ZuluTrade Blog

What Is Bitcoin & How Does It Work? [Beginner's Guide for 2022]

Knowledge Crunch | Wednesday, November 24, 2021 11:38 AM GMT

Not only is Bitcoin the first cryptocurrency but it’s also the official currency of the country of El Salvador and is the best known of the more than 13,000 cryptocurrencies in existence today. Financial media eagerly covers each new dramatic high and stomach churning decline, making Bitcoin an inescapable part of the landscape.

Bitcoin, the digital currency, has been all over the news for years. But because it’s entirely digital and doesn’t necessarily correspond to any existing fiat currency, it’s not easy to understand for the newcomer. Let’s break down the basis of exactly what Bitcoin is, how it works, and its possible future in the global economy.

While the wild volatility might produce great headlines, it hardly makes Bitcoin the best choice for novice investors or people looking for a stable store of value. Understanding the ins and outs can be tricky—let’s take a closer look at how Bitcoin works.

 

Table of Contents

 

What is Bitcoin?

How Does Bitcoin Work?

Is Bitcoin Safe?

Bitcoin Mining

Bitcoin Wallet

Buying & Selling Bitcoin








What is Bitcoin?

The idea of digital currency developed right along with the launch of the World Wide Web in the late 1980s and early 1990s. Wei Dai is generally considered to be among the first to articulate the idea of creating a new form of money that didn’t rely on some central authority. This idea remained more of a great subject to discuss until around 2008.

At that time, a person or group using the pseudonym of Satoshi Nakamoto began work on a white paper that took the first specification and proof of the Bitcoin concept. Using the idea of an open-source community as the foundation, Bitcoin began to be generated.

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 a type of cryptocurrency. There are no physical Βitcoins, only balances kept on a public ledger that everyone has transparent access to. All bitcoin transactions are verified by a massive amount of computing power. 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 (the exemption being El Salvador), Bitcoin is very popular and has triggered the launch of hundreds of other cryptocurrencies like Ethereum, collectively referred to as altcoins. Bitcoin is commonly abbreviated as "BTC". Now let’s see how Bitcoin actually works.






How Does Bitcoin Work?

Bitcoin is a digital currency that operates free of any central control or the oversight of banks or governments. Instead, it relies on peer-to-peer software and cryptography.

In a basic sense, each Bitcoin is basically a computer file that is stored in a 'digital wallet' app on a smartphone or computer. People can send Bitcoins (or part of one) to your digital wallet, and you can send Bitcoins to other people as a sort of payment system. 

Every single transaction is recorded in a public list called the blockchain. This makes it possible to trace the history of Bitcoins to stop people from spending coins they do not own, making copies or undoing transactions. To fully understand how the inner workings make sense, we need to understand how blockchains work.

Source: Pixabay.com 

What is a blockchain?

At its most basic, a blockchain is a list of transactions that anyone can view and verify. The Bitcoin blockchain, for example, contains a record of every time bitcoin users sent or received bitcoin. Cryptocurrencies and the blockchain technology that powers them make it possible to transfer value online without the need for a middleman like PayPal, a central bank or a credit card company.

Almost all cryptocurrencies are secured via blockchain networks. This means their accuracy is constantly being verified by a huge amount of computing power.

The list of transactions contained in the blockchain is fundamental for most cryptocurrencies because it enables secure payments to be made between people who don’t know each other without having to go through a third-party verifier to a bank with a traditional currency like the U.S. dollar

Due to the cryptographic nature of these networks, payments via blockchain can be more secure than standard debit/credit card or bank account transactions. This opens up a world of possibilities including peer-to-peer financial services, such as loans or decentralized savings and checking accounts, wherein banks or any intermediary is irrelevant.

When making a Bitcoin payment, for instance, you don’t need to provide any sensitive information. That means there is less risk of your financial information being compromised, or your identity being stolen. While that sounds great, is Bitcoin really safe?





Is Bitcoin Safe?

While every transaction is recorded publicly through a distributed ledger it's very difficult to copy Bitcoins, make fake ones or spend ones you don't own. The Bitcoin network and currency have proven to be secure, functional, and efficient. 

The technology used to build Bitcoin is mathematically secured by the laws of the universe and is constantly being improved upon by the open-source community. Though there have been Bitcoin-related compromises in the past, this does not reflect upon the security of the Bitcoin network itself. 

It is possible to lose your Bitcoin wallet or delete your Bitcoins and lose them forever. There have also been thefts from websites that let you store your Bitcoins remotely.

Bitcoin-related thefts are usually the result of improper security or negligence on the part of the person or service holding the bitcoins. This is why it is important to trust the security practices of any Bitcoin-related service you use.

As more stakeholders become interested in the success of Bitcoin, the system will become more secure, as increasingly significant resources are being devoted to closing security holes and thoroughly vetting any proposed changes.

It’s also important to mention that Bitcoin had an upgrade recently called “the taproot upgrade”. A big part of bitcoin’s makeover has to do with digital signatures, which are like the fingerprint an individual leaves on every transaction. 

Right now, Bitcoin uses something called the “Elliptic Curve Digital Signature Algorithm,” which creates a signature from the private key that controls a bitcoin wallet, and ensures that bitcoin can only be spent by the rightful owner. 

The Taproot upgrade will add something known as Schnorr signatures, which essentially makes multi-signature transactions unreadable thus increasing security for Bitcoin as a currency.








Bitcoin Mining

Bitcoin mining is the process of attaching new transaction records as blocks to the existing blockchain ledger. Once a block is secured, new block units of cryptocurrency known as ‘block rewards’ get credited to a node or miner. Miners can inject these units directly back into the market. This process is called proof of work, due to their crucial role in the process, miners can exert ownership of their bitcoin within 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.

Bitcoin miners employ a PoW technique, in which computers compete to solve mathematical problems that validate transactions. 

In general, miners attempt to generate a 64-digit hexadecimal number, referred to as a hash, that is less than or equal to the target hash.  Bitcoin hash rate indicates the estimated number of hashes created by miners attempting to solve the current Bitcoin block or any given block. 

The hash rate of Bitcoin is measured in Hashes per Second, or H/s. Miners need a high hash rate, measured in megahashes per second (MH/s), gigahashes per second (GH/s) and terahashes per second (TH/s), to mine successfully.

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."

One bitcoin is divisible to eight decimal places (100 millionths of one bitcoin), and this smallest unit is referred to as a Satoshi.5 If necessary, and if the participating miners accept the change, Bitcoin could eventually be made divisible to even more decimal places.









Bitcoin Wallet

In order to get an amount of Bitcoin, you first need to set up a Bitcoin wallet.  A Bitcoin wallet contains your public and private keys which allow you to spend, receive and store your Bitcoin.  There are several types of Bitcoin wallets, each offering different levels of security, anonymity and control over your cryptocurrency.  

Web wallets

Web wallets allow you to send, receive and store Bitcoin through your web browser. These are usually hosted by a third party provider that manages the security of the private keys associated with your account. Most major cryptocurrency exchanges package an online wallet with your user account. Bitcoin exchanges such as Coinbase provide a wallet when you sign up.

Desktop wallets 

Desktop wallets can be downloaded onto your personal computer. They give you full responsibility over the management and security of your wallet.  

Mobile wallets 

Mobile wallets allow you to make Bitcoin transactions through your mobile phone by downloading an app.  

Paper wallets 

Paper wallets are an offline way of storing your Bitcoin. They exist in physical form, usually paper or plastic and include a printed version of your public and private keys. If you lose your paper wallet, however, you lose your entire Bitcoin investment.  

Hardware wallets 

Hardware wallets are specifically designed to store Bitcoin. They come in the form of digital devices that can be connected to your computer so that you can make transactions. 

Wallet safety is essential, as cryptocurrencies are high-value targets for hackers. Some safeguards include encrypting the wallet with a strong password, using two-factor authentication for exchanges, and storing large amounts in an offline device. 

Most modern wallets are generated from a twelve-word mnemonic seed, which can be used to restore the wallet if the device is lost or damaged. These words should be carefully stored in a safe place since anyone who finds them will be able to steal your cryptocurrency. Now let’s look at how you buy and sell your bitcoin.








Buying & Selling Bitcoin

Εvery Bitcoin wallet has a unique address. Your wallet address consists of a random mix that includes letters and numbers. The wallet address is randomly generated as a security measure; the wallet address is also called a ‘public key.’ 

You need a Bitcoin address to receive Bitcoin from a client or friend. When you receive Bitcoin in your wallet, the sender has transferred ownership of the cryptocurrency to you.

After sharing your ‘public key’ to receive Bitcoin from anyone, you will need to enter your ‘private key,’ which is also your password, to complete the transactions and gain access to the coins you have received. To protect your Bitcoin from hackers and thieves, you mustn't share your ‘private key’ with anyone.

For convenience, all owners of Bitcoin wallets are given paired public and private keys, which are unique. For a transaction to be completed, you’re the characters that make up your public and private keys must be a match. 

Source: Pixabay.com 

Should you buy Bitcoin?

When looking to buy Bitcoin one would naturally look at the cryptocurrency exchanges and first look at the price of Bitcoin. You should first ask yourself why you are investing. Although the price of Bitcoin has risen substantially over the past year, it can be extremely volatile. Thus, if you buy BTC simply hoping the price will rise, you may end up frustrated.

 

Investing in bitcoin

You might consider investing in digital assets like Bitcoin to your portfolio for a few reasons. Choosing your investment strategy is important to success in investing. A common strategy is to buy and hold onto Bitcoin in the hopes of riding out the ups and downs in valuation for a higher average return.

Most experts would recommend allocating a very low percentage of your portfolio to cryptocurrency investments in general, especially when starting out. A small amount of your total investment portfolio is reasonable but again that’s all down to a risk factor.

 

How to trade bitcoin

Bitcoin doesn't trade on any major stock platform. You can't go to your online discount broker and buy BTC. You have to convert it into your wallet in order to trade it.  Trading Bitcoin can be done on any crypto exchange (like Coinbase) or cryptocurrency trading platform but there are other ways users trade. 

Once you own BTC, the selling of Bitcoin is just like the opposite of buying. You simply place a sell order on the exchange - like Coinbase or Binance. It's important to note that you don't have to sell Bitcoin and receive cash for it. On many exchanges, you can sell BTC and receive different cryptocurrencies or USD. For example, you could sell Bitcoin and receive USDC, USDT, or even BTC.

Another way is through Copy Trading. Every time a trader you follow opens a trade in BTC/USD pairs, you automatically replicate (copy) their trades in your brokerage account. All these great features are available on ZuluTrade. Bitcoin can experience volatility in some instances, but it is important to note that this is when it achieves its all-time high (as with most altcoins).





Now Over to You

Bitcoin and cryptocurrency are fascinating developments, a mark of the desire for participants in the information age to lessen their dependence on the economic and legal systems that prop up institutions from before the 21st century. The long-term viability of Bitcoin as a medium for wealth has yet to be determined.

Always remember that all crypto investments do carry risks and we can’t stress enough that you should always carry out your own research before investing in any asset, digital or not.

We hope you enjoyed this edition of the knowledge crunch blog just as much as we enjoy writing them! Stay tuned for more and be sure to check out our other helpful blogs with advice and tips to reach your investment goals with ZuluTrade. 

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DisclaimerThe views expressed do not constitute investment or any other advice/recommendation/suggestion and are subject to change. Reliance upon information in this material is at the sole discretion of the reader. Opinions expressed in this article do not represent the opinion of ZuluTrade Social Trading Platform and do not constitute an offer or invitation to anyone to invest or trade. Every metric and the statistical number is a result of a past performance which does not constitute a promise or a certainty for a future one.

 

 

 

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