Bitcoin's price has risen over 28000% over the past decade, many people are curious about this revolutionary digital currency but find it challenging to grasp the basics.
In this guide, we’ll break down what Bitcoin is, how it works, and why it matters in a straightforward and accessible way.
The vast majority of people around the world still do not own Bitcoin, and even among those who do, many lack a clear understanding of what it actually is. As Bitcoin continues to grow in popularity and more individuals begin to accumulate it, having a solid grasp of its fundamentals can provide a significant advantage.
To illustrate Bitcoin’s function, let’s start with a straightforward example. Imagine I owe you ten dollars. The simplest way for me to pay you would be to hand you ten dollars in cash. This method has several advantages: it’s instant—once I give you the cash, our debt is settled, and you can use the money right away. There’s no third party involved; it’s a direct transaction between us.
In today’s world, there are various electronic methods to send money. I could use a bank transfer, but that can take a while, especially if we’re in different countries and using different currencies. Anyone who has tried an international bank transfer knows it can be complicated and slow, often taking several days to complete. Meanwhile, you wouldn’t have access to that money.
The ideal solution to this problem would be a form of digital cash that allows for peer-to-peer transfers without the need for intermediaries. This is where Bitcoin comes in.
When you transfer value using Bitcoin (with a small "b") on the Bitcoin network (capital "B"), the currency is often referred to by its ticker symbol, BTC. From now on, I’ll use BTC to specifically describe the currency itself, as opposed to the network it operates on.
This network was created by an unknown individual known as Satoshi Nakamoto, whose true identity remains a mystery. On October 31, 2008, Satoshi published the Bitcoin white paper, titled "Bitcoin: A Peer-to-Peer Electronic Cash System," which detailed how Bitcoin works and its purpose. The opening line states, "A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution."
This leads us to the complex challenge Satoshi aimed to address: how to create a system that enables people to transact over the internet without a centralized authority overseeing all transactions. The goal was to eliminate financial institutions from the equation and allow for direct peer-to-peer transactions. This is a remarkably difficult problem, as without a third party to monitor everyone's spending, it becomes challenging to ensure that individuals only spend what they actually have.
If there’s no record-keeper, how can you prevent people from spending their digital money multiple times? Essentially, how can you develop a system that operates without requiring trust? It's unrealistic to assume that people will always act honorably and only spend the digital money they possess, as human nature often leads individuals to act in their own self-interest. There must be safeguards to prevent dishonest behavior; otherwise, the entire system becomes unworkable.
In everyday transactions, there are mechanisms to prevent this. For example, cash is difficult to forge, and attempting to do so can lead to serious consequences. In electronic transactions, banks keep track of how much money everyone has. When you spend using a card or make a bank transfer, your bank updates your balance to reflect these activities, ensuring you don’t exceed your available funds. This means we must rely on a third party to maintain accurate records and trust that the central bank won’t devalue the currency by printing excessive amounts—something many central banks have done in recent years.
BTC mining explained: Miners compete to submit trillions of guesses to find the correct number, all while others are doing the same. Eventually, one miner will get lucky, and the process starts anew. It’s important to note that this guessing process demands substantial computing power, which in turn consumes a lot of electricity. This has led to criticism that Bitcoin mining is harmful to the environment. However, if the energy used comes from renewable sources, this concern is mitigated—though that’s a topic for another discussion.
One final point about Bitcoin for this introduction: you might think that to use Bitcoin, you need to download and run the software as a node or a miner. That’s not the case. Anyone with an internet connection can use Bitcoin to send BTC to any other Bitcoin user, regardless of their location.
A key component of Bitcoin’s security as a payment network is public key encryption. This system consists of three components that work together to enable users to transfer BTC. The first is a private key, which is randomly generated by the Bitcoin software for each new user. This private key must be kept secret; without it, you can’t access your BTC. If someone else acquires your private key, they can access your funds, similar to how a password protects your online banking account.
Now that you're familiar with the basics, using a reputable exchange is the first step to acquiring some BTC. However, the next crucial step is to take custody of your private keys yourself. The best way to do this is by using a wallet that you control—one that isn’t hosted by an exchange or any third party.
Remember, Bitcoin is designed to be trustless. If you rely on someone else to hold your private keys, you’re undermining the very principles of Bitcoin. While trusting an exchange may be convenient and many reputable exchanges have robust security protocols, you can never be entirely sure of their safety.
You have two main options for managing your keys:
1. Software Wallet: You can download a software wallet that allows you to securely store your keys on your laptop or mobile device.
2. Hardware Wallet: For the highest level of security, consider a hardware wallet. This type of wallet stores your keys on an encrypted device that never connects to the internet. This makes it far less vulnerable to online threats.
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