Amidst a growing desire for more control over personal finances and a growing resistance against the grip of traditional banks, the demand for a decentralised currency reached unprecedented levels.
Emerging during the tumultuous times of the 2008 financial crisis, which later became known as The Great Recession, Bitcoin made its debut. This digital, decentralised, and trustless form of currency aimed to shift power back to individuals.
Since its inception, Bitcoin has paved the way for the creation of over 10,000 other cryptocurrencies and has gradually risen to become the largest cryptocurrency in the industry. However, understanding Bitcoin and its technology can be challenging.
Let's dive deeper into this technology to explore how Bitcoin operates.
What is Bitcoin?
Bitcoin is a decentralised virtual currency that is cryptographically encrypted and made open-source using blockchain technology. This means that Bitcoin is transparent and secure, transactions recorded in the blockchain are immutable and it runs on a trustless peer-to-peer system that does not require a trusted third party, unlike the traditional banking system.
Bitcoin marked a breakthrough in commerce as it solved the fundamental problem of transferring value across borders from one person directly to another without third parties like banks in the middle. Creating a viable solution to this problem provided insights into further applications of this virtual currency.
To some, Bitcoin is a means of transferring value across borders; to others, it is a store of value similar to gold; and to some, it is an investment vehicle that generates portfolio income.
Just like the internet is exclusively digital, borderless, without a governing, authoritarian body, and available 24/7, so is Bitcoin.
How is Bitcoin Different from Regular Money?
Bitcoin is designed for global reach, completely breaking all geographical barriers as it allows exchange from every corner of the world without limitation. Also, Bitcoin guarantees privacy as transactions contain no identifying information other than the Bitcoin addresses and amounts involved.
Similarly, Bitcoin payments are more secure than standard debit and credit card transactions because they are based on cryptography, which is a mathematical method of encoding data. This makes it very difficult for hackers to tamper with or steal users’ identities.
The Bitcoin network is transparent, meaning that all transactions are recorded on a public ledger called the blockchain. This makes it impossible to manipulate transactions or change the supply of Bitcoin without the cooperation of a majority of the network. The Bitcoin software is also open-source, meaning that anyone can review the code and verify that it is fair and secure.
Bitcoin’s History
Bitcoin was launched in January 2009 by an anonymous individual, or perhaps a group, with the pseudonym Satoshi Nakamoto. Predating this event was the first publication of Bitcoin’s whitepaper in October 2008, titled "Bitcoin: A Peer-to-Peer Electronic Cash System", a historic event that changed the course of finance forever.
On January 3, 2009, the first Bitcoin block, Block 0, was mined. This is also known as the "genesis block" and contains the text: "The Times, 03/Jan/2009 Chancellor on brink of second bailout for banks." This message serves as a timestamp for the genesis block and may also be interpreted as a political commentary on the financial crisis of 2008.
In retrospect, Bitcoin was not the first attempt at virtual currencies; in fact, a few virtual currencies like DigiCash, E-gold, and Liberty Reserve were all functional before Bitcoin was launched, but they were eventually shut down by the U.S. government. Bitcoin, on the other hand, has so far managed to evade government intervention. This is because its architecture is designed to be decentralised and censorship-resistant, making it difficult for governments to control.
How Does Bitcoin work?
The Bitcoin network is built on a technology called blockchain, which is essentially a transparent distributed ledger. This ledger is immutable and divided into linked blocks. Whenever a transaction is validated, the network updates every user’s copy of the ledger to reflect the latest changes.
As each block is updated and eventually filled, a new block is created, and the process repeats itself.
However, to validate a transaction, secure the network, and prevent double-spending, Bitcoin employs a Proof of Work (PoW) consensus mechanism. PoW is an energy-intensive process that relies on network contributors called miners, who dedicate an immense amount of computing power to creating new blocks—a process that typically takes approximately 10 minutes.
When a miner successfully adds a new block to the blockchain (usually by solving complex mathematical problems), he is allowed to fill it with 1 megabyte’s worth of validated transactions. To reward their efforts and incentivise mining, the miners are rewarded with a block reward, which is a combination of newly minted bitcoins and transaction fees.
Only 21 million Bitcoins exist and will ever exist, and block rewards are how they get mined and supplied to the market. After every 210,000 blocks, the block reward is halved, and the number of bitcoins issued declines by 50%, reducing the inflation rate. This event is known as the Bitcoin halving, and it occurs every four years.
How is Bitcoin Mined?
Before going mainstream, miners could mine Bitcoin right from their personal computers; however, as the market grew and more miners joined the network, receiving a block reward has become intensely competitive.
Miners invest in machines specifically built for this purpose in order to generate enough computation power to compete for block rewards. These machines are called application-specific integrated circuits (ASICs), and they typically cost about $20,000. Miners also have to consider other expenses, such as paying for electricity and rig maintenance.
Examples include the Whatsminer M30S and the Antminer S19 Pro.
Should You Invest in Bitcoin?
Bitcoin is widely used as an investment vehicle to diversify an active portfolio, and due to its volatility, it has returned an average ROI of 820% since 2019.
However, as its valuation climbs, Bitcoin presents less upside potential, making it a bad fit for small investors looking for large returns. On the other hand, big investors with large capital seeking a conservative, low-risk investment may find Bitcoin very attractive.
Where Can I Buy Bitcoin?
Bitcoin is publicly traded on every centralised exchange, like Binance, Kucoin and Coinbase. However, it is not advisable to keep long-term holdings in CEXes, especially if investment capital is substantial, due to the counterparty risk of not holding your own investment in your own wallet.
Consider moving your assets to a cold wallet, and do not forget to manage your risk accordingly.
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This article is intended for educational purposes and is not financial advice.
