What is Bitcoin and how does it work?

What is Bitcoin and how does it work?

Dean Decho February 24, 2023
12 min read

The topic of bitcoin is on everyone’s lips and, in the meantime, the question to ask is: what exactly is it? What is bitcoin, how does bitcoin work, what is bitcoin mining, how to buy bitcoin?

Bitcoin is abbreviated to BTC and is a digital currency. Bitcoin was invented in 2008 by a person or group of people under the pseudonym Satoshi Nakamoto.

The basis of bitcoin technology was described by Satoshi in a so-called white paper. In it, he describes a peer-to-peer (P2P) system in which one person can send bitcoin digital currency to another without the need for an intermediary. Transactions are publicly available and stored on the so-called blockchain. The blockchain can be defined as a public accounting system.

Bitcoins can be easily and quickly transferred from one person to another, with no barriers to entry or verification required.

The decentralized nature of bitcoin means that it is not controlled by any government, institution, or company, and the distributed nature of the blockchain makes it virtually impossible to shut down.

Many proponents of bitcoin believe that it has the potential to not only serve as an alternative payment system, but also to improve efficiency on the internet and disrupt various industries through its innovative technology. If you’re interested in learning more about bitcoin, it can be helpful to delve deeper into the subject and understand its various features and potential applications.

What is Bitcoin? – Key Terms

  • Blockchain: a series of records linked by cryptographic techniques. Also to be understood as a publicly available accounting system.
  • Decentralisation: nobody owns the bitcoin network, which is completely independent of states and institutions. It cannot be switched off. The bitcoin blockchain is distributed worldwide on the computers of all participants.
  • Transaction fees: staggering, usually in the range of cents, regardless of where bitcoins are sent.
  • Pseudonymity: the bitcoin network does not display names when receiving and sending bitcoins, only alphanumeric addresses such as 1GzhZsvkFxULMvXRjfMguNuhvN78B8PJrV. Comparable to the IBAN address of a bank account.
  • Encryption: a mathematical method of encrypting data in such a way that not everyone can read it. Necessary to send and receive bitcoin transactions securely.
  • Free accessibility: anyone, anywhere in the world, can participate in the bitcoin network. No verification or bank account required, for example. No discrimination.
  • Immutability: the existing and ever-expanding blockchain cannot be changed. Data cannot be manipulated. Transactions cannot be cancelled (irreversible).
  • Mining of bitcoins: creation of new bitcoins by providing computing power. It is used to secure the network and process bitcoin transactions. Bitcoin miners are paid in bitcoin currency.

Number of bitcoins

In 2140, the last of the 21 million bitcoins will be mined. To date, approximately 19 million have been generated. One BTC can be divided to 8 decimal places. 0.000001 BTC is considered a small unit, which is called 1 satoshi.

Bitcoin-Supply-Curve
Bitcoin in circulation, an asymptotic approach to the maximum number of 21 million bitcoins

Bitcoin price

Since the beginning of 2009, the bitcoin exchange rate has developed rapidly.

In 2009. 1 bitcoin could be bought for a few cents, while by the turn of 2017/18 it had already reached a price of around 18,000.

Along the way, there have always been extreme highs and lows, characterised by very large price fluctuations (volatility). The undulatory movement of the bitcoin exchange rate is particularly striking. There have been periods when the price of bitcoin has risen several times in the space of a few weeks.

A strong positive momentum was created and there were hardly any days of losses. On many occasions, the price rose by double-digit percentages. On the other hand, there were also days of negative momentum that lasted for weeks or months. If you invest in bitcoin, you have to navigate these strong cycles and be fully aware of them. you can get rich very quickly with bitcoin, but you can lose money just as easily.

Otherwise, bitcoin would not currently have such a high value and would not have reached a multi-billion dollar market capitalisation.

Tendenza Bitcoin
Rates for bitcoin from 2014 to present

Bitcoin: Buying and Selling

Where can you buy or sell bitcoin?

To answer this very common question, we have created a section specifically for you on exchanges.

The key thing to note is that you need to choose a reliable, licensed and established bitcoin trading platform.

There are already many bitcoin brokers you can trade with.

Not all of them have the necessary licences in the EU. For this reason, you should avoid unregulated exchanges. You can rely on recommended bitcoin exchanges that have been thoroughly tested. If you wish to buy bitcoin using a credit card, debit card or PayPal, we provide a list of trading platforms where you can safely invest in bitcoin. Choose the one that suits you best. You can also buy Ethereum, Cardano, Tezos, IOTA, Ripple, Litecoin on most bitcoin trading sites.

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Bitcoin Wallets

In order to store bitcoins, you need a bitcoin wallet. First of all, it guarantees independence from exchanges and other service providers. The user is the owner, as he or she holds the private keys (see below for details). There are different types of bitcoin wallets.

  • Bitcoin desktop wallet
    • A software that downloads the entire Blockchain (many GB of data) to its computer.
  • Bitcoin Hardware Wallet
    • A device that stores your private key and thus your bitcoins offline. Often in the form of a USB stick.
What is a bitcoin wallet
Bitcoin hardware wallets, USB sticks, still packed: Ledger Nano S on the left, Trezor on the right (own photo)

Sending bitcoins

Sending bitcoins is similar to a transaction on your bank account. Access your wallet. Enter the recipient’s bitcoin address and the amount. You can then send the transaction. A very small sending fee is required, usually a few cents. Every 10 minutes, transactions are processed on the bitcoin network, so be patient. The network is available 24 hours a day, 7 days a week.

Receiving bitcoin

To receive bitcoin, you don’t have to do anything. Just make sure you give the sender the correct address – the public key. You can often see incoming bitcoin transactions immediately after sending, but it may take a few minutes to confirm.

Bitcoin Public key

The bitcoin public key or bitcoin address is similar to the IBAN number of your bank account. Anyone can see this unique address and you can pass it on to debtors, e.g. to settle an invoice. A bitcoin address consists of 27-34 alphanumeric characters and starts with 1 or 3. The letter ‘O’, the capital letter ‘I’, the lower case letter ‘l’ and the number ‘0’ are not used due to the likelihood of confusion. Upper and lower case letters are required. An example of a bitcoin address could be: 1GzhZsvkFxULMvXRjfMguNuhvN78B8PJrV. The address can also be displayed as a QR code. You have probably already seen the sign ‘Bitcoin is accepted here’ on shop doors, with a bitcoin QR attached. Bitcoin addresses can be accessed from your Bitcoin wallet.

Bitcoin Private Key

The private key must be kept secret and must not be shared. The private key allows access to bitcoin at any time, anywhere in the world. Private keys are usually stored in a bitcoin wallet. This wallet can only be opened with a password. It is unlikely to matter much to you, but the bitcoin private key is used to generate your bitcoin address. Interestingly, the reverse is not true, i.e. the private key is derived from the public key (its bitcoin address).

Earning BTC

If you do not want to buy bitcoins but wish to participate in the blockchain, there are still ways to earn your first coins. Firstly, you can always find so-called bitcoin taps on the internet. Taps are websites where you can, for example, watch a 30-second spot and receive EUR 0.10 in bitcoin. We do not recommend these sites here, because they change often and everyone prefers a different one. Another option is to receive bitcoins for services offered. This option is particularly suitable for freelancers. Thirdly, you can earn bitcoin by putting its computing power at the disposal of the bitcoin network. For more information, see the next section on bitcoin mining. Other known methods of earning bitcoin can be found in the article “4 ways to earn bitcoin today

Bitcoin Mining

Bitcoin mining is the process of adding new blocks to the bitcoin blockchain and releasing new bitcoins into circulation.

It is a vital part of the bitcoin network as it helps to secure the blockchain and confirm previous transactions. In order to mine bitcoins, powerful computers must be used to solve complex cryptographic problems, also known as proof of work.

When a miner successfully discovers a new block, they are rewarded with a certain number of bitcoins and transaction fees included in the block.

The difficulty level of mining adjusts every two weeks based on the amount of computing power being used for it, and the higher the difficulty, the more computing power and cost is required for successful mining.

what is bitcoin mining
Bitcoin mining hardware, ASICs connected in series

Is bitcoin mining profitable?

The previous paragraph poses the question: is bitcoin mining profitable? In the past, it was easy to mine on a computer or laptop, because the level of difficulty was relatively low. Today, things are different. In most cases, the electricity bill for an average household would be too high to be paid by the mining rewards (12.5 BTC + participants’ transaction costs). However, there are two scenarios for earning bitcoin. First, if the cost of electricity is extremely low, such as in industry or in a country where energy costs are low. Second, if it uses dedicated equipment to mine bitcoin. Add another problem beyond his control: the price of bitcoin is rising!

Hardware for Bitcoin mining

Nobody uses their own computer or laptop to mine bitcoin efficiently and profitably. Special bitcoin mining machines or bitcoin generators, most commonly ASICs (application-specific integrated circuits), are used. The critical factor for the success of ASIC bitcoin miners is the Hashrate.

The higher the hasrate is, the better the Bitcoin Generator. It is often stated in ter per second, th/s. The performance of bitcoin mining equipment has another important aspect. This is the ability to convert electrical energy into computing power, measured in watts per gigahertz (watts/GH). Finally, these two factors influence the price. A normal mining product such as Antminer can cost between EUR 100 and EUR 1,000.

Bitcoin mining pool

It can offer its computing power in a bitcoin mining pool. He receives a share of the mining reward proportional to his computing power. Bitmain, BitFury or Spondoolies Tech. The term ‘cloud mining’ is often used in this context. In this case, dedicated servers are rented in data centres to increase computing power.

Bitcoin Fork

A bitcoin fork is essentially a split in the blockchain, creating two (or more) separate blockchains. This can happen when multiple bitcoin nodes generate a valid block, and the network must decide which block to accept.

Typically, the first block received is chosen, but in some cases both branches may continue with valid blocks.

The chain that lasts the longest becomes the main blockchain, while the other chain becomes useless.

However, the second chain may still have support from miners, in which case the fork is successful and there are now two separate blockchains. Forks are often planned in advance and some mining pools may offer support for the new chain. This was the case with the creation of Bitcoin Cash, which was a fork of the main bitcoin blockchain with the goal of developing a technically different chain.

cos'è il fork di bitcoin
Example: Bitcoin Forks, the Bitcoin we know is specifically Bitcoin Core (Segwit 2x) in purple

Bitcoin and taxes

In Germany for example, the ownership of digital currencies held for more than one year is not taxable. However, income earned from selling or trading cryptocurrencies is considered taxable income and is subject to a 19% tax. This income is treated as the sale of financial assets and is declared in an individual’s annual tax return. It is not clear if specific documentation is required to be attached to the tax form to prove the realized income.

The bitcoin tax regulation will deffer from country to country and is recommended to check it with your local tax office.

Cryptocurrency mining, on the other hand, is taxed differently. If an individual engages in the activity of creating and trading bitcoins as a professional activity, meaning it is a regular source of income and the individual is considered an entrepreneur under the Trade Act, then the income from cryptocurrency mining is taxed as a sole proprietorship under the Tax Act. In other words, cryptocurrency mining may be considered a business activity in Germany.

Bitcoin millionaire

You may have heard about bitcoin from various sources such as news articles, television, or acquaintances. These often portray stories of individuals who invested in bitcoin early on and held onto it, becoming millionaires as a result.

While it is true that there are many bitcoin millionaires and even billionaires who have made a fortune from the cryptocurrency, some have chosen to convert their bitcoins into fiat currency while others continue to hold onto them.

Some believe that the price of bitcoin will continue to rise, while others see the bitcoin financial system as stable and envision a future where bitcoin can be used to pay for everything.

These wealthy bitcoin holders are often referred to as ‘bitcoin whales’ and may have some influence on the price, particularly on exchanges with low trading volume.

Many bitcoin millionaires also use their wealth to contribute to the development and improvement of bitcoin and other cryptocurrencies, and many successful bitcoin trading platforms and blockchain startups have been founded by these individuals.

Bitcoin target price

It is impossible to accurately predict the target price of bitcoin with any certainty. The direction of the price in the short, medium, and long term is uncertain and subject to speculation.

Some, like John McAfee, believe that a target price of $100,000 for bitcoin is achievable in the near future. However, it is important to note that the adoption and implementation of cryptocurrencies in various industries may drive demand for bitcoin, as it is often seen as the entry point for investors.

The limited supply of bitcoins, capped at 21 million, and the increasing demand for products and services built on blockchain technology may also contribute to a rise in price. It is worth considering including bitcoin in a diversified investment portfolio due to its potential, but it is important to approach any investment with caution and to carefully consider the risks involved.

‘Bitcoin to the moon’

For some time now, there has been an increasingly common English phrase among bitcoin enthusiasts: ‘Bitcoin to the moon’. In our opinion, it is a good ending for this section.

Conclusion

By now, you should have a clear understanding of what bitcoin is. It is a digital currency that offers many benefits such as decentralization, accessibility, immutability, pseudonymity, and low transaction fees. It uses cryptographic methods to create a secure, transparent blockchain for transferring bitcoins.

Bitcoin has gained recognition as both a substitute currency and a financial instrument, and many investors see it as a good addition to their portfolio due to its potential and low correlation with other asset classes. In addition, the underlying blockchain technology has the potential to revolutionize industries by making processes faster and more secure, potentially leading to cost savings for businesses looking to increase efficiency.

FAQ


  • Where can I find the current bitcoin exchange rate?

    We invite you to check the current cryptocurrency exchange rates at www.CoinMarketCap.com. This is the largest website dedicated to the cryptocurrency market.


  • Is bitcoin in a bubble?

    The price of bitcoin is highly volatile. Extreme lows can be followed by extreme highs. Investing in cryptocurrencies is very risky, but it can also be very profitable. Everyone has heard of bitcoin millionaires in context. As with any financial product, you should only risk as much as you are willing to lose.


  • How do you store bitcoin?

    For this, you need a bitcoin wallet. First of all, there is an online version of one at www.BlockChain.info. On the other hand, you can download the Bitcoin Core desktop client or use hardware wallets in the form of a USB stick, such as Ledger Nano or Trezor.

Dive Deeper into Bitcoin

bitcoin hall
Bitcoin decentralizacja ekoinomia twarz dziewczyny

Dean Decho

Dean is a passionate advocate for the financial freedom and independence offered by Bitcoin and the cryptocurrency space. He's built this crypto learning platform to help others in the industry learn, grow and be part of it.