The Bitcoin world is abuzz with both excitement and
curiosity… and the opportunity for upside potential to skyrocket. Everyone from
everyday Joes to reputable experts are betting on Bitcoin’s success.
It’s been a wild 8 years since Bitcoin’s release.
Most notably, we’ve seen headlines of people who fortuitously purchased
bitcoins early on turn into kid-millionaires. With the immense potential of new
cryptocurrencies, our attention often turns to Bitcoin as a quintessential
example of what’s to come.
We’ve designed this guide to teach you about Bitcoin
so that you’re up to speed and ready to join the crypto-world.
What
is Bitcoin?
Released as an open-source software in 2009, Bitcoin
is often credited as the world’s first cryptocurrency and is best defined as a
digital currency that only exists electronically.
Bitcoin is decentralized, meaning it doesn’t have a
central issuing authority or political institution that controls the amount of
bitcoin in circulation. But the Bitcoin platform is far from anarchy.
The whole process is pretty simple and organized:
Bitcoin holders are able to transfer bitcoins via a peer-to-peer network. These
transfers are tracked on the “blockchain,” commonly referred to as a giant
ledger. This ledger records every bitcoin transaction ever made. Each “block”
in the blockchain is built up of a data structure based on encrypted Merkle
Trees. This is particularly useful for detecting fraud or corrupted files. If a
single file in a chain is corrupt or fraudulent, the blockchain prevents it
from damaging the rest of the ledger.
Instead of relying on a government to print new
currency, Bitcoin’s blockchain programming handles when bitcoins are made and
how many are produced. It also keeps track of where bitcoins are and ensures
the transactions are accurate.
There are currently about 17 million bitcoins in
circulation. There isn’t a central regulatory agency or government controlling
the supply of bitcoins, meaning the supply is controlled by design. The total
supply to ever be created is capped at 21 million bitcoins.
This cap raises an argument that Bitcoin could have
problems scaling. However, since Bitcoin is essentially infinitesimally
divisible (meaning users can transfer as little as 0.00000001 bitcoins), this
doesn’t really create a scaling issue. The magic number of 21 million is
arbitrary.
It’s believed that Bitcoin was designed to become a
deflationary currency to combat the government’s use of inflation as a hidden
taxation to redistribute earned wealth. Many people praise Bitcoin for
empowering the people by overthrowing the currency printing powers of transient
politicians.
How
Does Bitcoin Work?
One of Bitcoin’s most appealing features is its
ruthless verification process, which greatly minimizes the risk of fraud. Since
Bitcoin is decentralized, volunteers—referred to as “miners”—constantly verify
and update the blockchain. Once a specific amount of transactions are verified,
another block is added to the blockchain and business continues per usual.
What
is “Mining”?
Instead of a single central server verifying every
transaction, essentially every other person on the network verifies each
transaction.
Cue the “miners.”
Let me simplify the process so we all understand:
Miners are presented with a complicated math problem and the first one to solve
the math problem adds the verified block of transactions to the ledger. The
calculations are based on a Proof of Work (POW), or the proof that a minimum
amount of energy was spent to get a correct answer.
There aren’t actual human beings hunched over
computers with scraps of notebook paper and calculators doing pre-calculus
homework; hardware is used to perform Bitcoin mining.
Bitcoin’s built-in reward system compensates
successful miners with a chunk of bitcoins. The reward changes over time per
Bitcoin’s programming, and the block reward halves about every four years. The
current reward for each new block of verified transactions is about 12.5
bitcoins.
The mining processes have become increasingly
sophisticated. The most popular method uses ASICS–Application-Specific
Integrated Circuits. ASICS are hardware systems similar to CPU computers that
are built for the sole reason of mining bitcoins.
Bitcoin mining operations take a lot of effort and
power, and the sheer amount of competition makes it difficult for newcomers to
enter the race and profit. A new miner would not only need to have adequate
computing power and the knowledge to use it to outcompete the competition, but
would also need the extensive amount of capital necessary to fund the
operations.
A Simple Bitcoin Transaction Example
While Bitcoin’s underlying technology may seem hard
to grasp, using Bitcoin does not have to be difficult. Here’s an example of how simple a real world
Bitcoin transaction can be.
Bitcoin
Wallets: How to Store Your Bitcoins
So, you’ve got this digital currency. You can’t
really chuck it in your pocket. Let’s go through some useful definitions before
we jump into storing cryptos:
1. Exchange
platform: where you trade money for cryptocurrencies such as Bitcoin, Ethereum,
or Litecoin. You can also trade one cryptocurrency for another.
2. Wallet
platform: essentially a bank account where your cryptocurrencies are kept.
3. Hard
wallet: an “offline” wallet that is not linked to a network.
4. Public
Cryptographic Key: your account number. Similar to how someone would send money
to your bank account via your account number, your public cryptographic key is
the information you give to someone to receive cryptos.
5. Private
Cryptographic Key: the key that allows you to spend your Bitcoins and other
cryptocurrencies. You guard this with your life. If someone has access to it,
they can transfer (steal!) your bitcoins.
Now that we’ve got that out of the way, we can
discuss Bitcoin wallet better.
When you hear of bitcoins being hacked, you’re
probably hearing about an “exchange platform” being hacked. Since Bitcoin’s
blockchain structure makes it EXTREMELY difficult to hack (borderline
impossible), it is considered very secure.
Exchanges, however, are a different story. Perhaps
the most notable Bitcoin exchange hack was the Tokyo-based MtGox hack in 2014,
where 850,000 bitcoins with a value of over $350 million suddenly disappeared
from the platform. This doesn’t mean that Bitcoin itself was hacked; it just
means that the exchange platform was hacked. Imagine a bank in Iowa is robbed:
the USD didn’t get robbed, the bank did.
Industries surrounding Bitcoin are new and not
without their kinks. Bitcoin advocate and esteemed venture capitalist Marc
Andreessen stated, “MtGox had to die for Bitcoin to thrive. Its former role
from early Bitcoin days has been supplanted by better, stronger entities.”
Even though most wallet platforms are considered
extremely secure, the prospect of hackers makes many users paranoid.
That brings us to hard wallets. A hard wallet is
essentially a USB that allows users to store their cryptographic keys offline
and off of exchanges. Your cryptographic key only lives on your hard wallet and
is impossible to hack (unless someone physically steals your hard wallet).
Hard wallets are so secure that there are countless
stories of people carelessly misplacing a hard wallet full of cryptos and never
being able to recover thousands, hundreds of thousands, or millions of
bitcoins.
Some users opt to use a “paper wallet,” which is
essentially your cryptographic keys on a piece of paper stored somewhere safe
like a bank vault. Although paper wallets are not recommended, they can be done
either by an online key generator (not recommended due to threats of malware)
or handwritten.
For more information on Bitcoin wallets, read out
Guide to Finding the Best Bitcoin Wallet.
Bitcoin is often hailed as the future of the
monetary world for a variety of reasons.
• It’s
decentralized and brings power back to the people. Launched just a year after
the 2008 financial crises, Bitcoin has attracted many people who see the
current financial system as unsustainable. This factor has won the hearts of
those who view politicians and government with suspicion. It’s no surprise
there is a huge community of ideologists actively building, buying, and working
in the cryptocurrency world.
• Freedom.
The concept that one could carry millions or billions of dollars in Bitcoin
across borders, pay for anything at any time, and not have to wait on extended
bank delays is a major selling point.
• Security.
Bitcoin payments don’t necessarily need to be tied to one’s personal
information. Since personal information is left out of the transactions, users
aren’t as exposed to threats such as identity theft. Bitcoin can also be backed
up and encrypted to ensure the security of your money.
• Low
Transaction Fees. Banks and companies like PayPal charge to send and receive
money. Bitcoin replaces the 2.5% “transaction fee” with one that’s only a
fraction of that.
The Immutable Ledger. Bitcoin’s blockchain public
ledger is objective. People trust it to be fair because it is based on pure
mathematics, rather than the human error and corruption of questionable
politicians.
What
are the disadvantages of Bitcoin?
For all its advantages, Bitcoin does still pose some
significant issues.
Perhaps one of the largest reasons everyone hasn’t
jumped on the Bitcoin train is because its price is shrouded in uncertainty.
Many people are concerned with…
1. Legal
Gray Area. Major governments have largely remained on the sidelines, and this
has created both a sense of potential and apprehension for Bitcoin proponents
and critics respectively. Bitcoin isn’t backed by a regulatory agency and a
government would technically be ceding power by supporting a decentralized
currency. This has been largely officially unaddressed. Bitcoin’s price,
however, tends to be very sensitive to any news concerning the US government’s
opinion of cryptocurrencies. For example, when the SEC denied the approval of
bitcoin-based exchange-traded-products—essentially bitcoin-backed assets on the
stock market—in 2017, Bitcoin’s price dropped 18%. Yet while the price and
adoption of Bitcoin would be affected by government action, governments are
unable to criminalize Bitcoin. In fact, governments such as the United States
and China have invested in it at some capacity.
2. Exchange
hacks. As stated above, an exchange hack has nothing to do with the integrity
of the Bitcoin system… but the market freaks out regardless. This trend seems
to minimize as users see that cryptos recover from exchange hacks. As exchanges
evolve and become more secure, this threat becomes less of an issue.
Additionally, outside investments funneling into exchanges are providing the
capital for them to grow stronger.
3. Illiquidity.
This is mostly moot due to Bitcoin’s $47 market cap but it still makes users
sweat. It’s highly unlikely that Bitcoin’s price would plummet and you’d be
unable to take action, but it’s still unsettling. As more investors invest, however,
illiquidity becomes a negligible risk, as there will likely always be a buyer
for Bitcoins waiting.
4. Volatility.
This very reason many speculators are attracted to Bitcoin is the same reason
many potential users are hesitant to get involved. Users that look at Bitcoin
as a speculative investment option are essentially gambling on the process, and
the future price of Bitcoin is largely unknown. There are estimates that
Bitcoin will both be worth pennies in a few years, while some predict that a
single bitcoin will be worth $500k in three years. As new investors continue to
invest and the market cap grows, Bitcoin’s price could become more stable.
5. Lack
of adoption by businesses. The price volatility is a large reason that many
businesses have yet to adopt Bitcoin as a form of payment. Increased consumer
adoption and price stability will eventually mitigate this disadvantage.
Another disadvantage is that while many people have
heard of Bitcoin, few understand exactly what it is or how it functions. Guides
like this help to push the needle and build a foundation, but it’s ultimately
on the users to seek out more information.
Bitcoin’s strength lies in its networking effect.
The more we spread the word and grow the Bitcoin community, the better off our
bitcoins will be.
How
to Buy Bitcoin
As mentioned above, in the early years of Bitcoin it
was difficult to find a trustworthy place to buy the cryptocurrency. With the increase in demand for Bitcoin, numerous
new companies have sprouted to help facilitate easily purchasing Bitcoin.
These days, many Bitcoin exchanges have received
huge investments from venture capitalist.
They’re also now more heavily regulated, especially those based out of
the United States. You can compare
exchanges and view our in depth reviews in our How to Buy Bitcoin Guide. We’ve also listed our top two recommended
options below:
• Coinbase
launched in 2012 with the hopes of giving users an easier way to buy
Bitcoin. Since its launch, the San
Francisco based startup has become the most commonly recommended buying option
for newbies. You can learn more in our
complete Coinbase Review and User’s Guide.
• Gemini
was founded in 2015 by Tyler and Cameron Winklevoss. While they launched more recently than many
of their competitors, the New York based cryptocurrency exchange has quickly
built a great reputation in the crypto community. You can learn more in our Gemini Review and
User’s Guide.
Who
invented Bitcoin?
Satoshi Nakamoto is credited with designing Bitcoin.
Nakamoto claims to be a man living in Japan born on April 5th, 1975 but there
are speculations that he is actually either an individual programmer or group
of programmers with a penchant for computer science and cryptography scattered
around the United States or Europe. Nakamoto is believed to have created the
first blockchain database and have been the first to solve the double spending
problem other digital currency failed to. While Bitcoin’s creator is shrouded
in mystery, his Wizard of Oz status hasn’t stopped the digital currency from
becoming increasingly popular with individuals, businesses, and even
governments.
Bitcoin’s
Popularity
It’s important to take a look at Bitcoin’s
popularity over time because… well, have a look below:
Google Trends structures the chart to represent a
relative search interest to the highest points in the chart. A value of 100 is
the peak popularity for the term “Bitcoin” and a value of 50 means it was half
as popular at that time. A score of 0 indicates that the term was less than 1%
as popular as the peak. It’s amazing how the searches relating to Bitcoin have
spiked in the past few years.
When Bitcoin began circulating in 2009, its early
adopters consisted of programmers and a niche crowd of technical people. Its
popularity over time indicates that many of the disadvantages of Bitcoin will
likely dissipate as Bitcoin becomes more standard.
Unsurprisingly, Bitcoin’s price has grown with
increased demand. As you can see, more buyers enter the market and raise the
price as more people learn about Bitcoin and its technical applications.
Bitcoin’s popularity has undeniably been its number
one advantage over the numerous other cryptocurrencies. By gaining a large
number of adopters and users, Bitcoin has achieved a network effect that
attracts even more users. Users who would otherwise be more apprehensive
investing in a relatively unknown and unproven digital currency are reassured
by Bitcoin’s performance over time, its growing community, and the fact that
people they know are adopting cryptos.
Bitcoin’s first mover advantage, popularity, and
network effect has cemented it as the most popular cryptocurrency with the
largest market cap. Rivals like Litecoin may have numerous technical advantages
over Bitcoin’s algorithm (see more about that here), but they only hold a
fraction of Bitcoin’s market cap and their dwindling communities largely
consist of loyalists, speculators, and antagonistic anti-Bitcoin buyers.
What
We Can Learn From Bitcoin’s Popularity
Understanding what makes Bitcoin so popular allows
us to not only conceptualize where Bitcoin is headed, but also how other
cryptocurrencies generally function. Bitcoin is able to attract users better
than any other cryptocurrency because…
1. It has
the network effect. Bitcoin’s network validates its worth to newcomers and
gives Bitcoin a viral growth rate.
2. The
high market cap is comforting. Bitcoin’s massive market cap gives users a sense
of security and stability. With a market cap of about $69 billion, Bitcoin is
comparatively a much safer crypto investment.
3. Speculation
drives numbers. Many Bitcoin users are holding onto their bitcoins in hopes of
selling them off for an enormous profit one day. With news articles portraying
Bitcoin millionaires as lucky kids who got in early, you can’t really blame
them. For example, if you had spent your $5 latte money on 2,000 bitcoins one
morning in 2010, they would be worth about $5.4 million today. Makes you really
wish you’d managed your Starbucks budget better, doesn’t it?
News drives attention, and attention drives
understanding. While many people have flocked to cryptocurrencies purely in
search of financial gain, there are a ton of people that are simply curious.
Some peoples are sticking around and trying to understand what cryptos are all
about. While more users increases Bitcoin’s network effect, more people forming
in-depth understandings of cryptos also strengthen the active Bitcoin
community.
Final
Thoughts
Bitcoin is still a relatively young currency but it
has achieved substantial user adoption and growth. Bitcoin’s network only grows
stronger as more people learn about Bitcoin’s fundamental technology and
potential in relation to other methods of value storage.
As the flagship of the cryptocurrency fleet, Bitcoin
is considered the “gateway” cryptocurrency. Understanding Bitcoin’s potential
is an essential first step to seeing the brilliant solutions being worked on in
the cryptocurrency world.
Bitcoin paints a future that is drastically
different from the fiat-based world today. This is either exciting or
unsettling for the vast majority. Equip yourself with the best possible
resources. Become active in communities that further explore not only the
technical applications of Bitcoin and other cryptos, but with their overall
potential to disrupt virtually every market. Brace yourselves. Cryptos are
coming.
