Guide: What is Bitcoin & How Does It Work?

By Techfunnel Author - Published on February 23, 2021
A Brief Explanation About Bitcoin

Bitcoin is continuously becoming a lucrative investment. Considering only its price history, it is safe to say that it has indeed been a decent investment for the dedicated few. In January 2009, bitcoin had zero value but in February 2021 (12 years later), it reached an all-time high of a surprising $50,000. Today, a lot of people are interested in knowing what bitcoin is and how it really works.

What is Bitcoin?

Bitcoin is a cryptocurrency that was developed in January 2009. It is based on the ideas shared in a whitepaper by the anonymous Satoshi Nakamoto. The identity of the founder of the innovation is still unknown. It provides the benefit of reduced transaction fees compared to traditional online payment institutions and as opposed to government-issued currencies; bitcoin is regulated by a decentralized authority.

It is a form of digital currency: this means that there are zero physical bitcoins, but balances that are stored on a public ledger that is transparently accessible to everyone. It is popularly identified with the abbreviation “BTC”.

How Does Bitcoin Work?

This is a common question usually surrounded by lots of confusion, so we’ll be giving a brief explanation of how does bitcoin works.

  1. Blockchain

    This is a shared public ledger on which the whole Bitcoin network is dependent. All verified transactions are contained in the blockchain. It enables Bitcoin wallets to calculate what their spendable balance is so that new transactions are confirmed therefore ensuring that they’re indeed owned by the spender. The chronological order and the integrity of the blockchain are strengthened with cryptography.

  2. Private and public keys

    Transactions refer to the transfer of value between Bitcoin wallets that are contained in the blockchain. Bitcoin wallets store a confidential piece of data known as a private key, which allows users to sign transactions, serving as mathematical evidence that they have been sent from the owner of the wallet.

    The signature equally secures the transaction so that it can not be changed after it has been issued. All transactions are transmitted to the network and typically start to get verified within 10 to 20 minutes, via a process known as mining.

  3. Bitcoin mining

    The mining process is a distributed consensus system that enables the confirmation of pending transactions by adding them to the blockchain. It exerts a chronological order in the blockchain, safeguards the neutrality of the system, and enables various computers to come to an agreement regarding the condition of the system. In order to be verified, transactions have to be kept in a ‘block’ that complies with very strict cryptographic rules that will be confirmed by the network.

    These rules prohibit the modification of previous blocks as that would make all the subsequent blocks to be invalid. In addition, mining establishes the equivalent of a competitive lottery which restricts any individual from casually including new blocks consecutively to the blockchain. By doing this, no individuals or group can manipulate what is added to the blockchain or alter parts of the blockchain to withdraw their own spending.

Use of Bitcoin

It is indisputably better than any traditional currency. To start with, it is digital and decentralized: bitcoin gives you the opportunity to exchange value in the absence of intermediaries which means lower fees and greater control of your funds. While banks control cash, bitcoin on the other hand has owners. It is more secure, cheaper, faster, and immutable.

Another reason why use bitcoin is to shop online with ease. It makes online shopping much safer and exciting. It can be likened to an e-wallet which can be developed in blockchain technology to keep, monitor, and transfer digital money. Moreover, bitcoin is globally accepted and has less volatility than local currency or cash. Hence, it becomes easier to execute transactions online and across boundaries.

How Does Bitcoin Make Money?

The law of demand and supply determines the value of bitcoin – and since demand increases and decreases, the cryptocurrency price is highly volatile.

Apart from bitcoin mining, in which technical expertise and investing in high-performance computers is required, a lot of individuals buy bitcoins as a kind of currency speculation – predicting that the worth of one bitcoin in U.S. dollars will be more expensive in the future than it is now. However, that is a tough bet.

( Also Read: Benefits of Bitcoin )

Where Can You Buy Bitcoin?

  1. Cryptocurrency exchanges:

    There are many exchanges in the U.S. and other countries. Coinbase is the number one cryptocurrency exchange in the United States, trading over 30 cryptocurrencies.

  2. Investment brokerages:

    The first mainstream investment brokerage company to provide Bitcoin and other cryptocurrencies are Robinhood. Sofi Active Investing, eToro, and TradeStation also offer cryptocurrency trading in many U.S. states.

  3. Bitcoin ATMs:

    In the United States, there are over 7,000 bitcoin ATMs.

  4. Peer-to-peer purchases:

    You can purchase bitcoins directly from other owners or sellers of bitcoin via peer-to-peer tools such as LocalBitcoins.com, Bitquick, and Bisq.

  5. Bitcoin mining:

    Mining can also earn you bitcoins, although the required technical skills and computer expense make this option a no-go area for most people.

How to Sell Bitcoin

Selling bitcoin is actually quite simple. The first thing you need to do is visit a cryptocurrency exchange, such as Bitcoin.com Exchange. Then you create an account and confirm your identity as indicated. Different websites may have varying requirements and procedures. Follow the instructions on the website to sell your (BTC). If you sell off bitcoin for fiat money, then you can withdraw the money into your bank account.

Safest Ways to Store Bitcoin

  • Cloud wallets

    A cloud wallet stores your encrypted transaction file on a cloud storage infrastructure such as Dropbox. You could as well email them to yourself on Gmail. For security reasons, a cloud wallet is not recommended. A user might decide to execute encryption for 2-factor authentication; however, this is reduced to one-factor when the wallet is being uploaded to the cloud. In addition, there are a plethora of ways through which two-factor authentication can be compromised, especially SMS-based 2FA, like through a SIM-Swap.

  • Software wallets

    These are programs that are installed on a computer. A software wallet is a kind of keychain that holds the keys that grant you access to the coins. This means that your coins are not actually going to be stored on your computer. Private keys are stored in the application of software wallets; however, this is not to say that you can not lose your coins. If a person hacks your computer or gets your password, that person can gain access to your coins. This is why it is necessary to create a backup.

    There are many types of software wallets, including Exodus, Jaxx Liberty, Copay, etc.

  • Mobile wallets

    Mobile wallets refer to bitcoin wallet apps that can be installed on mobile phones. For each mobile operating system, like Blackberry, Windows, Android, and iOS, there are compatible wallets.

Below are the different Bitcoin mobile wallets and their mobile operating system compatibilities.

  • Android Wallets:

    • TrustWallet
    • Guarda
    • Edge
    • Coinomi
  • iOS Wallets:

    • Blockchain
    • Bitpie
    • TrustWallet
    • Edge
    • CoPay
    • Breadwallet
    • Muun Wallet
  • Hardware wallets

    Also known as Cold Storage, this is the fastest and most secure way of storing bitcoins because they are kept in an offline infrastructure.

    So far, there has been no reported loss or theft of bitcoin from cold storage. The digital signature and private keys required to transfer bitcoins are generated through these wallets. Examples of hardware wallets are Ledger Nano X, Trezor, and Safepal.

  • Paper wallets

    A paper wallet is a sheet of paper with a private address and public address printed on it.

    Using the public address, you can transfer any amount of bitcoins. Then you can save the sheet of paper since it also holds the private key which is used to spend/transfer bitcoins or clear the paper wallet entirely to another wallet.

    As the keys are offline, and printed and protected by the owner, the risk of any electronic damage to your bitcoins is eliminated, except you lose the printed keys.

Buying Bitcoin: The Pros and Cons

The pros

  • Secret, secure transactions anytime — With lower potential fees: as a bitcoin owner, you can send them anywhere, anytime, decreasing the duration and potential cost of any transaction. Personal data, such as credit card name or number, is not contained in the transactions and this removes the threat of user data being hijacked for identity theft or illegal purchases. (It is however necessary to know that you’ll generally have to link your bank account before you can buy bitcoins on an exchange).
  • The potential for massive growth: A number of investors who purchase and retain the currency are predicting that the moment bitcoin matures, greater use and more widespread trust will follow, and consequently the value of bitcoin will grow.
  • The freedom from government and/or traditional banking intermediaries: Following the Great Recession and the financial crisis, optimistic investors are excited to embrace an alternative currency that is decentralized – one that is particularly beyond the reach of traditional banks, government institutions, or other intermediary agencies.

The Cons

  • Volatile price: The 2017 surge in the price of bitcoin was caused by an influx of speculators into the bitcoin market. If you bought bitcoin in 2018, then you should be excited about the recent gains; people who purchased in 2017 when the price of bitcoin was spiking toward $20,000 had to be patient until December 2020 to recover their losses.
  • Hacking issues: Although experts claim that the blockchain technology upon which bitcoin relies has even better security than regular electronic money transfers, the problem is that hackers have identified bitcoin hot wallets as an attractive target. There have been reports of several high-profile hacks, one of which is the news broadcast in May 2019 that over $40 million worth of bitcoin was hijacked from different high-net-worth accounts on cryptocurrency exchange Binance (the organization concealed the losses).
  • Restricted (but increasing) use: Telecommunications giant AT&T, in May 2019, joined organizations such as Dish Network, Microsoft, and Overstock.com to accept bitcoin payments. These organizations are however the exception, not the norms.
  • No protection by SIPC: The Securities Investor Protection Corporation provides insurance to investors as high as $500,000 if funds are stolen or a brokerage falls through. However, the insurance does not apply to cryptocurrency.

Online brokers that offer Bitcoin

Below are the most popular online brokers:

  • Coinbase
  • eToro
  • Robinhood
  • SoFi Active Investing
  • TradeStation

Final Thoughts

In all, bitcoin is not a traditional asset neither are its key values measured in traditional terms. It is a highly speculative investment and it is extremely volatile. For instance, bitcoin rose 20% in the first weekend of this year, but then fell 20% the following Sunday.

The most important thing you should consider before deciding whether bitcoin is a good investment for you or not is determining what your financial targets are. The price is basically determined by what someone else is ready to pay for it. It has no intrinsic worth at all. Nonetheless, bitcoin is a highly trusted currency all thanks to its dependence on blockchain technology which nullifies hacking and counterfeits.

Techfunnel Author

Techfunnel Author | TechFunnel.com is an ambitious publication dedicated to the evolving landscape of marketing and technology in business and in life. We are dedicated to sharing unbiased information, research, and expert commentary that helps executives and professionals stay on top of the rapidly evolving marketplace, leverage technology for productivity, and add value to their knowledge base.

Techfunnel Author

Techfunnel Author | TechFunnel.com is an ambitious publication dedicated to the evolving landscape of marketing and technology in business and in life. We are dedicate...

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