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How Does Bitcoin Work?

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In March 2021, Bitcoin reached an all-time high that again made this world’s first and most popular digital currency an important part of every headline. For decades, the cryptocurrency has enjoyed great acceptance among retail investors and large institutions. Its numerous and dramatic highs have always made a great headline, but this recent rise in the price of Bitcoin made it clear that it is indeed an inescapable part of the crypto landscape.

However, with the dramatic volatility of Bitcoin, it hardly makes it the best choice for novice investors or people looking for a stable store of value. That is why it is important to understand how Bitcoin works before opting for it.

What is Bitcoin?

Bitcoin is a decentralized digital currency that you can buy, sell, and exchange directly, without an intermediary like a bank. The digital currency was created in 2008 by Satoshi Nakamoto, with the vision of creating an electronic payment system that will be based on cryptographic proof instead of trust.

Every Bitcoin transaction that has ever happened exists on a public ledger where it is accessible to everyone, making it super difficult to fake Bitcoin transactions. At the same time, the transactions are not reversible. Bitcoin is not backed by the government or any issuing institution.

Although the coin has once sold for about $67.81, it has continually experienced a dramatic rise in price since its public launch in 2009. Plus, experts have predicted that the price will keep rising even in the coming years – thanks to its limited supply.

How Does Bitcoin Work?

Blockchain is a shared public ledger on which the entire Bitcoin network is built. Just as the name implies, blockchain is a linked body of data, made of small units referred to as blocks that contain information about every transaction that happens on the Bitcoin network. The blocks contain every detail, including the time, date, total value, buyer and seller, and a unique identification code for each exchange.

Blockchain is decentralized, which means it is not controlled by any one organization. However, anyone who has a link can contribute to it. While that may look risky, that is actually what makes the Bitcoin blockchain secure and trustworthy. Before a transaction can happen on the network and its block added to the Bitcoin blockchain, it has to be verified by the majority of all Bitcoin holders.

That makes it nearly impossible for anyone to make fraudulent Bitcoin transactions. The odd of correctly guessing the key code of your Bitcoin wallet is the same as the odd of someone winning a Powerball lottery nine times in a row.

Bitcoin Mining: How Does It Work?

Bitcoin mining is the process of adding new blocks (transactions) to the Bitcoin blockchain. This is a pretty tough job and requires a lot of energy. Because of the challenging nature of the job, miners are rewarded with new Bitcoins for their hard work. And that is how new coins are created.

However, mining is not what it used to be in the past. It is now more challenging and requires more computing resources to solve the mathematical puzzles that verify transactions before they are added to the Bitcoin blockchain.

Miners now require powerful computers and access to massive amounts of cheap electricity to carry out Bitcoin mining.

Halving: Another Technical Term You Should Know

As we already explained, miners get their reward in Bitcoin for their hard work, verifying blocks and transactions. However, for every 210,000 blocks mined, or about every four years, this reward is cut in half. This event is called “halving,” and it is done to control the amount of Bitcoin that is mined.

After the last halving that happened on May 11th, 2020, the reward for each block mined is now 6.25 Bitcoin against 12 Bitcoin they get before the halving.

How Does Bitcoin Make Money?

The digital currency obeys the law of demand and supply. That means because of the rise and fall in demand that happens from time to time, there is much volatility with the price of the currency. So, apart from mining to get a reward, people also buy bitcoins as a form of currency speculation, waiting to sell when the price goes up.

Storing Your Bitcoin: Cold vs. Hot Wallets

Regardless of how you get your Bitcoin – whether as a reward from mining or you buy it, you will need a digital wallet to store it. These wallets can be of two types. You can either store your Bitcoin in a hot or a cold wallet.

A hot wallet, which is also called an online wallet, provides a means of storing your Bitcoin in the cloud on a trusted exchange or provider, and accessed through a smartphone app, computer browser, or desktop. Common examples of online wallet providers include Exodus, Mycelium, and Electrum.

On the other hand, a cold wallet is an offline device used to store your bitcoins without having to connect to the internet. Because these wallets don’t require internet connectivity, they are considered more secure and protected from hackers. Some examples of this include Ledger and Trezor.

How to Use Bitcoin?

In the U.S, Bitcoin is used by people as an alternative investment, helping them diversify a portfolio apart from bonds and stocks. Bitcoin can also be used to make purchases, as more and more vendors now accept it as a payment method. However, the number of vendors that accept the cryptocurrency is still limited.

Some services also allow you to connect your crypto account to your debit card. That means you can use Bitcoin the same way you would use a credit card.

In other countries, especially places with less stable currencies, people sometimes use cryto instead of their own currency.

Bitcoin can also be used to store value without relying on a government-backed currency. This gives people an upper edge for a worst-case scenario. In countries like Argentina, Venezuela, and Zimbabwe who are heavily in debt, Bitcoin is making great headway there.

Where to Buy Bitcoin

There are majorly four options available to you when it comes to buying Bitcoin. This include:

  • Bitcoin mining: we already explained this. It is one of the ways you can get Bitcoin, but it requires lots of technical expertise and computer costs. Because of that, this option is not in the reach of most people.
  • Cryptocurrency exchanges: these are platforms from which you can buy or trade more than 30 cryptocurrencies, including Bitcoin. The largest cryptocurrency exchange in the U.S is Coinbase.
  • Bitcoin ATMs: these are kiosks where you can buy Bitcoin and other cryptocurrencies using cash or debit card. There are more than 7000 Bitcoin ATMs in the US.
  • Investment brokerages: a good example of this in the U.S is Robinhood Crypto, and it is available in most, not all, U.S states.
  • Peer-to-peer purchases involve buying Bitcoin directly from other Bitcoin owners through peer-to-peer tools like Bitquick, Bisq, and LocalBitcoins.

Should You Buy Bitcoin?

While Bitcoin is expensive, you can buy fractional Bitcoin from vendors. In such a situation, you will be charged a small percentage of your crypto transaction amount as the transaction fee.

So, coming back to whether you should buy Bitcoin, this totally depends on you. If you think it’s good for your portfolio, why not? But remember that Bitcoin is extremely speculative and volatile. So if you are new to cryptocurrencies, you might want to consider some less risky cryptos.

However, if you want to go with Bitcoin or any other cryptos, it is recommended that you don’t invest more than 10% of your overall portfolio. Always invest what you can afford to lose!