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Bitcoin 101
How it works and how you can invest in it.
Contributed article by : Beverly Wilks – Financial Education Advocate and Blogger at Bacon & Heels
Invented in 2009 by an unknown person or group of people using the name Satoshi Nakamoto, Bitcoin is a digital currency that was designed to let you store, send, and receive money without any banks or credit card companies. It can be used by anyone, anywhere in the world.
Bitcoin is not controlled by any person, company, or government. It’s run by the community of its users, hence this completely digital currency is a decentralized currency.
Bitcoin’s supply is limited to 21 million coins. It was designed to be scare and this scarcity increases the value over time.
HOW BITCOIN WORKS
What better way to explain a difficult topic than with an example:
Imagine four strangers sitting in a room, each with their own notebook. Because they are strangers, they don’t know or trust each other.
One stranger gives one bitcoin to another stranger. Now, EACH of the four strangers records this transaction.
They then compare all their notebooks to make sure they match. If all four notebooks match up, everything is fine. The transaction is approved by everybody.
If one notebook is different from the other three, we have a problem. It means one stranger is lying about the transaction. We also know which stranger is lying (hint: it’s the one with the notebook that doesn’t match the others). As a result, the three others ignore the notebook that doesn’t match and move on. The transaction is not approved. Bitcoin works exactly like the notebook example. Each Bitcoin user has an identical copy of the Bitcoin “notebook” which publicly records all transactions. All notebooks get constantly compared to make sure they match. Additionally, Bitcoin stores all past transactions permanently so that there is a record of where all bitcoin currently are. This proves who owns which bitcoin.
The technology that stores and constantly compares Bitcoin’s “notebooks” to make sure they are all identical is called the Blockchain.
Blockchain is the technology that makes Bitcoin so valuable, because it removes the need for a costly third party (like banks and credit card companies) to check transactions. With Blockchain, total strangers can now exchange money without any trust and without any third parties being required.
HOW IS BITCOIN SHARED?
Just like real money, bitcoin is stored in wallets. But Bitcoin’s wallets are digital. Your Bitcoin wallet is like a bank account, it is how you access your money. Each Bitcoin wallet has a unique address so you can send money to and from it. To send bitcoin from one wallet to another, you first need to authorize the transaction. Just like in real life, you authorize transactions through a signature. For Bitcoin, this signature is done with a password called your private key.
Let’s use another example to put it all together:
Say Albert wants to send Melanie one bitcoin.
The bitcoin will be sent from Albert’s wallet to Melanie’s wallet. To do this, Albert enters Melanie’s Bitcoin address, and then his wallet uses the digital signature (private key) to authorize the transaction.
Once Albert hits “Send” his bitcoin transaction is added to the Blockchain for processing.
Here is how processing works: Transactions from the last 10 minutes are bundled together. Each of these bundles is called a block. Together, the blocks form the Blockchain, hence the name. All Bitcoin transactions are bundled and added to blocks in order. Each Bitcoin block gets filled up with new transactions until it’s full. Overflowing transactions are simply added to the next block.
So who bundles and processes bitcoin transactions? That’s done by users called miners. Miners bundle transactions, verify them, and add them to the Blockchain. Here is the interesting part: Miners do this work because they get paid in bitcoin for every block they add and for every transaction they process. In fact, they get brand new bitcoins which were just created by the system.
There are a lot of miners and they are all competing to add the next block to the Bitcoin Blockchain to get paid. There is a fixed total number of bitcoin. Every 10 minutes, new bitcoin are released and miners compete to earn them. This process will continue until the year 2140 when all 21 million bitcoins have been created. There can never be more! After that, miners will continue to get small transaction fees, but no new bitcoin.
PROS AND CONS
Some people own Bitcoin mainly as an investment in the hope it will keep climbing higher and higher in price over time. Other people use it to make actual day-to-day purchases. But before you open up a digital wallet, there are some trade-offs to consider:
PROS
Can be used anywhere in the world
Users are anonymous
Can be bought or sold without a credit card or bank account
Ability to transfer funds without a fee
No limit on sending or receiving funds
CONS
Not widely accepted by businesses
Anonymity increases potential for illegal use
Not backed by the federal government (ie: not FDIC or CDIC insured)
Prices are volatile
If you lose your key, get hacked, or have a computer crash, the cryptocurrency disappears
THE BOTTOM LINE
So there you have it, Bitcoin is a clever system that allows complete strangers to securely send money directly between each other with no third party (banks, credit card companies). Bitcoin is revolutionary because it gives you full control over your money, from ownership all the way to transactions. Like all investments, be sure to look before you leap and in view that Bitcoin is very dynamic, be sure to do your homework.
(Example Source: Upfolio)
To learn more about Beverly and Bacon & Heels, read the "Power 5" interview that we did with her in September 2021 - you can read the full blog post HERE.
Thank you for your contribution Beverly!
Contributed article by Beverly Wilks, tech marketing executive, financial literacy champion and blogger at Bacon & Heels.