s important to use best practices like using secure wallets, storing and securing private keys, and knowing about scams trying to separate you and your Bitcoin.
Will Bitcoin be around forever?
Predicting the future of any technology can prove to be challenging. However, certain factors suggest that Bitcoin will be around for the foreseeable future.
Bitcoin is decentralized, operates 24/7, and doesn’t rely on any single entity, making it less vulnerable to outside influences such as censorship or control.
The substantial network effect that Bitcoin has achieved since its inception, with its growing user base and ecosystem will only strengthen as more people and institutions adopt it.
Bitcoin is scarce with a fixed supply of only 21 million coins enforced by the network protocol. This scarcity, combined with ever-increasing demand has the potential to drive value over time.
Institutional adoption is starting to catch up, as evidenced by the introduction of U.S. Bitcoin ETFs launched in 2024. Institutional involvement contributes to increased liquidity, market depth, and regulatory clarity.
Global demand will continue to accelerate, especially in regions where traditional banking access is limited, or in places that experience hyperinflation and economic instability.
Wrapping it up
The future looks bright with Bitcoin! With its decentralization, network effect, scarcity, institutional adoption, and global demand, Bitcoin will have longevity and resilience, in the face of our financial landscape.
Now, when someone asks you what is Bitcoin and how does it work, you’ll be able to tell them getting involved, and investing is as easy as buying on their favorite exchange. Remember, Bitcoin is volatile, everyone should always carefully consider any investment to make sure it’s the right one for them.