What Is
Bitcoin?
Bitcoin is a decentralized digital currency created in January 2009. It follows the
ideas set out in a whitepaper by the mysterious and pseudonymous Satoshi
Nakamoto.1 The identity of the person or persons who created the technology is
still a mystery. Bitcoin offers the promise of lower transaction fees than traditional
online payment mechanisms and, unlike government-issued currencies, it is
operated by a decentralized authority.
Bitcoin is known as a type of cryptocurrency because it uses cryptography to
keep it secure. There are no physical bitcoins, only balances kept on a public
ledger that everyone has transparent access to (although each record is
encrypted). All bitcoin transactions are verified by a massive amount of
computing power via a process known as "mining." Bitcoin is not issued or
backed by any banks or governments, nor is an individual bitcoin valuable as a
commodity. Despite it not being legal tender in most parts of the world, bitcoin is
very popular and has triggered the launch of hundreds of other cryptocurrencies,
collectively referred to as altcoins. Bitcoin is commonly abbreviated as "BTC"
when traded.
KEY TAKEAWAYS
Launched in 2009, bitcoin is the world's largest cryptocurrency by market
capitalization.
Unlike fiat currency, bitcoin is created, distributed, traded, and stored with
the use of a decentralized ledger system, known as a blockchain.
Bitcoin's history as a store of value has been turbulent; it has gone through
several cycles of boom and bust over its relatively short lifespan.
As the earliest virtual currency to meet widespread popularity and success,
bitcoin has inspired a host of other cryptocurrencies in its wake.
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What Is Bitcoin
Understanding Bitcoin
The bitcoin system is a collection of computers (also referred to as "nodes" or
"miners") that all run bitcoin's code and store its blockchain. Metaphorically, a
blockchain can be thought of as a collection of blocks. In each block is a
collection of transactions. Because all the computers running the blockchain
have the same list of blocks and transactions, and can transparently see these
new blocks being filled with new bitcoin transactions, no one can cheat the
system.
Anyone—whether they run a bitcoin "node" or not—can see these transactions
occurring in real-time. To achieve a nefarious act, a bad actor would need to
operate 51% of the computing power that makes up bitcoin. Bitcoin has around
13,950 full nodes, as of mid-October 2021, and this number is growing, making
such an attack quite unlikely.2
But if an attack were to happen, bitcoin miners—the people who take part in the
bitcoin network with their computers—would likely fork to a new blockchain,
making the effort the bad actor put forth to achieve the attack a waste.
The private key (comparable to an ATM PIN) is meant to be a guarded secret
and only used to authorize bitcoin transmissions. Bitcoin keys should not be
confused with a bitcoin wallet, which is a physical or digital device that facilitates
the trading of bitcoin and allows users to track ownership of coins. The term
"wallet" is a bit misleading, as bitcoin's decentralized nature means it is never
stored "in" a wallet, but rather distributed on a blockchain.
Peer-to-Peer Technology
Bitcoin is one of the first digital currencies to use peer-to-peer (P2P) technology
to facilitate instant payments. The independent individuals and companies who
own the governing computing power and participate in the bitcoin network—
bitcoin "miners"—are in charge of processing the transactions on the blockchain
and are motivated by rewards (the release of new bitcoin) and transaction fees
paid in bitcoin.
These miners can be thought of as the decentralized authority enforcing the
credibility of the bitcoin network. New bitcoins are released to the miners at a
fixed, but periodically declining rate. There are only 21 million bitcoins that can be
mined in total. As of October 2021, there are over 18.845 million bitcoin in
existence and less than 2.155 million bitcoin left to be mined.3
In this way, bitcoin and other cryptocurrencies operate differently from fiat
currency; in centralized banking systems, currency is created at a rate matching
the growth of the economy; this system is intended to maintain price stability. A
decentralized system, like bitcoin, sets the release rate ahead of time and
according to an algorithm.
Bitcoin Mining
Bitcoin mining is the process by which bitcoin is released into circulation.
Generally, mining requires solving computationally difficult puzzles to discover a
new block, which is added to the blockchain.
Bitcoin mining adds and verifies transaction records across the network. Miners
are rewarded with some bitcoin; the reward is halved every 210,000 blocks. The
block reward was 50 new bitcoins in 2009. On May 11th, 2020, the third halving
occurred, bringing the reward for each block discovery down to 6.25 bitcoins.4
A variety of hardware can be used to mine bitcoin. However, some yield higher
rewards than others. Certain computer chips, called Application-Specific
Integrated Circuits (ASIC), and more advanced processing units, like Graphic
Processing Units (GPUs), can achieve more rewards. These elaborate mining
processors are known as "mining rigs."
Early Timeline of Bitcoin
Aug. 18, 2008
The domain name bitcoin.org is registered.6 Today, at least, this domain is
"WhoisGuard Protected," meaning the identity of the person who registered it is
not public information.
Oct. 31, 2008
A person or group using the name Satoshi Nakamoto makes an announcement
to the Cryptography Mailing list at metzdowd.com: "I've been working on a new
electronic cash system that's fully peer-to-peer, with no trusted third party. This
now-famous whitepaper published on bitcoin.org, entitled "Bitcoin: A Peer-to-
Peer Electronic Cash System," would become the Magna Carta for how bitcoin
operates today.7
Jan. 3, 2009
The first bitcoin block is mined—Block 0. 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," perhaps as proof that the block was mined on or after
that date, and perhaps also as relevant political commentary.8
Jan. 8, 2009
The first version of the bitcoin software is announced to the Cryptography Mailing
list.
Jan. 9, 2009
Block 1 is mined, and bitcoin mining commences in earnest.
Who Is Satoshi Nakamoto?
No one knows who invented bitcoin, or at least not conclusively.
Satoshi Nakamoto is the name associated with the person or group of people
who released the original bitcoin whitepaper in 2008 and worked on the
original bitcoin software that was released in 2009. In the years since that time,
many individuals have either claimed to be or have been suggested as the real-
life people behind the pseudonym, but as of October 2021, the true identity (or
identities) behind Satoshi remains obscured.9
Although it is tempting to believe the media's spin that Satoshi Nakamoto is a
solitary, quixotic genius who created bitcoin out of thin air, such innovations do
not typically happen in a vacuum. All major scientific discoveries, no matter how
seemingly original, were built on previously existing research.
There are precursors to bitcoin: Adam Back’s Hashcash, invented in 1997, and
subsequently Wei Dai’s b-money, Nick Szabo’s bit gold, and Hal Finney’s
Reusable Proof of Work.1 0 The bitcoin whitepaper itself cites Hashcash and b-
money, as well as various other works spanning several research fields. Perhaps
unsurprisingly, many of the individuals behind the other projects named above
have been speculated to have also had a part in creating bitcoin.
There are a few possible motivations for bitcoin's inventor deciding to keep their
identity secret. One is privacy: As bitcoin has gained in popularity—becoming
something of a worldwide phenomenon—Satoshi Nakamoto would likely garner a
lot of attention from the media and from governments. Another reason could be
the potential for bitcoin to cause a major disruption in the current banking and
monetary systems. If bitcoin were to gain mass adoption, the system could
surpass nations' sovereign fiat currencies. This threat to existing currency could
motivate governments to want to take legal action against bitcoin's creator.
The other reason is safety. Looking at 2009 alone, 32,489 blocks were mined; at
the reward rate of 50 bitcoin per block, the total payout in 2009 was
1,624,500 bitcoin. One may conclude that only Satoshi and perhaps a few other
people were mining through 2009 and that they possess a majority of that stash
of bitcoin.
Someone in possession of that much bitcoin could become a target of criminals,
especially since bitcoin is less like stocks and more like cash, where the private
keys needed to authorize spending could be printed out and literally kept under a
mattress.
While it's likely the inventor of bitcoin would take precautions to make any
extortion-induced transfers traceable, remaining anonymous is a good way for
Satoshi to limit exposure.
Special Considerations
Bitcoin as a Form of Payment
Bitcoin can be accepted as a means of payment for products sold or services
provided. Brick-and-mortar stores can display a sign saying “Bitcoin Accepted
Here”; the transactions can be handled with the requisite hardware terminal or
wallet address through QR codes and touch screen apps. An online business
can easily accept bitcoin by adding this payment option to its other online
payment options: credit cards, PayPal, etc.
El Salvador became the first country to officially adopt Bitcoin as legal tender in
June 2021.
Bitcoin Employment Opportunities
Those who are self-employed can get paid for a job related to bitcoin. There are
several ways to achieve this, such as creating any internet service and adding
your bitcoin wallet address to the site as a form of payment. There are also
several websites and job boards that are dedicated to digital currencies:
Cryptogrind brings together work seekers and prospective employers
through its website.
Coinality features jobs—freelance, part-time and full-time—that offer
payment in bitcoin, as well as other cryptocurrencies
like Dogecoin and Litecoin.
Jobs4Bitcoins is part of reddit.com.
BitGigs
Bitwage offers a way to choose a percentage of your work paycheck to be
converted into bitcoin and sent to your bitcoin address.
How to Buy Bitcoin
Many bitcoin supporters believe that digital currency is the future. Many
individuals who endorse bitcoin believe it facilitates a much faster, low-fee
payment system for transactions across the globe. Although it is not backed by
any government or central bank, bitcoin can be exchanged for traditional
currencies; in fact, its exchange rate against the dollar attracts potential investors
and traders interested in currency plays. Indeed, one of the primary reasons for
the growth of digital currencies like bitcoin is that they can act as an alternative to
national fiat money and traditional commodities like gold.
In March 2014, the IRS stated that all virtual currencies, including bitcoin, would
be taxed as property rather than currency. Gains or losses from bitcoin held
as capital will be realized as capital gains or losses, while bitcoin held
as inventory will incur ordinary gains or losses. The sale of bitcoin you mined or
purchased from another party, or the use of bitcoin to pay for goods or services,
are examples of transactions that can be taxed.1 2
Like any other asset, the principle of buying low and selling high applies to
bitcoin. The most popular way of amassing the currency is through buying on a
bitcoin exchange, but there are many other ways to earn and own bitcoin.
Risks Associated With Bitcoin Investing
Speculative investors have been drawn to Bitcoin after its rapid price
appreciation in recent years. Bitcoin had a price of $7,167.521 3 on December 31,
2019, and a year later, had appreciated more than 300% to $28,984.98. It
continued to surge in the first half of 2021, trading at a record high of over
$64,000 in April 2021.
Thus, many people purchase bitcoin for its investment value rather than its ability
to act as a medium of exchange. However, the lack of guaranteed value and its
digital nature means the purchase and use of bitcoin carries several inherent
risks. Many investor alerts have been issued by the Securities and Exchange
Commission (SEC), the Financial Industry Regulatory Authority (FINRA),
the Consumer Financial Protection Bureau (CFPB), and other agencies.
The concept of a virtual currency is still novel and, compared to traditional
investments, bitcoin doesn't have much of a long-term track record or history of
credibility to back it. With its increasing popularity, bitcoin is becoming less
experimental every day; still, after only a decade, all digital currencies remain in a
development phase. "It is pretty much the highest-risk, highest-return investment
that you can possibly make,” says Barry Silbert, CEO of Digital Currency Group,
which builds and invests in bitcoin and blockchain companies.
Regulatory Risk
Investing money into bitcoin in any of its many guises is not for the risk-averse.
Bitcoin is a rival to government currency and may be used for underground
market transactions, money laundering, illegal activities, or tax evasion. As a
result, governments may seek to regulate, restrict, or ban the use and sale of
bitcoin (and some already have). Others are coming up with various rules.
For example, in 2015, the New York State Department of Financial Services
finalized regulations that would require companies dealing with the buy, sell,
transfer, or storage of bitcoin to record the identity of customers, have a
compliance officer, and maintain capital reserves. Any transactions worth
$10,000 or more will have to be recorded and reported.1 5
The lack of uniform regulations about bitcoin (and other virtual currencies) raises
questions over their longevity, liquidity, and universality.
Security Risk
Most individuals who own and use bitcoin have not acquired their tokens through
mining operations. Rather, they buy and sell bitcoin and other digital currencies
on any of the popular online markets, known as bitcoin exchanges or
cryptocurrency exchanges.
Bitcoin exchanges are entirely digital and, as with any virtual system, are at risk
from hackers, malware, and operational glitches. If a thief gains access to a
bitcoin owner's computer hard drive and steals their private encryption key, they
could transfer the stolen bitcoin to another account. (Users can prevent this only
if their bitcoin is stored on a computer that is not connected to the internet, or
else by choosing to use a paper wallet—printing out the bitcoin private keys and
addresses, and not keeping them on a computer at all.)
Hackers can also target bitcoin exchanges, gaining access to thousands of
accounts and digital wallets where bitcoin is stored. One especially notorious
hacking incident took place in 2014, when Mt. Gox, a bitcoin exchange in Japan,
was forced to close down after millions of dollars worth of bitcoin was stolen.1 6
This is particularly problematic given that all bitcoin transactions are permanent
and irreversible. It's like dealing with cash: Any transaction carried out with
bitcoin can only be reversed if the person who has received them refunds them.
There is no third party or a payment processor, as in the case of a debit or credit
card—hence, no source of protection or appeal if there is a problem.
Insurance Risk
Some investments are insured through the Securities Investor Protection
Corporation. Normal bank accounts are insured through the Federal Deposit
Insurance Corporation (FDIC) up to a certain amount depending on the
jurisdiction.
Generally speaking, bitcoin exchanges and bitcoin accounts are not insured by
any type of federal or government program. In 2019, prime dealer and trading
platform SFOX announced it would be able to provide bitcoin investors with FDIC
insurance, but only for the portion of transactions involving cash.1 7
Fraud Risk
While bitcoin uses private key encryption to verify owners and register
transactions, fraudsters and scammers may attempt to sell false bitcoin. For
instance, in July 2013, the SEC brought legal action against an operator of a
bitcoin-related Ponzi scheme.1 8 There have also been documented cases of
bitcoin price manipulation, another common form of fraud.
Market Risk
Like with any investment, bitcoin values can fluctuate. Indeed, the value of the
currency has seen wild swings in price over its short existence. Subject to high
volume buying and selling on exchanges, it has a high sensitivity to any
newsworthy events. According to the CFPB, the price of bitcoin fell by 61% in a
single day in 2013, while the one-day price drop record in 2014 was as big as
80%.1 9
If fewer people begin to accept bitcoin as a currency, these digital units may lose
value and could become worthless. Indeed, there was speculation that the
"bitcoin bubble" had burst when the price declined from its all-time high during
the cryptocurrency rush in late 2017 and early 2018.
There is already plenty of competition, and although bitcoin has a huge lead over
the hundreds of other digital currencies that have sprung up because of its brand
recognition and venture capital money, a technological breakthrough in the form
of a better virtual coin is always a threat.
Splits in the Cryptocurrency Community
In the years since bitcoin launched, there have been numerous instances in
which disagreements between factions of miners and developers prompted
large-scale splits of the cryptocurrency community. In some of these cases,
groups of bitcoin users and miners have changed the protocol of the bitcoin
network itself.
This process is known as "forking," and it usually results in the creation of a new
type of bitcoin with a new name. This split can be a "hard fork," in which a new
coin shares transaction history with bitcoin up until a decisive split point, at which
point a new token is created. Examples of cryptocurrencies that have been
created as a result of hard forks include bitcoin cash (created in August 2017),
bitcoin gold (created in October 2017), and bitcoin SV (created in November
2017).
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Why Is Bitcoin Valuable?
Bitcoin's price has risen exponentially in just over a decade, from less than $1 in
2011 to more than $60,000 as of October 2021. Its value is derived from several
sources, including its relative scarcity, market demand, and marginal cost of
production.2 1 Thus, even though it is intangible, bitcoins command a high
valuation, with a total market cap of $1.15 trillion2 2 as of October 2021.
Is Bitcoin a Scam?
Even though bitcoins are virtual and can't be touched, they are certainly real.
Bitcoins have been around for more than a decade and the system has proven
itself to be robust. The computer code that runs the system, moreover, is open
source and can be downloaded and analyzed by anybody for bugs or evidence of
nefarious intent. Of course, fraudsters may attempt to swindle people out of their
bitcoin or hack sites like crypto exchanges, but these are flaws in human
behavior or third-party applications, and not with Bitcoin itself.
How Many Bitcoins Are There?
The maximum number of bitcoins that will ever be produced is 21 million, and the
last bitcoin will be mined some time around the year 2140. As of October 2021,
more than 18.845 million (almost 90%) of those bitcoins have been
mined.2 3 Moreover, researchers estimate that up to 20% of those bitcoins have
been "lost" due to people forgetting their private key, death without leaving
instructions, or sending bitcoins to unusable addresses.2 4
Should I Capitalize the 'B' in Bitcoin?
By convention, use a capital 'B' when discussing the Bitcoin network, protocol, or
system. Use a small 'b' when talking about individual bitcoins or bitcoin as a unit
of value (e.g., I sent two bitcoins).
