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Bitcoin: A beginner's guide

Bitcoin
Erik Martin
Apr 28, 2022
Key Takeaways:
  • a form of cryptocurrency safeguarded by encryption and managed using a shared online ledger.
  • A Bitcoin’s worth depends upon supply and demand in the marketplace, as with stocks and other commodities.
  • The process of making and introducing new Bitcoins into circulation is called mining.

Dollar bills have long been our country’s most accepted form of currency. But what if you could make a transaction without paper money – using a form of digital currency instead? Bitcoin lets you accomplish this. It’s a form of cryptocurrency safeguarded by encryption and managed using a shared online ledger.

But that only skims the surface. Take the time to learn the answers to essential questions about this form of crypto.

  • What is Bitcoin?
  • How does it work?
  • How is its value determined?
  • What are the risks and rewards?
  • How do you buy Bitcoin?
  • Is it legal and safe?

This article will aim to address each of these queries.

What is Bitcoin?

Contrary to what you might think, Bitcoins don’t exist as physical coins or tangible tokens that you can hold in your hand. A Bitcoin is a type of cryptocurrency – virtual or digital currency that can be used to buy and sell goods and services. Bitcoin relies on peer-to-peer software and is protected via cryptography, which employs codes to secure data by altering it into a form that only intended recipients can read and process. Every Bitcoin transaction is held on computer servers around the world that are part of a special network.

“Each Bitcoin is nothing more than a unique digitized string of numbers serving as an identifier for an intangible asset that users have collectively agreed has a certain value,” says Carol Goforth, a professor of law at the University of Arkansas in Fayetteville, Arkansas.

Normal currency like US dollars is held by banks and managed by regulating financial organizations. But Bitcoin and other cryptocurrencies are decentralized. That means they are not backed by any government or governing body that validates them as legal tender. Instead, Bitcoin employs a series of cryptography calculations to authenticate transactions.

Bitcoin is technically the world’s first true cryptocurrency. Launched in early 2009 on the Bitcoin network, a publicly distributed blockchain (more on that next), Bitcoin has grown from a zero worth to a trading value that has exceeded $66,000 over the years.

The idea of Bitcoin was first posted on an online cryptography chat by a person using the pseudonym Satoshi Nakamoto.

What is a blockchain?

Bitcoin transactions are logged in an online ledger called a blockchain – a series of connected blocks. Each block includes several transactions that have been verified independently by each member involved in the Bitcoin network. Every block also has a particular storage limit. When the limit is reached, the block is closed and connected to the last filled block. This produces a data chain, or “blockchain.”

“All Bitcoin network participants have access to the same ledger, and transactions on that ledger cannot be changed after being recorded,” notes Eddie Rajcevic, a market expert and researcher at Tastytrade in Chicago. “When one user decides to initiate a Bitcoin transaction, that activity is broadcast to all network participants. These participants then use various complex hashing algorithms to verify the transaction. Once verified, that transaction is combined with others to form a block. This block of transactions is then added to the existing blockchain, and all future transactions are then appended to this.”

A blockchain is designed to help prevent transaction fraud. Each new block created has to be authenticated by every node in the Bitcoin network.

What determines Bitcoin’s value?

A Bitcoin’s worth depends upon supply and demand in the marketplace, as with stocks and other commodities.

“When the demand for Bitcoin increases, so does the price,” says Abby Sklencar, a consultant with Pelicoin, a cryptocurrency ATM network.

The maximum number of Bitcoins that can be generated is 21 million. Currently, over 19 million Bitcoins exist, with less than 2 million Bitcoins remaining to be mined.

How Bitcoin is made

The process of making and introducing new Bitcoins into circulation is called mining.

“Bitcoin miners compete to solve incredibly complicated math problems that necessitate the use of expensive computers and massive amounts of electricity to properly add a block to the Bitcoin blockchain,”Jonathan Merry, director at Bankless Times, notes. “If a miner successfully solves the math problem and adds a block to the blockchain, they are rewarded with Bitcoins.”

New Bitcoins are only created when a computer node performs the service of validating a previous block of transactions that will be added to the Bitcoin ledger.

“At the beginning of every block of possible transactions, there is a unique cryptographic identifier. At the end of that block, there is a complicated algorithmic problem. The first computer to solve that problem broadcasts the solution to the network, along with the identifier for the block that the computer has validated,” Goforth says. “That block is then added to the ledger, and the successful miner is rewarded with a specific amount of Bitcoins.”

Every four years, or every 210,000 blocks created in the Bitcoin blockchain, the incentive value of Bitcoin is cut in half.

“The reward was originally set at 50 Bitcoins, but that reward has been cut in half several times. Today, a miner can expect to receive 6.25 Bitcoins for each block they add to the ledger,” Goforth continues.

Pros and cons of Bitcoin

Bitcoin offers several advantages to its users, including:

  • Resistance to censorship and centralized control. No central authority or government supervises Bitcoin. That means no one can prevent a Bitcoin transaction from occurring.
  • International acceptance. Bitcoin doesn’t need to be converted when you exchange it in another country that accepts Bitcoin. This currency can be transacted across borders without needing the permission of financial authorities.
  • Inflationary protection. Remember that Bitcoin has a limited supply of 21 million coins that cannot be changed. In other words, central banks cannot arbitrarily inflate the supply or value of Bitcoin.
  • Speedy transactions. A Bitcoin transaction is practically instantaneous, meaning you don’t have to wait for the funds to clear.
  • Lower risk of fraud. The Bitcoin blockchain helps prevent criminals from engaging in phony crypto transactions.
  • Individuals have complete control and custody over their assets.
  • Bitcoin markets are available 24/7.
  • Bitcoin keeps users’ identities anonymous.
  • Bitcoin can increase in value and yield significant returns for investors.

However, Bitcoin has its downsides, too.

“Bitcoin’s value is highly volatile. It has no government regulation, and its use is limited,” cautions Sklencar.

Additionally, “the technology is quite new and complex for many individuals. There is also a lot of uncertainty regarding future government regulation,” adds Rajcevic.

Also, the future value of Bitcoin is unpredictable, unlike other kinds of investments. With a stock, you can investigate the company’s financials, leadership, and goods and services provided. Bitcoin is less of a known commodity and quantity, and its track record only dates back a few years.

Furthermore, while blockchain technology is designed to protect against fraud, Bitcoin can be used by bad actors who desire to purchase illegal services or products or engage in money laundering.

Bitcoin requires massive amounts of electricity and computing power to mine this digital currency, as well. Consequently, miners can pay thousands in technology and utility costs simply for the chance to mine, with no certainty of earning Bitcoins.

How to get Bitcoin

You can earn Bitcoin by providing services or products to someone willing to pay you in Bitcoin. Alternatively, you can purchase Bitcoin directly from a website that sells it. Bitcoin can also be acquired or traded using brokers, special apps, or platforms called cryptocurrency exchanges, including Coinbase.

Typically, to make a Bitcoin transaction, you must interchange currency with a peer using a special digital wallet that allows you to move funds from one place to another. You’ll also require a password, known as a private key, to complete a transaction. The transaction is recorded on a public ledger that shows transaction totals without revealing the identities of anyone involved in the transaction.

You can also acquire Bitcoin by attempting to mine it yourself.

How safe is Bitcoin?

The good news is that Bitcoin is legal and permitted to be exchanged in the United States. This is also true in many other countries. But many experts emphasize caution before attempting to purchase or trade Bitcoin.

“I believe Bitcoin is safe, so long as individuals do their research before investing in any cryptocurrency,” says Rajcevic. “But in its current state, it might be a better fit for younger investors since, if they have an unprofitable trade, they have more time to make that money back.”

If you desire a more secure investment, Bitcoin is probably not a safe choice, per Goforth.

“On the other hand, Bitcoin is clearly not fraudulent and appears to have considerable staying power. It has tremendous market capitalization and should retain at least some value for the foreseeable future,” says Goforth. “If you believe that more people will want to own Bitcoin, it could be a reasonable addition – in moderation – to a diversified investment portfolio. But you would need to be highly risk-tolerant.”

Other forms of cryptocurrency

Bitcoin remains the most widely used and traded of all cryptocurrencies. Other popular and emerging cryptocurrencies today include Ethereum, Solana, Luna, Tether, XRP, USD Coin, Terra, and Binance Coin.

Consider that the entire crypto market is expected to be worth more than $2.3 trillion by 2028. Bitcoin’s worth represents a significant percentage of the entire cryptocurrency market.

Frequently Asked Questions

How does Bitcoin work?

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Bitcoin is a form of digital currency that can be used to buy and sell products and services. Bitcoin is safeguarded by cryptography, which employs codes to protect data by converting it into something that only intended recipients can process and read. Bitcoin transactions are stored in a public online ledger that uses blockchain technology. Bitcoin is also decentralized, unlike regular currency held by a central bank and managed by regulating financial organizations.

How do you buy Bitcoin?

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You can acquire Bitcoin by offering services or products to someone willing to pay you in Bitcoin. Or, you can purchase Bitcoin directly from a website that sells it. Bitcoin can be bought or traded using brokers, special apps, or platforms called cryptocurrency exchanges, as well. Alternatively, you can get Bitcoin by attempting to mine it yourself if you have the right computer equipment.

Is Bitcoin legal?

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It is legal to mine, purchase, trade, and invest in Bitcoin in the United States and many other countries. Some nations have banned Bitcoin, including China.