What Is Bitcoin? A Complete Guide for Cryptocurrency Beginners
This article explains what bitcoin is, how the system behind it works, and gives baseline information on investing in the most well-known of all crypto coins.
What Is Bitcoin?
As an easy start, think of Bitcoin as ‘numbers’ stored on the Internet. As more and more people started to trade Bitcoin, it gradually became a more recognized medium of exchange. Bitcoin has also been referred to as the currency of the Internet.
Who Created Bitcoin?
Bitcoin was conceived in 2008, when someone under the name ‘Satoshi Nakamoto’ (whose real identity is still a mystery) published a paper called ‘Bitcoin: A Peer-to-Peer Electronic Cash System’. The title of the paper captures the two key features of Bitcoin1:
- Peer-to-Peer: Bitcoin allows direct P2P payments without 3rd-party intermediaries such as banks or payment processors. This is a major reason why Bitcoin is commonly regarded as a highly ‘decentralised’ currency;
- Electronic Cash: There have been many past attempts to develop electronic cash, but what makes Bitcoin stand out is its clever use of existing technologies like cryptography and distributed systems to make it highly secure and efficient.
How Does Bitcoin Work?
Bitcoin uses blockchain technology. Normal users like you and I can use the system to send and receive money easily, but the real difficult work underneath is handled by miners.2
Miners are a specialized group of people who are responsible for maintaining the bitcoin system. They may or may not know each other, and everyone, including you, is able to partake in mining.
Users send and receive money via the Bitcoin system, with the difficult work underneath handled by miners
Miners need to run computers with a lot of processing power to store data, handle and broadcast transactions, and solve a complex mathematical puzzle (called Proof-of-Work (PoW)) to reach what is known as ‘consensus‘. When you send a new transaction to the Bitcoin network, miners will pick up your transaction and do all the complicated work mentioned above, under the hood.
You may wonder why miners would volunteer to maintain this decentralized network. That’s because they are not doing their work for free. Miners are incentivized to do so by receiving mining rewards and transaction fees. Of course, paid in Bitcoin!
Why Is Bitcoin So Revolutionary?
Bitcoin is the first payment network that is fully autonomous and self-sustaining3, where no single party or incident can intervene or terminate the system. You can use it anytime, anywhere in the world as long as you have internet access.
It paved the way for the next technological revolution since the Internet – a global digital currency without middle-man fees.
Other interesting aspects of Bitcoin (and cryptocurrencies in general) include:
- Limited supply (which leads to scarcity, likening it to digital gold)
- Fast settlement (1 hour versus 2 days for wire transfer)
- Potential to develop applications on its system (called smart contracts)
Why Are There So Many Different Cryptocurrencies Besides Bitcoin?
Alternative coins (altcoins) are the other cryptocurrencies out there that are not Bitcoin. Different altcoins exist for their own purposes, similar to why we see many different companies in our economy. They exist with different visions, and users, or because they have an edge that others do not have.
This is also the case for cryptos, the common abbreviation for cryptocurrencies. Examples like Litecoin (LTC) and Bitcoin Cash (BCH) share Bitcoin’s features but offer faster transactions. Ethereum (ETH) and EOS focus on providing an open platform for writing smart contracts and building decentralized applications (dApps).
Here is a simple classification system for cryptocurrencies:
- Cryptocurrencies/payment tokens
They are tokens that are used to pay for goods and services, or to transfer money - Security tokens
They represent credit or debt, for example, a share in future company earnings or future capital flows - Utility tokens
Created to provide digital access to an application or service, they offer blockchain based infrastructure
Is Bitcoin Safe?
There is no simple answer. While the Bitcoin network is reasonably safe and has endured real-life usage for over 10 years, it is equally important for users to be cautious of how they store crypto and protect their keys as users often lose their access or compromise it.
To keep your cryptocurrency holdings safe, you can store your cryptocurrencies on professional crypto wallets using an institutional-grade storage solution that offers customer service support. Stay away from phishing websites, and always keep your password confidential. Read more on how to keep your money safe here.
Should I Invest in Bitcoin?
Here are a few things you should consider before investing in Bitcoin:
- Evidence suggests that cryptocurrency has a low correlation with other tradable financial assets, hence it may provide diversification benefits4
- The underlying blockchain technology is improving with thousands of research papers being published every year
- The cryptocurrency ecosystem (cryptocurrency projects, start-ups, investors, etc.) is maturing everyday. More interest is being shown by institutional investors, MNCs, and regulators
- With reference to historical data, this area is growing rapidly
To conclude, cryptocurrency is an emerging new asset class that is worth considering to add to your portfolio.
How Is the Cryptocurrency Market Different From TradFi?
Investing in Bitcoin or other cryptocurrencies is different from the fiat (meaning government-issued currency) financial market.
These are the key points characterising the cryptocurrency market that Bitcoin operates in:
- The only asset class that can be traded 24 hours a day, 7 days a week
- A global market without geographical barriers
- The first payment network that is fully autonomous, self-sustaining, and decentralized
- A liquid and highly efficient market (for major cryptocurrencies) 5
- A new and high growth market which attracts lots of talent and capital
- A highly volatile market, bringing a unique set of both advantages and disadvantages to investors
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References
1. Nakamoto, S. (2008). Bitcoin: A Peer-to-Peer Electronic Cash System, 1–9. Retrieved from https://bitcoin.org/bitcoin.pdf
2. Beck, R. (2018). Beyond Bitcoin: The Rise of Blockchain World. IEEE Computer Society, 51(2), 54–58. Retrieved from https://ieeexplore.ieee.org/stamp/stamp.jsp?tp=&arnumber=8301120
3. Hsieh, Y.-Y., Vergne, J.-P., Anderson, P., Lakhani, K., & Reitzig, M. (2018). Bitcoin and the rise of decentralized autonomous organizations. Journal of Organization
4. De Kajtazi, A., & Moro, A. (2018). The Role of Bitcoin in Well Diversified Portfolios: A Comparative Global Study. SSRN Electronic Journal, 12–12. doi: 10.2139/ssrn.3261266sign, 7(1). doi: 10.1186/s41469-018-0038-1
5. Wei, W. C. (2018). Liquidity and market efficiency in cryptocurrencies. Economics Letters, 168(July 2018), 21–24. doi: https://doi.org/10.1016/j.econlet.2018.04.003
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