What is a Bitcoin and what should you know about them? Bitcoin is a form of digital money that operates without the need for a centralized entity such as a bank or credit card company.
This is a very simple answer to a much more complex question, but I think it is a good place for us to start. I bought my first Bitcoin a few years ago and quickly realized why this technology is so intriguing. I also began to realize that there is a lot of technological complexity which directly impacts how they are used, what their value is, and their potential impact on our future economic landscape. My goal with this article is to discuss everything from A to Z, in the simplest way that I can think to explain it. And, it will all be compiled in this one helpful article so you don't have to search 10 different places to find your answers. Let's dive in!
What Makes Bitcoin Different From Our Current Digital Payment Systems?
Credit Cards, Paypal, and Bank Transfers all require transaction data to be exchanged through a single centralized processing center. Bitcoin does not.
Instead, Bitcoin is transacted through a massive network of computers around the world which all verify your transaction information. If any one of these computers cannot verify that your transaction matches the information found in the rest of the network, your transaction will not be completed. This is known as peer to peer processing (through a blockchain) and eliminates the need for a central processing center. In other words, it is decentralized.
Why Is Decentralization So Important?
When a large company has all of your information (and millions of other people's information) all in a central location, it is a magnet for bad guys. Every year, there are around 16 million identity thefts resulting directly from attacks on centralized processing centers. In addition, the financial loss resulting from these thefts is somewhere around $17 billion per year. (According to Javelin Strategy)
Using Bitcoin could provide valuable solutions to these types of thefts and data breaches.
How Do Bitcoin Transactions Actually Work? (Warning...Technical Stuff!)
Each person in a transaction has a private key and a public key. Each of these keys are a combination of random numbers and letters which are at least 30 characters long.
When you send a Bitcoin, what you are actually doing is sending specific transaction details which are coded and encrypted into your public key.
Your public key gets matched with the receivers private key.
This new combined number needs to be verified and validated by every computer in the network in order for the transaction to be completed. (This is known as mining. More on this later)
Once the transaction is validated by all peers in the network, it is then recorded in a distributed ledger which everyone (and anyone) can see at anytime.
This transaction can never be altered, changed, forged or duplicated.
Are Bitcoin and Blockchain The Same Thing?
No. Bitcoin is the coded and encrypted transaction information which can then be transmitted through blockchain. Blockchain is the decentralized, peer to peer network that Bitcoin is transacted through.
This is an important difference. Bitcoin is basically limited for use in financial type transactions. On the other hand, Blockchain can be used across multiple industries and for many different purposes.
Is Bitcoin A Physical Item?
No. Bitcoin is a digital representation of money that is accomplished through programming and coding. Each Bitcoin is encrypted, easily transferred, and is secured on a distributed ledger.
What Gives Bitcoin Value?
There are at least 5 answers to this question.
1) Bitcoin's underlying technology (blockchain): Blockchain provides a secure, decentralized, pseudonymous, and unchangeable platform through which transactions are made. Before now, there has never been a way to make transactions securely and without a centralized processor.
2) User-ability: Being able to make transactions worldwide without a centralized banking system is convenient. In addition, international fees are generally much lower than typical SWIFT banking transfers.
3) Supply and demand: There will only be 21 million Bitcoin ever made. The higher the demand for Bitcoin the higher the value will be and vice versa.
4) Durability: Paper money only lasts so long before it needs to be reprinted. Electronic currency can last forever.
5) Limited government control: Because governments do not control Bitcoin, they also cannot artificially inflate the number of Bitcoin in circulation. Governments cannot manipulate Bitcoin the way they do with paper money. This creates the opportunity for higher trust and a more level financial playing field.
Read "Is Cryptocurrency Dead? What Is Its True Value?" for a more in depth discussion about this topic.
Are Bitcoin Considered An Asset, Currency, Collectible or Commodity?
Bitcoin is an innovative new technology that has created its own category. It doesn't easily fit into pre-existing financial boxes. In the case of Bitcoin, it really depends on what your purpose for owning them is that helps you decide how to define them. My view is that it is a blend of all of them.
Asset: An asset is a resource with economic value which an individual, corporation or country owns with the expectation it will provide a benefit in the future (according to Investopedia). With this definition in mind, there are many people who are speculating in Bitcoin with the hope of a financial gain in the future. Just keep in mind that they can lose value also!
Currency: Bitcoin can be used to buy physical items, online items, trade with foreign currencies and can also be exchanged in person. This gives Bitcoin the ability to be used in the same way as paper money. It also offers the advantage of not having to carry cash or being limited by country borders. On the other hand, there are a few disadvantages, such as slow transaction speeds and also having to learn new technology. These shortcomings will likely be improved as technological progress continues.
Collectible: Even if Bitcoin doesn't succeed as the digital currency of the future, they will likely have collector value because they were the first to bring this technology to society. Think of it like owning an old Babe Ruth baseball card or piece of fine art.
Commodity: Physical gold has long been a hedge against inflation due to its limited supply, worldwide recognition, and durability. Bitcoin offers many of the same advantages that physical gold offers while adding some additional perks like easy storage and simpler transfer-ability.
Clearly, Bitcoin is in a class of its own. All of these pieces are what makes Bitcoin so intriguing as part of our monetary system. With time, and more technological advancement, it will be interesting to see what role it carves out for itself.
How To Purchase Bitcoin
There are actually several ways that you can purchase Bitcoin.
1) The most popular way to purchase them is through trusted exchanges. Coinbase is the most well known.
2) Public Trade sites Like LocalBitcoins allow you to purchase them from other individuals.
3) You can also purchase them with a credit card through companies like CoinMama.
4) Bitcoin ATM's : There are some of these around but are somewhat hard to find. Also, they generally have high built in fees.
What Bitcoin Exchanges Are Trustworthy?
All exchanges are not created equal. Some exchanges are more secure, and easy to use, than others. Also, regulations and guidelines vary by country which clearly adds risk when you are purchasing Bitcoin. To add to the confusion, there are also different types of exchanges such as centralized and decentralized exchanges. With all of that being said, it is important to stick to exchanges that are well known and reputable. It is probably not a good idea to use a small exchange, in a foreign country, in which you are unaware of the financial regulations guiding the exchange.
See my Resource Page for a list of trusted exchanges that I have personally used and recommend.
Also, you can download my step by step tutorials for how to set up accounts for each exchange HERE.
How To Protect Your Bitcoins
Alert! This is very important!
Bitcoin are digital currency and are stored in a digital wallet. Depending on how you are planning to use your Bitcoin will help you decide which type of wallet you will need to protect them. There are 2 different kinds of Wallets. Software and Hardware. Some are better for quick trading and transfers while others are better for long term holding. In addition, some wallets are more easily accessible than others. Overall, there are pros and cons to every type of wallet so be sure to review your specific needs carefully.
Software Wallets (Online or Desktop Wallets):
Online Wallets allow you to download an app or use pre-built exchange wallets to access your Bitcoin anywhere, anytime. These are great if you plan on trading often or purchasing items regularly. The downside is that they are centralized and susceptible to hacking.
Desktop Wallets are wallets that you download and keep on your desktop computer. There is more security because it is stored on your computer as opposed to an exchange, however you are limited in being able to use them because they are only on your desktop computer.
These are encrypted flash drive type storage disks that allow you to take your Bitcoin completely offline (Cold Storage). Many people lock these in a safe and completely eliminate the risk of hacking. These are great for large amounts of Bitcoin that you do not plan on using often. Downside they are only accessible when you have your flash drive.
For a more detailed discussion on wallets read "Which Crypto Wallet? And How To Use Them"
Also, you can find my recommended wallets on my Resource Page.
How To Actually Make A Transaction With Bitcoin
A transaction using Bitcoin is basically just transferring the wallet address associated with the account you are sending from. Transactions can be made in many different ways, but they all require transferring this coded information. In addition, each Bitcoin is divisible to the 8th decimal point (known as a Satoshi) which allows for smaller transactions.
QR Code: The easiest transaction method is using the QR code associated with your wallet. All you have to do is let the receiving person, or business, scan your QR code and wait for the transaction to be completed. This is best for in store type purchases or in person exchanges.
Copy and Paste: If you are transferring from one wallet to another you can also copy and paste your sending wallet address. This works for sending Bitcoin from wallet to wallet and also for online purchases.
In Writing: If you trust the person you are dealing with you can simply write down your wallet address and give it to them. They can input your wallet address into their receiving wallet address and the transaction would then be completed. This would be challenging because the wallet address is usually 30+ numbers letters long, but it could be done if necessary.
Read "How To Actually Use Your Cryptocurrency" for deeper discussion and more specific details about how to do this.
Who Accepts Bitcoin as Payment?
Many companies worldwide are wrestling with the idea of accepting Bitcoin as payment. There are several large fortune 500 companies who are already accept them, and there are also many small businesses that will as well.
Here is a list of all the current stores that accept Bitcoin...Click Here
Other Ways To Obtain Bitcoin: (Without Buying Them)
1) Own a business that accepts bitcoins as payment.
2) Ask your employer if they will pay you a percentage of your check in Bitcoin.
2) Find a Bitcoin Faucet. Small amounts of Bitcoin are given in exchange for taking surveys or completing certain tasks.
3) Play cryptocurrency games that payout in Bitcoin.
See my Resource Page for recommendations.
What Different Kind Of Bitcoin Investments Are There? (Aside From Just Owning Them)
1) Own a business that accepts Bitcoin. ----->>> Read "How To Accept Cryptocurrency. What Why How"
2) Bitcoin IRA's. ----->>> Read "10 Things To Know Before Buying A Crypto IRA"
3) Bitcoin Mining.
What is Bitcoin Mining?
Bitcoin transactions require large amounts of computing power and electricity to keep transactions secure and organized. When a transaction is made, it then needs to be verified by the complete network and also secured into an unchangeable distributed ledger (Blockchain). Essentially, this is the function of Bitcoin miners. Miners are rewarded with Bitcoin in exchange for successfully completing these duties.
From an investment point of view, anyone can participate in Bitcoin mining if they purchase the required equipment. However, there is extremely high competition and increasingly sophisticated equipment which requires the use of massive amounts of electricity. Be sure to calculate all of these variables into your decision making process.
How Are Bitcoin Taxed? (US)
In the United States, Bitcoin and cryptocurrency is currently treated the same as property. It is not considered currency. Because it is treated the same as property it is subject to capital gains tax. These tax rules are likely to change with time and will be treated differently from country to country. Be sure to consult a tax professional when you are considering the purchase of Bitcoin or other cryptos.
Scams To Be Aware Of
Just like any financial industry there are plenty of scams to guard yourself from. Bitcoin is no exception. Here is a quick list of the most common schemes:
Ponzi schemes, phishing, fake coins, corrupt exchanges, fake wallets, pump & dumps, impersonators, fake websites, ICO schemes and ransom.
This is not a complete list, but they are the most common scams that you need to be aware of.
Read "10 Common Cryptocurrency Scams And How To Avoid Them"
What Advantages Do Bitcoin Have Over Paper Money?
1) Easily Transferred
2) No International Transfer fees (such as SWIFT banking system).
3) Increased User Control
4) Increased Security
5) Transparency in Transactions.
6) Transactions cannot be manipulated.
7) Durable (Paper $ breaks down over time).
8) Limited Supply (not subject to inflation).
9) Easily divisible (Satoshi).
10) Mostly anonymous transactions.
What Limitations Do Bitcoin Have?
1) Slow Transaction Speed
2) Price Volatility
3) High Transaction Fees when transaction volume is high.
4) Not Enough Users.
5) High Learning Curve.
Important History Lesson!
In 2008, the world economy was just beginning to feel the pain of the Great Recession. It was clear that the financial systems of the world had been rigged and the house of cards was beginning to collapse. Bitcoin was created in response to this. It was a way to challenge and remove power from the huge central banking systems which control our economy.
Because only 21 million Bitcoin will ever be produced, it is much more resistant to currency manipulations like inflation and deflation. With this in mind, Bitcoin quickly became the first clear alternative to fiat paper money. The thought that a government can't just fire up the money printing press to fund a war, or social policy, brings increased security and the need for financial responsibility. In short, it gives control back to the individual user and limits the power that a government has.
Regulations & Government
Governments around the world are struggling to decide if they should recognize Bitcoin as a currency, or treat it as illegal. Governments like to be in control of the money supply, and when they are not, it poses a direct threat to their power. Bitcoin can be influenced by government regulation through taxes and laws, but cannot be directly controlled by any single entity. Countries like the United States seem to be taking a cautious approach in balancing how quickly, and willingly, they will adopt Bitcoin. Smaller countries with smaller economies tend to be adopting Bitcoin much more quickly. Regulations will continue to change the landscape of Bitcoin into the future. It should be interesting to see how it unfolds around the world.
For a deeper discussion about this read: "Blockchain Impact: Political, Economic, Social"
Interesting Fun Facts
-Bitcoin was officially created in January of 2009.
-The first purchase made with Bitcoin was for 2 slices of pizza in May 2010. At the time the 2 slices of pizza cost 10,000 Bitcoin. Bitcoin was .08 at the time. So...10,000 Bitcoin x Today's Bitcoin Price = Expensive Pizza!
-No one knows who created Bitcoin. Credit is given to Satoshi Nakamoto but this is an alias name.
-Bitcoin is accepted as tax payments in Ohio, and there are several other states ready to follow suite.
-Transactions cannot be reversed.
- FBI is one of the largest holders of Bitcoin after shutting down the silk road network.
-An estimated 25% of Bitcoin mined have been lost and are gone forever. If you lose your wallet or forget your password it is gone!
-Bitcoin is illegal in many countries.
-It takes about as much electricity to run the Bitcoin network as it does to run a small country.
-Bitcoin "farms" are large warehouses full of mining rigs which solve complex algorithms.
It is exciting to be on the cutting edge of something that offers so many potential ramifications for our financial landscape. Regulations, taxes, and user experience are all shaping the direction Bitcoin will go in the future. Hopefully this guide gives a great overview, and great resources, which will helped you understand everything you need to know about Bitcoin and how they work.