Bitcoin is the world’s first digital currency known as cryptocurrency.
Satoshi Nakamoto created Bitcoin in 2009 as an alternative to traditional money. His goal was for Bitcoin to become a globally accepted legal tender that people could use as a medium of exchange to purchase goods and services.
To explain how bitcoin works, it helps to understand how traditional currency is controlled. Banks and financial institutions rely on traditional fiat money and financial systems for permission to transfer money among existing debit/credit accounts. However, bitcoin is decentralized, meaning anyone in the world can buy, sell and exchange bitcoin without the involvement of a bank, government, or other institution.
Similar to Paypal and Venmo, Bitcoin uses a digital payment system where users can exchange value with one another directly through a peer-to-peer electronic cash system, also called a peer-to-peer network. This is an online network where all users have equal power and are connected without the involvement of a central authority or intermediary company. Again, the only difference is that bitcoin uses a digital currency instead of a traditional currency.
The bitcoin network is completely public or “open-source.” Open-source means anyone in the world with an internet connection and device can connect to the network, view bitcoin, secure bitcoin, and send and receive bitcoin. Every Bitcoin transaction ever made is stored on a shared database accessible to everyone, making transactions hard to reverse and difficult to fake.
Bitcoin’s history as a store of value has been turbulent; it has gone through several boom and bust cycles over its relatively short lifespan. Due to this volatility, the price of bitcoin is extremely unpredictable.
How is bitcoin created?
Bitcoin, like other types of cryptocurrencies, is created using blockchain technology. A blockchain is a shared database that stores data known as a distributed ledger.
Encryption methods within the blockchain secure the data. When a transaction takes place on the blockchain, an algorithm encrypts the information into a code and displays it on a digital block. The code contains all the transaction data and information from blocks before and joins a queue.
As with traditional bank transfers, transactions need to be verified to ensure they are legitimate. However, instead of a central bank or institution verifying the transaction, bitcoin miners in the bitcoin blockchain network verify the transaction themselves, which is called proof-of-work. Bitcoin miners, also known as “nodes,” are ordinary people that have chosen to invest in a variety of hardware and software that can access or “mine” bitcoin.
To verify a transaction in the queue, the miners must compete simultaneously using software and hardware that attempts to “crack” the encrypted code displayed on the block. This process, known as cryptography, requires the miners to randomly regenerate letters and numbers until they meet a target combination specified by the blockchain.
Once the correct number is met, the code is “solved,” and the system creates a new bitcoin. The system then creates a new block in the chain for new transactions to be encrypted and verified, and the process starts again. On average, it takes 10 minutes for the bitcoin mining network to validate a block. There will only ever be 21 million bitcoin in circulation as this amount has been programmed into the system.
When a miner or group of miners successfully solves a code, they receive a reward known as a block reward. The block reward is 6.25 BTC per block. The miners can save the reward, sell the reward, exchange the reward for fiat currency via cryptocurrency exchanges or use it to make purchases from merchants and retailers that accept bitcoin.
How do you use bitcoin?
To store, exchange, buy and sell bitcoin, you need to have a bitcoin wallet. These digital wallets hold the private keys to your bitcoin account, which you must enter when conducting a transaction. Providers of online wallets include Exodus, Electrum, and Mycelium.
To set up a digital wallet, you’ll need to verify your identity and provide some funding source, such as a bank account, debit card, or credit card.
Most people buy bitcoin via cryptocurrency exchanges. Bitcoin exchanges allow you to buy, sell and hold cryptocurrency. Major exchanges include Coinbase, Kraken, and Gemini. You can also buy Bitcoin at an online broker like Robinhood.