What Is Bitcoin? How Does Bitcoin Work?
Anyone with access to the internet or television has most likely heard of cryptocurrencies. Of these, Bitcoin is king and has often been directly associated by some as being one and the same. It’s difficult to believe that a currency that is not backed by any government or other entity can “suddenly” be so valuable… But hey, it’s 2021 and technology is surprising us every day!
If you are reading this article, you likely have an idea of what Bitcoin is. However, most people will not be familiar with the technology behind it. If you are looking to learn more about Bitcoin, that’s great! The first place toward investing in Bitcoin should be having a general understanding of how it works in the background. This is especially true at a time when new cryptocurrencies are being created every day.
So exactly what is Bitcoin, what makes it valuable, and how does it work? If you’re still in the dark about all things Bitcoin, this is the place for you. We’ll be giving you a quick overview of what Bitcoin is and how it works.
What is Bitcoin?
Bitcoin is a decentralized digital currency created in 2009 by the mysterious Satoshi Nakamoto. Mysterious because nobody knows who the creator or creators are. This has been one of the big mysteries in the crypto world since its release.
While Bitcoin’s creation resulted in the spawn of many other cryptocurrencies, all have failed to replace it as the biggest. When looking at the cryptocurrency markets, you will always find that Bitcoin is the one that holds the largest market capitalization.
But why exactly is it that people are willing to pay thousands of dollars for just ones and zeroes? Well, unlike a traditional currency that is issued by a central bank, Bitcoin can’t just be printed. This means that it is not subject to inflation like any fiat currency you know.
If we consider the USD, you’re quite aware that what you can buy now for your money is much less than what could be bought in the 50s. Now, this is the USD, other currencies are much more volatile.
Let’s take a look at some of the factors that give Bitcoin its value:
Just like gold has its value due to its scarcity, so does Bitcoin. The network that Bitcoin works on only lets new Bitcoin be created at pre-designed intervals and at a fixed rate. On top of that, the creation rate is built to slow down over time.
This happens as a result of “Bitcoin halving”. These events reduce the rate at which new Bitcoin created is reduced to half, hence the name.
Let’s take the example of the beginning of Bitcoin. Before the first halving event, for every block that was ‘mined’, 50 Bitcoin was created. After the halving event, only 25 were released per block processed.
This will continue until the total amount of Bitcoin, 21 million coins, is mined. At that point, no new Bitcoin will ever be created. The last Bitcoin will be mined in the year 2140 so we still have a long way to go.
Although it still is a bit difficult to pay for your coffee with Bitcoin, the technology has become high demand in the investing world. The fact that it’s entirely digital and not controlled by any government are things that are attractive to people around the world.
For one, it has become a popular medium to create savings in places where inflation has gone rampant. On top of that, investors and speculators have taken an interest in the currency, making it popular in the media, driving demand even higher.
Real Life Infrastructure
While Bitcoin is a digital asset, the coin still requires physical components to exist. Those mining Bitcoin do incur costs in the form of electricity bills and computer hardware, as mining isn’t exactly cheap. According to the New York Times, Bitcoin Mining uses more electricity than many countries.
While in 2009, you could mine a coin with your home computer, this is simply not possible nowadays. All this incurs costs that largely add to the price of Bitcoin. If you want to learn more about mining, we recommend this guide we created on the topic.
How does Bitcoin Work?
It is not possible to talk about what is bitcoin without talking about how it works: Blockchain. In the coin’s whitepaper, Nakamoto details how blockchain will be the backbone of Bitcoin’s Peer-to-Peer (P2P) electronic cash system.
Being P2P, the currency is not backed by any centralized government that ensures its legitimacy. However, transactions can be legitimized by independent parties who participate in the Bitcoin network. By having multiple members of the network reach a consensus, the credibility of a transaction can be confirmed. Let’s take a look at how blockchain works.
Essentially, the blockchain would simply be a list of transactions stored using cryptography in a series of “blocks”. As each block links to the previous and the next one, it is easy to go through the chain to verify transactions. This chain of blocks is the heart and soul of cryptocurrencies, providing them with security and transparency.
The fact that it’s accessible to everyone and all these parties have a copy of a transaction makes them essentially impossible to forge. After the transaction has taken place, no individual can deny it did. The transaction is already recorded over hundreds or thousands of different computers. The added cryptographic nature of the blocks further ensures no one can modify them.
Bitcoin ownership is essentially composed of a private and public key. The public key is displayed on the blockchain. The private key on the other hand would be the password needed to confirm any transaction. This translates to a simple truth in crypto: “Not your keys, not your coins”. Whoever owns the private key to an address owns any crypto stored on it.
If you want to know more about how blockchain technology works, we have written a guide on that topic. You can find it here.
So we’ve roughly gone over what the blockchain is but what exactly is the mining process? If you didn’t read our article on Proof-Of-Work, worry not. Here is a small refresher of what mining is and how it contributes to Bitcoin’s security.
As we previously mentioned, what keeps Bitcoin working is the fact that all transactions are recorded over thousands of different computers. But how are these transactions stored, exactly?
Bitcoin mining has 2 steps that need to be completed for it to be successful. For one, if you want to receive your mined Bitcoin, you have to verify 1MB worth of transactions and solve a complex mathematical problem. While recording transactions is simple enough for computers, the mathematical problem on the other hand is much more difficult.
All the parties that are processing transactions are also running this mathematical problem. Hashing is simply passing some data through a formula that produces a result, called a hash. This problem is essentially trying to find a hash that must be lower or equal to a target hash.
What your computer does, in this case, is generate hashes at different rates, guessing all possibilities numbers until a correct solution is found. This makes it a total guessing game.
Once the solution is found, the same is shared, validated by other miners, and the block is completed. This completion also triggers the minting of new Bitcoin which is then awarded to the lucky person to find the solution. What all this does is make the process artificially more difficult, making these complete at a rate of around 1 block every 10 minutes.
It’s clear that a lot of thought has gone into Bitcoin and the technology behind it. As the cryptocurrency that started it all, it is not surprising it is still ruling the market.
However, there are a lot of coins looking to overcome it in the future. As such, we recommend you learn about other cryptocurrencies to diversify your portfolio. For example, you can read our guide on what cryptocurrencies to watch for in 2022!
This doesn’t mean that Bitcoin is obsolete or going to disappear. After all, its technical bases are solid, and it is far too popular to fail now. It also is a new way of thinking about money that brought a new dimension to the economic world.
While not meant to be an in-depth guide. We hope you now have an answer to the question “what is Bitcoin?”. However, you should be aware that there is so much more to Bitcoin than what we mentioned here. As such, you should take a look at our crypto section if you are interested in learning more.
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