Cryptocurrency - digital currency: what is the Bitcoin (BTC)?

Bitcoin

Bitcoins are the world's first cryptocurrency. A cryptocurrency is also called a digital currency, a crypto or a virtual currency. Bitcoins cannot be physically touched, they are pieces of code that only exist in a digital format.

Created in the aftermath of the 2009 financial crisis, Bitcoins were designed to offer an alternative to fiat currencies and traditional financial institutions. What makes Bitcoins different from previous attempts at digital currencies is the clever network and security systems on which they are based.

 

How do Bitcoins differ from traditional currencies?

Bitcoins are different in that...

  • They are decentralised: Bitcoins have no central issuing authority, so there is no single entity that controls the worldwide supply of Bitcoins in circulation. The value of a Bitcoin cannot be influenced by the decisions of governments or central banks. On the contrary, Bitcoins are entirely controlled by their users. Even the network Bitcoin operates on is managed by peers and a community.
  • They allow for direct transactions: Bitcoin transactions are carried out without intermediaries. If you want to pay me with Bitcoins in exchange for a good or a service, you pay me directly and no one else is involved. Anonymity and security are therefore completely guaranteed.
  • They offer relative annonymity: BTC transactions are carried out using randomly generated addresses and alphanumeric keys which keep your identity a secret. We will provide more info on how Bitcoin transactions work further below.

What technologies are used to create and maintain Bitcoins?

The answer to the above question is the blockchain: decentralised record keeping.

Bitcoins work through a blockchain which is a ledger that records all transactions. The registry is maintained by a network of peer-to-peer nodes using Bitcoin software. When transactions take place, they are grouped with other transactions in a "block". Blocks are processed, verified and added to the blockchain using advanced cryptographic methods that are highly secure and resistant to hacker attacks.

After being added to a blockchain, the blocks are broadcast to the network's other nodes. Each node keeps its own copy of the blockchain and checks each transaction along the way. The channel is immutable and accessible to everyone, which makes hacking impossible.

Bitcoin "mining"

The actual processing performed by these nodes is called "mining". Volunteers - know as "miners" - use extremely powerful computers to check incoming transactions, gather them into blocks and add them to the block chain.

To be validated by the network, each block requires what is called "proof of work". Miners are basically given an extremely difficult puzzle with a single numerical answer. The answer is usually numerical in form, and the puzzles get more and more difficult as time goes by.

There is no specific system for determining the answer, so miners simply have to use extremely powerful computers to find it, number by number, until they find the right one.

On average, the number of calculations that computers have to perform before finding the correct answer is more than 199 quintillion! It is a time and energy consuming process, even for the world's most powerful computers.

So why do Bitcoin miners bother spending all this time and energy trying to add blocks to the blockchain? It's quite simple: miners are rewarded with free new Bitcoins for each block they successfully add. Currently, the reward for adding a single block to the blockchain is 6.25 Bitcoins (as of today). This is what motivates miners to perform this task, thereby allowing the Bitcoin network to function smoothly.

It is clear that the mining process can be a rather profitable enterprise. That being said, it takes truly extraordinary computing power to compete with the largest mining organisations, and this is not the case for the average user.

How does one invest in Bitcoins?

Now that you understand what Bitcoins are and what technology they're based on, it's time to examine how you can buy them and how you can store them. In short: you can buy them from Bitcoin exchanges and store them with Bitcoin wallets.

The easiest way to buy Bitcoins is to exchange something else for them. Bitcoin exchanges are platforms on which you can buy, sell or trade Bitcoins in exchange for traditional currencies or other cryptocurrencies. There are many cryptocurrency exchanges and traders need to do a bit of research before settling on one that meets their needs.

Binance

Bitcoin wallets

A Bitcoin wallet is basically a digital account where you store your Bitcoins; it is a safe place to keep your virtual currency between two transactions. Your wallet doesn't hold actual Bitcoins. Rather, it contains the mathematical keys and addresses that allow you to spend and receive Bitcoins.

Bitcoins: private keys and addresses

Your private key is a random string of alphanumeric characters stored in your Bitcoin wallet which is used to sign the transactions you send. This is a password that allows you to send and spend Bitcoins.

Your private key must remain a secret, because if someone knows your private key, they could send your Bitcoins anywhere they want. Protecting your private key is the main objective of a Bitcoin wallet.

BTC wallets also contain your Bitcoin addresses. A Bitcoin address is also a long alphanumeric string, but it is used to receive Bitcoins rather than send them. Your Bitcoin address is cryptographically derived from your private key, and any Bitcoin sent to your address can only be accessed by a wallet that has your private key.

Even though the addresses are linked to your private key, there is no way to determine your private key just by looking at the address. This means that it is completely safe to communicate your Bitcoin address to others. In fact, it is a necessary step for someone to send you Bitcoins.

Types of wallets

Now that we understand what Bitcoin wallets do, we can talk about choosing the one that's right for you. In general, security is the most important consideration. That being said, other factors such as ease of access and convenience are also worth considering.

Here is a quick overview of the 5 different types of wallets that are available:

  • Online wallets can be accessed via your web browser. The main drawback is that your private keys are stored on the website's server, which means that you have to trust them to protect your Bitcoins. We recommend that you only store small amounts of Bitcoins in your online wallets.
  • Desktop wallets are software that you install on your computer and that store your private keys. These wallets are generally more secure than online ones, since your key isn't stored on the web. That being said, your computer remains vulnerable to viruses and malevolent applications that can steal your Bitcoins, and so these aren't really ideal for large amounts of Bitcoins either.
  • Mobile wallets are applications that you install on your smartphone or tablet. There are 2 types of mobile wallets: those that store your private keys locally on the device, and those that store your private keys online. Mobile wallets offer the convenience of being able to use your Bitcoins while on the go, but they pose the same security risks as online or desktop wallets.
  • Hardware wallets are physical devices that store your private keys offline. Most of these devices are small and plug into your computer via a USB port when you need to access your Bitcoins. These hardware devices are immune to viruses and are generally considered to be the safest wallets out there. The only real downside to hardware wallets is that you have to actually by physical hardware, although recent wallets like the Ledger Nano S are relatively inexpensive.
  • Paper wallets are an alternative method of offline storage. They are basically pieces of paper on which your public and private keys are written. Paper wallets are generally inferior to physical wallets because they are both less practical and less secure.

BTC virtual wallets

The Trezor, Ledger, KeepKey hardware wallets

How do Bitcoin transactions work?

Once your wallet has a positive balance and your Bitcoins are secure, you are ready to start trading with Bitcoins. If you think this is complicated, don't worry. Using Bitcoins is actually quite simple.

The vast majority of BTC transactions are done online. To pay online, just enter the seller's address and the amount of Bitcoins you want to send. Receiving Bitcoins is just as simple. Just give your address to the other party and they can send you the agreed amount.

Bitcoins are also increasingly accepted to buy things in stores. This usually requires using a wallet with a mobile app that can send Bitcoins to the store's address. Stores that accept Bitcoins often have a QR code that you can scan so that you can easily pay using Bitcoins.

Benefits of using Bitcoins

  • Security: Thanks to the blockchain and the advanced cryptography used in the transaction process, the Bitcoin system is very secure. The relative anonymity offered by Bitcoins is an added security bonus, as it makes problems like identity theft impossible.
  • Decentralisation: As mentioned above, Bitcoins are completely decentralised and therefore are not subject to any interference by politicians or bankers.
  • Internationality: Bitcoins are a truly international currency. It's incredibly easy to conduct international transactions with Bitcoins, and cryptocurrencies like this one will likely become more and more valuable as we move towards a more global economy.
  • Bitcoins may be the future: cryptocurrencies are quickly gaining acceptance and their use is growing. Many major players in the world of finance and technology confirm that a new era is underway. Its future remains uncertain, but Bitcoins may well be a game-changer.
  • Market share: Bitcoins have a huge share of the crypto market. It was the first digital currency and is by far the best known among ordinary people. If you want to invest in a cryptocurrency, Bitcoins are the most obvious choice.

The downside

  • Volatility: Bitcoins have experienced crazy price variations. Its value has increased exponentially, but there is always the fear that the bubble will burst - which happens (in 2020, BTC lost over 45% of its value in just one week). Bitcoin's price usually fluctuates by no more than 4%. The trend has been upward so far, so there are reasons to be optimistic, but the path to riches will be bumpy. As with many other types of investments, trade only what you can afford to lose.
  • Legal uncertainty: the legal and regulatory status of Bitcoins is uncertain in many territories.
  • Few retail participants: Although the list of retailers who accept Bitcoin is constantly growing, retailers have been slow to adopt this form of payment. This should become less of a problem as Bitcoins gain acceptance and become more widespread.
  • Scams and hackers: Cryptocurrencies are not immune to scams. Pyramid schemes promising huge profits have tempted many traders, and resulted in money losses. Hacking is less frequent, but still occurs. Some wallets have been hacked over the course of Bitcoin's creation, and stolen funds can be very difficult to recover. That being said, these bad experiences have led Bitcoin exchanges to ramp up their security, so scams are likely to become rare.
  • Bitcoins may be inferior to other newer cryptocurrencies: Despite its status as the first and most valuable crypto, some say that it is falling behind other alternatives. As it's decentralised, it cannot really evolve much. No company is backing it or monitoring it. Any change to the Bitcoin network or system requires a majority consensus by those who mine it. Competing currencies use newer technology and could benefit from a centralised model. The BTC has led the way, but another cryptocurrency may be the one to fully propell cryptos into broad use.

Conclusion

Bitcoins are taking advantage of blockchain systems to propose a new financial model. As such, banks could in theory become a relic of the past if people can store their money themselves. BTC enables people to control their money in an easy, safe and private manner, with no intervention.

Although Bitcoin's technology is advanced, and as it is so new, there are still a few issues to sort out. But over time, it is likely that its volatility will be kept to reasonable levels, and the legal questions surrounding it will be settled once and for all. In addition, more and more stores and businesses will be able to accept payments of this type.

Given the above, it is inevitable that cryptocurrencies (BTC included) successfully become a part of our payment options and continue to be traded on the market.

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