Ultimate Bitcoin Guide: How Does Bitcoin Work
What is Bitcoin?
It depends who you ask. To some, Bitcoin is a currency. To others, it’s an investment. And still others see it as an experiment, or an idea.
Whatever your perspective, one thing is clear: Bitcoin, above all, is an asset.
Bitcoin is, at its most basic, a cryptocurrency, also known as a virtual currency. It touts itself as 1) digital, 2) decentralized, and 3) peer-to-peer. But merely saying this doesn’t answer the question, how does Bitcoin work?
First, Bitcoin is digital. This means it doesn’t exist in any kind of physical form. Despite the shiny gold coins featured on this and many other articles about Bitcoin, you can’t hold bitcoin in your hands. They exist in the virtual world.
Second, Bitcoin is decentralized, meaning there is no single administrator or central bank behind the currency. This lowers transaction costs and is one of the central appeals of a cryptocurrency.
Third, transactions with Bitcoins are peer-to-peer, which means they take place directly between two users, buyer and seller, without a middle man. This is what allows Bitcoin to be used with a high degree of anonymity as compared with regular currency.
The Darker Side of Bitcoin
Because of this structure, many cryptocurrencies originally had philosophies that were, or are, steeped heavily in libertarian or anarchist values. As time has gone on and cryptocurrencies have become more accepted and valued by the mainstream, these philosophies have evolved or been abandoned.
That being said, the original appeal of Bitcoin wasn’t as a get-rich-quick device. Rather, it was intended to be a means of making purchases anonymously and cheaply. It became popular on the infamous Silk Road in the dark web because no buyer or seller identities were needed, only wallet IDs. This made illicit and illegal purchases much safer.
The History of Bitcoin
To understand the question “how does bitcoin work?”, it’s helpful to know its history.
Bitcoin was first created in 2009 as a way of eliminating the middle men in financial transactions – no governments, no banks, no anything.
The inception of the idea was published in a short 9-page white paper called “Bitcoin: A Peer-to-Peer Electronic Cash System” under the alias Satoshi Nakamoto on October 31, 2008. The paper itself is still available for download at http://www.bitcoin.org/bitcoin.pdf. The domain for the site was registered two months earlier on August 18th.
While not the first cryptocurrency – it was proceeded by a few earlier attempts such as Hashcash in 1997, Bitcoin was the first cryptocurrency to become established. Over the course of its early years, it attracted investments from several high-profile investors. These include the Winklevoss twins (of Facebook fame) and billionaire venture capitalist Peter Thiel.
Numerous people have been suggested as the real identity of Satoshi, but no one has ever come forward to claim the identity. The currency has grown with the auspices of any single clear founder, which some say has been a benefit.
The smallest divisible unit of a bitcoin, (.00000001 bitcoin) is known as a Satoshi in his honor. Although, it is uncertain if Satoshi is a he or she, or if it’s even a single person (it has been suggested that Satoshi could actually be a group of people).
What is Blockchain Technology?
Bitcoin relies on something called blockchain technology, which is vital to understanding the question “how does bitcoin work?”, and which I cover in-depth in a separate article. Essentially though, as blocks are mined, they are “chained” together to create a running ledger. This ledger is kept by the full network of computer involved.
The so-called “genesis block” or “Block 0” was mined on January 3, 2009 and contained the following text: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks” both as political commentary and as a time stamp. A few days late on the 8th, the first version of Bitcoin software was sent out via email to a specialized cryptography mailing list and the next day Block 1 was mined.
“Bitcoin” is only capitalized when referring to the entity or concept, but is lower case when talking about the quantity of the currency (for example, 100 bitcoins).
The Growth of Bitcoin
Over the course of several major financial crises around the globe from 2008 on, the price of Bitcoin rose steadily in large pulses. Ultimately, Forbes named it its best investment of 2013, despite warnings from financial regulatory agencies about the risk of the investment.
In July of 2010, a single bitcoin was worth 8 cents. By July of 2011 it hit $31 before dropping back down to $2 by December. It hit $266 in April of 2013 and then dropped back to $130 in May. Then, it rose to a new high of $1,242 in November of that year and then stabilized in the $700 range. Finally, it rose and fell within a few hundred dollars of this range until May of 2017. At this point it began its huge price hike leaving it hovering in the $14,000 range.
The First Bitcoin Transaction
One of the central pieces of Bitcoin lore is the story of the first bitcoin transaction.
Two individuals on a forum negotiated an exchange of 10,000 BTC (BTC is the accepted currency abbreviation for bitcoins, much like USD for dollars) for the delivery of two Papa John’s pizzas. Today those bitcoins would be worth almost $140 million. Talk about an expensive pizza!
So, How Does Bitcoin Work and How Do I Get Bitcoin?
To understand how Bitcoin works, you need to understand how to actually get Bitcoin. There are three main ways to get Bitcoin.
First, you can buy Bitcoin through an exchange, just like stock is purchased (often through the New York Stock Exchange). The most popular exchange currently is Coinbase, but Bitstamp and Bitfinex are also popular.
Second, you can transfer Bitcoin directly from person to person through apps or computer software.
Third, you can mine bitcoin.
How Does Mining Bitcoin Work?
Essentially, computers solve complex math puzzles, and the successful completion of those puzzles reward bitcoins. This is how the bitcoins are “mined” or “created”. New bitcoin is released at a fixed, declining rate, because the total supply of bitcoins will never exceed 21 million.
Because of this, the difficulty of the mining puzzles has been increasing.
In the beginning, a regular desktop could mine Bitcoin. Now, mining can’t be completed by a regular desktop computer anymore, and mining requires specialized hardware, which I cover in-depth in another article related to this one on “how does bitcoin work?”.
What is a Cryptocurrency Wallet?
Bitcoin, like all cryptocurrencies, is stored in “digital wallets” that can exist either on your computer or in the cloud. These act like a sort of virtual bank account. There are dangers to both approaches, since a cloud could be hacked, and a computer can be subject to human error (accidental deletion) or a virus.
Regardless of the method of storage, a virtual wallet works very similarly to a bank account. It should be guarded just as carefully.
The Value of Bitcoin
Much of Bitcoin’s value has been realized in the past weeks. In July of 2017, the currency was hovering around $2,000 a coin, but it began rapidly rising in late October until finally skyrocketing to an all-time high of around $19,100 a coin.
It’s hard to say whether the currency has stabilized or not, but it has been hovering in the $13,000 to $15,000 range for the past few weeks, although that number is likely to change. For a real time look at the value of bitcoin, you can go to bitcointicker.co.
As more people look into Bitcoin and figure out, “how does Bitcoin work?”, the value is likely to increase.
Government and Bitcoin
How governments will handle cryptocurrencies remains unclear. In fact, several governments have already begun trying to figure out how to handle virtual currencies like Bitcoin.
In 2014, the Internal Revenue Service decided to treat all cryptocurrencies like property, and announced it would tax them accordingly. While steps like this by governments and governmental agencies might increase the cost of investment in Bitcoin, they also serve to legitimize the currency. As governments wrestle with the question of “how does Bitcoin work?”, their regulation will evolve accordingly.
What Are Other Cryptocurrencies
Cryptocurrencies other than Bitcoin, sometimes known as Altcoins, have seen significant gains as well. I’ll be covering these other coins in my ongoing series on cryptocurrencies, but some notable currencies include Dash, Ethereum, Litecoin, and Ripple.
Since Bitcoin is only one of thousands of cryptocurrencies, it’s hard to say if it will always be the most popular one. Other coins are growing in popularity and may eventually vie with Bitcoin for the role of default cryptocurrency.
The Future of Bitcoin
Right now, one of the primary challenges facing Bitcoin is uncertainty. With several countries considering regulating the currency, wild price swings, and large-scale hackings, Bitcoin itself might face a rocky future.
However, cryptocurrencies are likely here to stay because of the portability, cost-effectiveness, and anonymity they offer.
Thanks for reading!
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