What is Bitcoin, and How Does It Work?

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Even though you may not be a cryptocurrencies trader, or very interested in that world, you may still be familiar with Bitcoin. It has been in the news so much lately; though most of the news surrounding it may go over your head. If you’ve ever wondered why it’s being talked about so much and how it might affect you, read on.

Here is your guide to Bitcoin and how it works. Below, we will discuss what Bitcoin is, how it came about, and how it works.

What is Bitcoin?

Bitcoin is a decentralized currency. Decentralized means that you can buy, sell, and exchange bitcoin without having to go through intermediaries like banks. Bitcoin was created by Satoshi Nakamoto (a pseudonym) who once said that there was a need for a payment system based on cryptographic proof.

In order to make Nakamoto’s version a reality, he/they made a system that would make it possible: Blockchain. Bitcoin operates on blockchain. Each bitcoin transaction is contained inside a digital public ledger. Each entry plugged into a blockchain is called a block. Each block is connected to the block before that, hence the term “blockchain”. Everything is publicly visible, so blockchain security issues are easily identified and curbed.

The difference between Bitcoin and fiat money

The main difference is that fiat currency is regulated by central authorities and governments. Examples of which are your US dollar and British pound currencies. The values of these currencies are dependent on economic policy and the state of the country’s economy. Bitcoin, on the other hand, is not regulated by any third party authorities or governments. The value of Bitcoin, much like any currency, is derived from trust.

Another major difference is that fiat money, in theory, can have an unlimited supply. Bitcoin has a supply that is capped at 21 million. This creates a scarcity that would, in theory, drive up its value.

Bitcoin does not have a physical representation. Meaning, there is no actual, physical coin that you can use for a physical transaction, unlike fiat money that has both physical (paper and coin money) and digital representations.

How does Bitcoin work?

Bitcoin is essentially lines of computer code in a blockchain. With Bitcoin operating on a blockchain, each block (or entry) will have a time and stamp, total value, the buyer and seller, and a unique identifier exclusive to that transaction. Each entry is arranged chronologically.

Anyone can contribute to a blockchain as long as they have a link. It may sound risky, but the nature of the blockchain itself actually makes it secure. Before a transaction block can be added to the blockchain, it must be checked and verified by the majority and the unique identifier must conform to the correct encryption pattern. These unique identifiers are hard to fake, and consist of a long line of entirely random numbers. The visibility of the blockchains also makes it virtually impossible to double-spend coins or spend coins they do not own.

How to use Bitcoin

Bitcoin can be used in many things, from online shopping to corporate expense management. Buying and selling Bitcoin is also very possible. You can start using Bitcoin with these simple steps:

  1. The Bitcoin wallet

In order to send and receive bitcoins, you will need a bitcoin wallet. There are many types available, you can take your pick.

Your wallet will have a public and private key. Your private key is your password. You MUST keep your private key secure. Do not show it to anyone or divulge it to someone for “safekeeping.”

  1. Getting bitcoin

You can get bitcoin in several ways:

  • Buy it. There are people who sell bitcoin, and you can buy it from them. The price of bitcoin is volatile, though, and could differ drastically from one day to the next. Make sure that you do proper vetting before buying from any source.
  • Accept bitcoin as a form of payment. If you run a business or provide a service, you can accept Bitcoin as a form of payment for your services.
  • Bitcoin mining. This method is a bit harder than just outright buying the cryptocurrency. To mine Bitcoin, you need to download software into your computer and start verifying transactions in the blockchain. It is very involved and requires extensive knowledge of how the network works.

Once you get the bitcoins, transfer them to your secure Bitcoin wallet for safekeeping.

  1. Send and receive Bitcoin

You can now transact using Bitcoin. To receive Bitcoin, share your public Bitcoin address. You can send Bitcoin by using the person’s public Bitcoin address.

Things to keep in mind

Bitcoin is volatile. If you are the type to be conservative about your finances, you will need to ensure that you can take the risk of its volatility in stride. Some people invest in Bitcoin like they do stocks. Each investor has their own philosophy about investing. You can follow the philosophy of someone whose thinking matches your own.

Security is always something that needs to be at the forefront of your mind when doing financial transactions. Whether using actual physical cash or using cryptocurrency, always ensure that your transactions are secure, that you are transacting with a legitimate entity, and that you keep your passwords and keys private.