What Is Bitcoin?
Bitcoin is a decentralized digital currency created in January 2009. It follows the ideas set out in a white paper by the mysterious and pseudonymous Satoshi Nakamoto.
The identity of the person or persons who created the technology is still a mystery. Bitcoin offers the promise of lower transaction fees than traditional online payment mechanisms do, and unlike government-issued currencies, it is operated by a decentralized authority.
Bitcoin is known as a type of cryptocurrency because it uses cryptography to keep it secure. There are no physical bitcoins, only balances kept on a public ledger that everyone has transparent access to (although each record is encrypted). All Bitcoin transactions are verified by a massive amount of computing power via a process known as "mining." Bitcoin is not issued or backed by any banks or governments, nor is an individual bitcoin valuable as a commodity. Despite it not being legal tender in most parts of the world, Bitcoin is very popular and has triggered the launch of hundreds of other cryptocurrencies, collectively referred to as altcoins. Bitcoin is commonly abbreviated as BTC when traded.
KEY TAKEAWAYS
- Launched in 2009, Bitcoin is the world's largest cryptocurrency by market capitalization.
- Unlike fiat currency, Bitcoin is created, distributed, traded, and stored with the use of a decentralized ledger system, known as a blockchain.
- Bitcoin's history as a store of value has been turbulent; it has gone through several cycles of boom and bust over its relatively short lifespan.
- As the earliest virtual currency to meet widespread popularity and success, Bitcoin has inspired a host of other cryptocurrencies in its wake.
Understanding Bitcoin
The Bitcoin system is a collection of computers (also referred to as "nodes" or "miners") that all run Bitcoin's code and store its blockchain. Figuratively speaking, a blockchain can be thought of as a collection of blocks. In each block is a collection of transactions. Because all of the computers running the blockchain have the same list of blocks and transactions and can transparently see these new blocks as they're filled with new Bitcoin transactions, no one can cheat the system.
Anyone—whether they run a Bitcoin "node" or not—can see these transactions occurring in real time. To achieve a nefarious act, a bad actor would need to operate 51% of the computing power that makes up Bitcoin. Bitcoin has around 13,768 full nodes, as of mid-November 2021, and this number is growing, making such an attack quite unlikely.
But if an attack were to happen, Bitcoin miners—the people who take part in the Bitcoin network with their computers—would likely split off to a new blockchain, making the effort the bad actor put forth to achieve the attack a waste.
Balances of Bitcoin tokens are kept using public and private "keys," which are long strings of numbers and letters linked through the mathematical encryption algorithm that creates them. The public key (comparable to a bank account number) serves as the address published to the world and to which others may send Bitcoin.
The private key (comparable to an ATM PIN) is meant to be a guarded secret and only used to authorize Bitcoin transmissions. Bitcoin keys should not be confused with a Bitcoin wallet, which is a physical or digital device that facilitates the trading of Bitcoin and allows users to track ownership of coins. The term "wallet" is a bit misleading because Bitcoin's decentralized nature means it is never stored "in" a wallet, but rather distributed on a blockchain.
Peer-to-Peer Technology
Bitcoin is one of the first digital currencies to use peer-to-peer (P2P) technology to facilitate instant payments. The independent individuals and companies who own the governing computing power and participate in the Bitcoin network—Bitcoin "miners"—are in charge of processing the transactions on the blockchain and are motivated by rewards (the release of new Bitcoin) and transaction fees paid in Bitcoin.
These miners can be thought of as the decentralized authority enforcing the credibility of the Bitcoin network. New bitcoins are released to miners at a fixed but periodically declining rate. There are only 21 million bitcoins that can be mined in total. As of November 2021, there are over 18.875 million Bitcoin in existence and less than 2.125 million Bitcoin left to mine.4
In this way, Bitcoin and other cryptocurrencies operate differently from fiat currency; in centralized banking systems, the currency is created at a rate matching the growth of the economy; this system is intended to maintain price stability. A decentralized system, like Bitcoin, sets the release rate ahead of time and according to an algorithm.
Bitcoin Mining
Bitcoin mining is the process by which Bitcoin is released into circulation. Generally, mining requires solving computationally difficult puzzles to discover a new block, which is added to the blockchain.
Bitcoin mining adds and verifies transaction records across the network. Miners are rewarded with some Bitcoin; the reward is halved every 210,000 blocks. The block reward was 50 new bitcoins in 2009. On May 11, 2020, the third halving occurred, bringing the reward for each block discovery down to 6.25 bitcoins.
A variety of hardware can be used to mine Bitcoin. However, some yield higher rewards than others. Certain computer chips, called application-specific integrated circuits (ASICs), and more advanced processing units, such as graphic processing units (GPUs), can achieve more rewards. These elaborate mining processors are known as "mining rigs."
One bitcoin is divisible to eight decimal places (100 millionths of one bitcoin), and this smallest unit is referred to as a Satoshi.6 If necessary, and if the participating miners accept the change, Bitcoin could eventually be made divisible to even more decimal places.
Who Is Satoshi Nakamoto?
No one knows who invented Bitcoin, or at least not conclusively. Satoshi Nakamoto is the name associated with the person or group of people who released the original Bitcoin white paper in 2008 and worked on the original Bitcoin software that was released in 2009. In the years since then, many individuals have either claimed to be or been rumored to be the real-life people behind the pseudonym, but as of November 2021, the true identity (or identities) of Satoshi Nakamoto remains obscured.
Although it is tempting to believe the media's spin that Satoshi Nakamoto is a solitary, quixotic genius who created Bitcoin out of thin air, such innovations do not typically happen in a vacuum. All major scientific discoveries, no matter how seemingly original, were built on previously existing research.
There are precursors to Bitcoin: Adam Back’s Hashcash, invented in 1997, and subsequently Wei Dai’s b-money, Nick Szabo’s bit gold, and Hal Finney’s Reusable Proof of Work. The Bitcoin white paper itself makes reference to Hashcash and b-money as well as various other works spanning several research fields. Perhaps unsurprisingly, many of the individuals behind the other projects named above have been speculated to have also had a hand in creating Bitcoin.
There are a few possible motivations for Bitcoin's inventor to keep their identity secret. One is privacy: As Bitcoin has gained in popularity—becoming something of a worldwide phenomenon—Satoshi Nakamoto would likely garner a lot of attention from the media and from governments. Another reason could be the potential for Bitcoin to cause a major disruption in the current banking and monetary systems. If Bitcoin were to gain mass adoption, the system could surpass nations' sovereign fiat currencies. This threat to existing currency could motivate governments to want to take legal action against Bitcoin's creator.
The other reason is safety. Looking at 2009 alone, 32,490 blocks were mined; at the reward rate of 50 Bitcoin per block, the total payout in 2009 was 1,624,500 Bitcoin. One may conclude that only Satoshi and perhaps a few other people were mining through 2009 and that they possess a majority of that stash of Bitcoin.
Someone in possession of that much Bitcoin could become a target of criminals, especially considering that Bitcoin is less like stocks and more like cash, wherein the private keys needed to authorize spending could be printed out and literally kept under a mattress.
Special Considerations
Bitcoin as a form of payment
Bitcoin can be accepted as a means of payment for products sold or services provided. Brick-and-mortar stores can display a sign saying “Bitcoin Accepted Here”; the transactions can be handled with the requisite hardware terminal or wallet address through QR codes and touchscreen apps. An online business can easily accept Bitcoin by adding this payment option to its other online payment options: credit cards, PayPal, etc.
Bitcoin employment opportunities
Those who are self-employed can get paid for a job related to Bitcoin. There are several ways to achieve this, such as creating any internet service and adding your Bitcoin wallet address to the site as a form of payment. There are also several websites and job boards that are dedicated to digital currencies:
- Jobs4Bitcoins is part of Reddit.com.
- BitGigs describes itself as "a Bitcoin job board."
- Bitwage offers a way to choose a percentage of your work paycheck to be converted into Bitcoin and sent to your Bitcoin address.
Investing in Bitcoin
Many Bitcoin supporters believe that digital currency is the future. Many individuals who endorse Bitcoin believe it facilitates a much faster, low-fee payment system for transactions across the globe. Although it is not backed by any government or central bank, Bitcoin can be exchanged for traditional currencies; in fact, its exchange rate against the dollar attracts potential investors and traders interested in currency plays. Indeed, one of the primary reasons for the growth of digital currencies like Bitcoin is that they can act as an alternative to national fiat money and traditional commodities like gold.
In March 2014, the IRS stated that all virtual currencies, including Bitcoin, would be taxed as property rather than currency. Gains or losses from Bitcoin held as capital will be realized as capital gains or losses, while Bitcoin held as inventory will incur ordinary gains or losses. The sale of Bitcoin you mined or purchased from another party, or the use of Bitcoin to pay for goods or services, are examples of transactions that can be taxed.
Like any other asset, the principle of buying low and selling high applies to Bitcoin. The most popular way of amassing the currency is through buying on a Bitcoin exchange, but there are many other ways to earn and own Bitcoin.
Risks Associated With Bitcoin Investing
Speculative investors have been drawn to Bitcoin after its rapid price appreciation in recent years. Bitcoin had a price of $7,167.52 on Dec. 31, 2019, and a year later, had appreciated more than 300% to $28,984.98. It continued to surge in the first half of 2021, trading at a record high of over $68,000 in November 2021.
Thus, many people purchase Bitcoin for its investment value rather than its ability to act as a medium of exchange. However, the lack of guaranteed value and its digital nature means its purchase and use carry several inherent risks. Many investor alerts have been issued by the Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA), the Consumer Financial Protection Bureau (CFPB), and other agencies.
The concept of a virtual currency is still novel and, compared to traditional investments, Bitcoin doesn't have much of a long-term track record or history of credibility to back it. With its increasing popularity, Bitcoin is becoming less experimental every day; still, after only a decade, all digital currencies remain in a development phase. "It is pretty much the highest-risk, highest-return investment that you can possibly make,” says Barry Silbert, CEO of Digital Currency Group, which builds and invests in Bitcoin and blockchain companies.
Regulatory risk
Investing money in any of Bitcoin's many guises is not for the risk-averse. Bitcoin is a rival to government currency and may be used for underground market transactions, money laundering, illegal activities, or tax evasion. As a result, governments may seek to regulate, restrict, or ban the use and sale of Bitcoin (and some already have). Others are coming up with various rules.
For example, in 2015, the New York State Department of Financial Services finalized regulations that would require companies dealing with the buy, sell, transfer, or storage of Bitcoin to record the identity of customers, have a compliance officer, and maintain capital reserves. Any transactions worth $10,000 or more will have to be recorded and reported.
The lack of uniform regulations about Bitcoin (and other virtual currencies) raises questions over their longevity, liquidity, and universality.
Security risk
Most individuals who own and use Bitcoin have not acquired their tokens through mining operations. Rather, they buy and sell Bitcoin and other digital currencies on any of the popular online markets, known as Bitcoin exchanges or cryptocurrency exchanges.
Bitcoin exchanges are entirely digital and—as with any virtual system—are at risk from hackers, malware, and operational glitches. If a thief gains access to a Bitcoin owner's computer hard drive and steals their private encryption key, they could transfer the stolen Bitcoin to another account. (Users can prevent this only if their Bitcoin is stored on a computer that is not connected to the internet, or else by choosing to use a paper wallet—printing out the Bitcoin private keys and addresses and not keeping them on a computer at all.)
Hackers can also target Bitcoin exchanges, gaining access to thousands of accounts and digital wallets where Bitcoin is stored. One especially notorious hacking incident took place in 2014, when Mt. Gox, a Bitcoin exchange in Japan, was forced to close down after millions of dollars worth of Bitcoin were stolen.
This is particularly problematic given that all Bitcoin transactions are permanent and irreversible. It's like dealing with cash: Any transaction carried out with Bitcoin can only be reversed if the person who has received them refunds them. There is no third party or payment processor as in the case of a debit or credit card—hence, no source of protection or appeal if there is a problem.
Insurance risk
Some investments are insured through the Securities Investor Protection Corporation (SIPC). Normal bank accounts are insured through the Federal Deposit Insurance Corporation (FDIC) up to a certain amount depending on the jurisdiction.
Generally speaking, Bitcoin exchanges and Bitcoin accounts are not insured by any type of federal or government program. In 2019, prime dealer and trading platform SFOX announced it would be able to provide Bitcoin investors with FDIC insurance, but only for the portion of transactions involving cash.
Fraud risk
Though Bitcoin uses private key encryption to verify owners and register transactions, fraudsters and scammers may attempt to sell false Bitcoin. For instance, in July 2013, the SEC brought legal action against an operator of a Bitcoin-related Ponzi scheme. There have also been documented cases of Bitcoin price manipulation, another common form of fraud.
Market risk
As with any investment, Bitcoin values can fluctuate. Indeed, the value of the currency has seen wild swings in price over its short existence. Subject to high volume buying and selling on exchanges, it has a high sensitivity to any newsworthy events. According to the CFPB, the price of Bitcoin fell by 61% in a single day in 2013, while the one-day price drop record in 2014 was as big as 80%.17
If fewer people begin to accept Bitcoin as a currency, these digital units may lose value and could become worthless. Indeed, there was speculation that the "Bitcoin bubble" had burst when the price declined from its all-time high during the cryptocurrency rush in late 2017 and early 2018.
There is already plenty of competition, and although Bitcoin has a huge lead over the hundreds of other digital currencies that have sprung up because of its brand recognition and venture capital money, a technological breakthrough in the form of a better virtual coin is always a threat.
Splits in the Cryptocurrency Community
In the years since Bitcoin launched, there have been numerous instances in which disagreements between factions of miners and developers prompted large-scale splits of the cryptocurrency community. In some of these cases, groups of Bitcoin users and miners have changed the protocol of the Bitcoin network itself.
This process is known as "forking," and it usually results in the creation of a new type of Bitcoin with a new name. This split can be a "hard fork," in which a new coin shares transaction history with Bitcoin up until a decisive split point, at which point a new token is created. Examples of cryptocurrencies that have been created as a result of hard forks include Bitcoin Cash (created in August 2017), Bitcoin Gold (created in October 2017), and Bitcoin SV (created in November 2018).
A "soft fork" is a change to the protocol that is still compatible with the previous system rules. For example, Bitcoin soft forks have added functionalities such as segregated witness (SegWit).
Why Is Bitcoin Valuable?
Bitcoin's price has risen exponentially in just over a decade, from less than $1 in 2011 to more than $68,000 as of November 2021. Its value is derived from several sources, including its relative scarcity, market demand, and marginal cost of production. Thus, even though it is intangible, Bitcoin commands a high valuation, with a total market cap of $1.11 trillion as of November 2021.
Is Bitcoin a Scam?
Even though Bitcoin is virtual and can't be touched, it is certainly real. Bitcoin has been around for more than a decade and the system has proved itself to be robust. The computer code that runs the system, moreover, is open source and can be downloaded and analyzed by anybody for bugs or evidence of nefarious intent. Of course, fraudsters may attempt to swindle people out of their Bitcoin or hack sites such as crypto exchanges, but these are flaws in human behavior or third-party applications and not in Bitcoin itself.
How Many Bitcoins Are There?
The maximum number of bitcoins that will ever be produced is 21 million, and the last bitcoin will be mined at some point around the year 2140. As of November 2021, more than 18.85 million (almost 90%) of those bitcoins have been mined. Moreover, researchers estimate that up to 20% of those bitcoins have been "lost" due to people forgetting their private key, dying without leaving any access instructions, or sending bitcoins to unusable addresses.
Should I Capitalize the B in Bitcoin?
By convention, use a capital B when discussing the Bitcoin network, protocol, or system. Use a small b when talking about individual bitcoins as a unit of value (for example, I sent two bitcoins).
Where Can I Buy Bitcoin?
There are several online exchanges such as Binance that allow you to purchase Bitcoin. In addition, Bitcoin ATMs —internet-connected kiosks that can be used to buy bitcoins with credit cards or cash—have been popping up around the world. Or, if you know a friend who owns some bitcoins, they may be willing to sell them to you directly without any exchange at all.
