What is a Bitcoin and how does it work?


What is a Bitcoin

Bitcoin is a digital currency created in January 2009 after the fall of the housing market. It follows the ideas set out in the whitepaper by the mysterious Satoshi Nakamoto and is a pseudonym. The identity of the person who invented this technology remains a mystery.

Bitcoin offers the promise of lower transaction fees than traditional online payment mechanisms and is operated by decentralized authorities, unlike government-issued currencies.

There are no physical bitcoins, only balances stored in the public ledger whose access is transparent to everyone, which along with all Bitcoin transactions, is verified by a large amount of computing power.

Bitcoins are not issued or supported by any bank or government, nor are individual bitcoins valuable as commodities. Although it is not a legitimate means of payment, bitcoin charts have high popularity, and have triggered the launch of hundreds of other virtual currencies collectively referred to as Altcoins.

Here's what bitcoin is and how it's used and its drawbacks and advantages to know:

What is Bitcoin?

Bitcoin (BTC) is a digital currency, used and distributed electronically. Bitcoin is a decentralized peer-to-peer network. There's not a single institution or person who controls it. Bitcoins are unprintable and the number is very limited - only 21 million Bitcoins can be created.

Bitcoin is a type of cryptocurrency. Bitcoin token balances are stored using public and private "keys", which are long sets of numbers and letters linked through encryption of the mathematical algorithms used to create them. 

A public key (comparable to a bank account number) serves as an address published to the world and to which others can send bitcoins. A private key (comparable to an ATM PIN) is intended as a guarded secret and is only used to authorize Bitcoin transmission.

Bitcoin keys are not the same as Bitcoin wallets, which are physical or digital devices that facilitate Bitcoin trading and allow users to track coin ownership. The term "wallet" is somewhat misleading, since the decentralized nature of Bitcoin means that it is never stored "in" the wallet, but rather decentralized within the blockchain.

How does bitcoin work?

How does bitcoin work?

Every bitcoin (the trading symbol "BTC," although "XBT" is also used) is a computer file stored in a digital wallet on a computer or smartphone. To understand how bitcoin works, it's worth understanding these terms and a little context:

Blockchain : Bitcoin is powered by open source code known as blockchain, which keeps the public ledger together. Each transaction is a "block" that is "chained" to the code, making a permanent record of each transaction. Blockchain technology is at the heart of the more than 2,200 cryptocurrencies that have followed after bitcoin.

Private and public keys: Bitcoin wallets containing public keys and private keys, which work together to allow owners to start and sign transactions digitally, provide proof of authorization.

Bitcoin miners : Miners - or members of peer-to-peer platforms - then independently confirm transactions using high-speed computers, usually within 10 to 20 minutes. Miners are paid in bitcoin for their efforts.

How does bitcoin make money?

The value of Bitcoin follows the laws of supply and demand, and as demand rises and falls, there is a lot of volatility in cryptocurrency prices.

In addition to mining bitcoin, which requires technical expertise and investment on a high-performance computer, most people buy bitcoin as a form of currency speculation, betting that the value of the US dollar from one bitcoin will be higher in the future than it is today. But it's hard to predict.

Disadvantages and Advantages of Bitcoin

Price volatility

The surge in the price of bitcoin in 2017 was driven by speculators rushing into the bitcoin market, as NerdWallet staff writers discussed at the time. The recent gains are good news if you buy bitcoin in December 2018; those who bought in 2017 when the price of bitcoin soared towards $20,000 still have to recover their losses.

Hacking problem

While proponents say the blockchain technology behind bitcoin is even more secure than traditional electronic money transfers, bitcoin hot wallets have become attractive targets for hackers. There have been a number of high-profile hacks, such as the news in May 2019 that more than $40 million of bitcoins had been stolen from several high-value accounts on the Binance cryptocurrency exchange (the company covered the losses).

Limited use (but counting)

In May 2019, telecommunications giant AT&T joined companies such as Overstock.com, Microsoft, and Dish Network in accepting bitcoin payments. But these companies are the exceptions, not the rules.

Not protected by SIPC.

The Securities Investor Protection Company insures investors up to $500,000 if the broker fails or the funds are stolen, but that insurance does not cover cryptocurrencies.

Once you have bitcoin, you can transfer it anytime, anywhere, reducing the time and potential cost of any transaction. Transactions do not contain personal information such as names or credit card numbers, which eliminates the risk of stolen consumer information for fraudulent purchases or identity theft. (However, keep in mind that to buy bitcoin on an exchange, you usually need to link your bank account first.)

Huge growth potential.

Some investors who buy and hold the currency bet that once bitcoin matures, greater trust and wider use will follow, and therefore the value of bitcoin will grow.

Ability to avoid traditional banks or government intermediaries.

After the financial crisis and the great recession, some investors were eager to embrace a decentralized alternative currency, a currency that was essentially out of the control of ordinary banks, government authorities or other third parties. (However, to buy bitcoin on an exchange with U.S. dollars, you may need to link your bank account.)