Bitcoin

What is bitcoin? A beginner’s guide

What is bitcoin?  A beginner's guide

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If there’s one cryptocurrency you should know about, it’s Bitcoin.

As the first cryptocurrency, Bitcoin has become the the most valuable and commonly held among the thousands of cryptocurrencies created since. Its rise in value and popularity has been steady, if not without ups and downs.

Bitcoin’s price surpassed $60,000 in April 2021, setting a new all-time high and coinciding with cryptocurrency exchange Coinbase going public. This high follows a meteoric rise in value during the first months of 2021, having first exceeded $20,000 in December 2020.

Here’s what you need to know about the world’s best known and most established cryptocurrency.

What is bitcoin?

Bitcoin was created in 2009 in the wake of the economic recession. Bitcoin was created to be a peer-to-peer electronic payment system, but also attracted crypto-curious investors as a store of value currency, comparable to gold.

History of bitcoin

The concept of Bitcoin was published in a white paper written by an anonymous character under the pseudonym Satoshi Nakamoto in 2008. No one knows the true identity of the author – or if it is even one person rather than a group of people. The document described how Bitcoin would work and the currency was officially launched on January 3, 2009, according to Ollie Leechlearn editor on CoinDeskone of the leading cryptocurrency news outlets.

How Bitcoin Works

Bitcoin’s maximum supply is 21 million – and that’s all there will ever be.

When a cryptocurrency is released, the creator(s) can set its parameters (how many there are, buying and selling rules, how new Bitcoins are added to the market, etc.), which cannot be modified afterwards. Locked in from the start, these rules effectively make Bitcoin a truly scarce resource, with a cap on the total amount that will ever be available.

“No one, not a government, not Satoshi themselves, can change this now that it’s been published,” says Leech. “You can’t duplicate Bitcoins, you can’t recreate them.”

This is where the comparison to gold falls a little flat, as gold is constantly entering the market as new ores and pockets are discovered, making it a relatively scarce resource.

Bitcoin is also much more transferable and more easily stored compared to a resource like gold. If you want to move gold, it will cost you a lot of money (armoured transport, security, cost of storing in a secure facility, etc.). Bitcoin can basically be stored on a USB stick – in what is known as a cold or hard wallet.

Investment vs Cash

Bitcoin was designed to be electronic money, as its white paper explains. But the currency’s volatility almost immediately abandoned that original intention, according to Leech.

For example, no “sane” person would want to buy coffee with Bitcoin, says Leech. This is because you could buy a coffee worth $3 today with Bitcoin, and tomorrow that same Bitcoin is worth $30, and you have effectively spent $30 on a cup of coffee.

Or take it from the merchant’s perspective – you use Bitcoin for your $3 coffee, and tomorrow that Bitcoin is worth 60 cents. Then the dealer lost. “Price volatility renders it completely useless as an electronic payment system,” says Leech.

As with gold, people buy Bitcoin “not because they expect to be able to go to the store and spend it, but because they expect it to retain its value,” explains Galen Moore, director of data and indexes at CoinDesk. “For the same reason people would have diamonds, or $100 bills, or gold coins in a safe, they would keep a digital wallet with their Bitcoin on it.

Why is Bitcoin so volatile?

Most of the volatility in cryptocurrencies is due to the “immature market,” says Leech. “Traders are very sensitive to emotions and fear and greed, and so you get these really extreme market reactions.”

There are also new regulations and policies that constantly reshape the market and cause drastic fluctuations. And then there is social media.

“It’s this weird new thing where viral social trends, like Wall Street Bets or Elon Musk for example, have a huge influence on crypto,” says Leech. “If Elon Musk puts the Bitcoin hashtag in his Twitter bio, he sends Bitcoin up 10%.”

While social media has a unique power to intrigue and excite, its influence on the Bitcoin market is also reason for casual investors to be cautious. “Please don’t invest in cryptocurrencies based on trends on Twitter,” says Kiana Danielauthor of “Cryptocurrency investing for dummies” and the personality behind the @Investdiva account on Instagram.

With so little historical context compared to more conventional investments, Bitcoin and other cryptocurrencies should always be considered riskier assets, says Danial. With the potential reward comes greater risk, so make sure any bitcoin investment is included in the riskier and more aggressive allocation of your larger portfolio.

Bitcoin mining

Along with Bitcoin, there is a finite supply of 21 million coins – although not all of them were released when Bitcoin was launched in 2009. Approximately 18 million of 21 million Bitcoin have been added to circulation since the “genesis block,” Bitcoin’s first block, was mined by Satoshi Nakamoto, Leech says.

New gold is also entering the market from mining – although with gold it is impossible to know exactly how much remains to be discovered and mined.

A new Bitcoin is discovered and made available for buying and selling through a digital mining process, which involves discovering the unique hash of new blocks (a very long string of numbers and letters) using an algorithm. Blocks are just groupings of transactions occurring in a given amount of time, and new blocks are constantly being made available.

Each block discovered through the mining process unlocks a set amount of Bitcoin. This brings rewards to those who discover new blocks and makes new Bitcoins available to buyers. There is no rhyme or reason for the hashing of each block, so miners configure their computers to create many guesses per second to try and guess these random codes.

Miners use powerful computers called “nodes” to search and discover new blocks. Anyone can be a bitcoin miner using free software available at Bitcoin.org, but running a computer like this consumes a lot of storage space and power.

Whoever guesses the code first gets the right to create the next block – and collect transaction fees for it when their Bitcoin is bought and sold. “Each new block has a treasure chest. And inside is a block reward which is free Bitcoin that enters the market,” says Leech.

This mining process is another contributing factor to Bitcoin’s wild daily fluctuations.

Today, around 900 Bitcoin come into circulation every day through mining, according to Leech. But there is a cyclical pattern called the “halving” written into the original Bitcoin code. Every four years, the amount of new Bitcoins entering circulation each day is halved.

The last halving was in 2020, so in April or May 2024 the amount of Bitcoin entering circulation each day will be reduced again. The reduction will continue until the last bitcoin is mined, which is expected to happen in 2140, Leech explains.

This halving happened three times ever since bitcoin was introduced, its adoption increasing all the time. Thus, the effects of the halving on the price of Bitcoin are difficult to pin down. The first halving, in 2012, caused the value of Bitcoin to rise, while the second halving in 2016 caused an initial drop before rising again. The third halving in May 2020 had no drastic impact on the price of Bitcoin, which has maintained record prices since late 2020.

With each halving comes more market swings in the price of Bitcoin. “It’s deflationary by design,” says Leech.