What is Bitcoin and How Does it Work?

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Contributor, Benzinga
February 7, 2024
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Bitcoin has been one of the best-performing assets of the past decade. Over the past several years, it has gone from being essentially worthless to an all-time high of over $67,000 and back down again. However, these price gains are not the entire story. Many people believe it to be one of the greatest innovations in finance. While you might expect such a highly regarded innovation to be extremely complex, you will soon see that it may not be as complex as it seems. 

It arose at a tumultuous time for the United States and much of the world, 2008. Satoshi Nakamoto, the anonymous founder or founders of Bitcoin, released the Bitcoin whitepaper in the middle of the financial crisis. They proposed a new system with no central authority to control it or make day-to-day decisions. They didn’t want to include banks and other financial intermediaries in transactions. They created Bitcoin, an electronic cash system (or cryptocurrency) using peer-to-peer technology. How does Bitcoin work?

Disclosure: ²Sum of median estimated savings and rewards earned, per user in 2021 across multiple Coinbase programs (excluding sweepstakes). This amount includes fee waivers from Coinbase One (excluding the subscription cost), rewards from Coinbase Card, and staking rewards. ³Crypto rewards is an optional Coinbase offer. Upon purchase of USDC, you will be automatically opted in to rewards. If you’d like to opt out or learn more about rewards, you can click here. The rewards rate is subject to change and can vary by region. Customers will be able to see the latest applicable rates directly within their accounts

What is Bitcoin and How Does It Work?

Bitcoin was the pioneer of blockchain technology. Public blockchains are a specific kind of distributed database or ledger that is open and accessible to anyone. Blockchains differ from regular databases in a few important ways. Data on the blockchain is aggregated in blocks that are linked together chronologically one after another. 

Decentralized blockchains like Bitcoin are accessible to the general public and are also controlled by their users. Network participants around the world, called nodes or validators, verify Bitcoin transactions by running the necessary software on expensive hardware.

The security of blockchains also arises from this decentralized control of the network. A malicious attack on the network to steal tokens or double-spend them, for example, would require the hacker to control more than 50% of the network’s validators. While this is a fear for some, the likelihood of it occurring on Bitcoin is slim due to the number of network participants.  

The security that decentralization provides makes changing the blockchain much more arduous because no central authority exists to decide on the changes. Instead, modifications are implemented with blockchain forks. A fork is when the validators or nodes on a blockchain no longer align with each other or are running different software. The two main types of forks, hard forks and soft forks, are used for different kinds of changes. 

  • Hard forks split the blockchain into two parts, the first fork adhering to the old rules and the other using the intended modifications.
  • Soft forks don’t create a new blockchain; they add a new rule to the old one. Soft forks generally cause less turbulence in the community and have fewer downsides, but they can’t be used for everything. Examples of Bitcoin forking include Bitcoin Cash and Bitcoin SV, both of which massively increased the block size, allowing for faster and cheaper transactions. Neither of these was incredibly successful, and most of the community has remained on the main Bitcoin blockchain. However, these cases show that blockchain can be malleable while retaining its strong decentralized nature. 

Bitcoin has a few main uses. First, it can be used as a form of payment. Users of Bitcoin can send tokens to each other through the use of wallets and wallet addresses. Additionally, it can serve as an alternative investment to help diversify portfolios or capture growth opportunities. 

How Do You Make Money With Bitcoin?

Now that you have a basic understanding of how Bitcoin works, as well as some of its use cases, let’s take a look at some of the possible ways you can make money with Bitcoin. 

  • Buying and holding Bitcoin: In 2022, a study found that over 65% of Bitcoin’s circulating supply had not changed hands in at least 12 months, showing that most holders (or the largest holders) are buying and holding their tokens long-term. To get in on the action, you can trade Bitcoin through a decentralized exchange (DEX), a crypto trading platform or in-person through Bitcoin ATMs. 
  • Lending Bitcoin: Some trading platforms allow you to lend Bitcoin to the exchange or other users. Most platforms have a minimum balance and timeframe for lending. In exchange, they offer interest on the tokens you lend. You can lend through both centralized and decentralized platforms. While the internal operations for each are slightly different, the outcome is the same: you lend Bitcoin in exchange for interest. 
  • Accepting payments in Bitcoin: If you are a vendor or someone who collects payments, you can begin using a transaction service that allows you to accept Bitcoin as payment. While there are many reasons that you may want to do this, some of the more notable ones are the increased ability to transact internationally, no risk of chargebacks or other disputes and potentially lower fees. 
  • Trading Bitcoin: Bitcoin often experiences extreme volatility, with prices moving an average of over 2% a day. For comparison, the S&P 500 moves an average of around 1% a day. Volatility creates opportunities for profitable trading. If you are able to buy when Bitcoin is going up and sell when it is going down, you could potentially make a profit trading. This would likely require you to engage in day trading or margin trading
  • Joining Bitcoin affiliate programs: Another way to make money with Bitcoin is through affiliate programs. These are promotions that crypto trading platforms offer for inviting new users to the site. The rewards can range from a few dollars to over $200 depending on the site. While this is not a sustainable way to make money with Bitcoin, it could certainly be a good way to get some extra Bitcoin by inviting your friends to create an account with a crypto brokerage. 
  • Bitcoin mining: Perhaps the most profitable way to make money with Bitcoin is through mining. Bitcoin uses computers to help validate transactions in exchange for freshly minted Bitcoins. This process is called mining, and it can be profitable. Some public companies earn money solely from mining Bitcoin. Let’s take a deeper look at mining.

How Do You Mine Bitcoin and is it Worth it?

Bitcoin network validators are called miners because they are rewarded with Bitcoin when they process a block of transactions and add it to the blockchain. This competitive process boils down to a technological arms race. Miners (or validators) fight for the privilege of processing a block and earning the Bitcoin that goes with it. This privilege is earned by solving a cryptographic puzzle by randomly guessing solutions as fast as possible. They use extremely powerful computers designed specifically for this purpose called ASIC miner rigs. 

It takes about 10 minutes to mine a Bitcoin block, and each block rewards a certain amount of Bitcoin to miners who solve that block. These rewards are split among a pool of miners proportional to the computing power provided by each user. It is difficult for one miner to mine even a single block when competing against billions of dollars of high-tech equipment. 

While Bitcoin could once be mined from just about anyone’s personal computer, today you must invest in state-of-the-art mining systems to have a chance at being successful. To mine one Bitcoin worth of rewards, the time is largely dependent on your miner. For the Antminer S19 Pro, a popular mining machine selling for several thousand dollars, it would take about 1,400 days to mine one Bitcoin. Today, millionaires, publicly traded companies and even the country of El Salvador are your competition in mining for Bitcoin.

Bitcoin mining is usually not worth it for the average person. The steep barrier to entry with expensive setups and deep technical knowledge requirements means that regular people often can’t participate profitably. Mining for Bitcoin is only a feasible investment for people or entities willing to invest lots of time, money and mental focus.

How Do You Buy Bitcoin?

Because Bitcoin is the largest and most popular cryptocurrency, you can buy it on most cryptocurrency exchanges and some brokerage apps. Some of the best trading platforms that offer Bitcoin trading are Robinhood, Coinbase, and Kraken For those outside of the U.S., PrimeXBT, eToro, and BYDFi are great options.  

Before you can purchase cryptocurrencies on these platforms, you need to verify your identity. This process entails providing your address, Social Security number and a picture of your driver’s license or other valid ID. Once your account is verified, you can fund your account and start trading. 

You can deposit a fiat currency or another supported cryptocurrency. All the trading platforms recommended above offer instant trading after your deposit, so you can purchase your Bitcoin immediately. All you need to do now is look for the trading pair with Bitcoin and the currency you want to buy it with, set your price and complete the transaction.

Benzinga’s Top Exchanges in the U.S.

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    Sum of median estimated savings and rewards earned, per user in 2021 across multiple Coinbase programs (excluding sweepstakes). This amount includes fee waivers from Coinbase One (excluding the subscription cost), rewards from Coinbase Card, and staking rewards. ³Crypto rewards is an optional Coinbase offer. Upon purchase of USDC, you will be automatically opted in to rewards. If you’d like to opt out or learn more about rewards, you can click here. The rewards rate is subject to change and can vary by region. Customers will be able to see the latest applicable rates directly within their accounts.

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How to Store Bitcoin Safely

The recent cracks forming in large centralized crypto platforms only further prove that it’s much safer to store your own cryptocurrencies. Storing it yourself comes with its own risks like phishing scams, but it’s almost always more secure if you are careful. There are two different kinds of personal wallets: hot wallets (software wallets) and cold wallets (hardware wallets). Hot wallets, like Coinbase Wallet and MetaMask, are often the easiest to use but can be more vulnerable to phishing scams or cyberattacks. Hardware wallets are kept completely offline, so they are nearly impervious to hacks. However, it doesn’t entirely prevent social engineering and phishing attacks.

The top hardware wallet brand in the world, Ledger, has two main models: the Nano X and the Nano S Plus. The Nano S Plus has everything you need to keep your cryptocurrencies secure. The Nano X has the same larger screen and adds BlueTooth functionality for seamless on-the-go use. All Ledger devices use the same certified secure chip that generates, encrypts and stores your private key. Without your private key, no one can access your wallet. Ledger supports more than 1,000 different cryptos on multiple blockchains including Ethereum, Bitcoin, XRP, Dogecoin and all ERC-20 tokens.

Pros and Cons of Investing in Bitcoin

Let’s take a look at some of the pros and cons of investing in Bitcoin.  

Advantages of Bitcoin

  • Halvings: Every 210,000 blocks, or roughly every four years, the number of Bitcoins created in each block algorithmically decreases by 50%. Block rewards are not gradually diminished, but rather they are immediately halved as soon as the 210,000th block is mined. Bitcoin halvings are Bitcoin’s way of enforcing synthetic price inflation until all Bitcoins are released. It is believed that the platform was put together in a way that would make it a deflationary currency — with purchasing power increasing over time. 
  • Decentralization: Bitcoin is built on a decentralized blockchain. No single entity can make impactful decisions that impact the other users of the chain. This is particularly important in examining the most prominent bank failures, almost all of which have been caused by excessive risk or poor decision-making on the part of upper management. Decentralization solves the problem of human error.
  • Investment appreciation: Over the past decade, billionaires have been made from Bitcoin. Some of these people spent a few hundred dollars on Bitcoin in the early 2020s, only to discover that it had appreciated into hundreds of millions of dollars years later. While there is no guarantee that Bitcoin will go up, there is a chance that investors could benefit from potential price increases. 

Disadvantages of Bitcoin

  • Risk of 51% attack: While Bitcoin cannot be hacked in the proverbial sense of a computer nerd in a hoodie breaking down the firewall, a theoretical way exists for Bitcoin to be hacked, although it is extremely unlikely. To hack Bitcoin, a group would have to control 51% of the verification power on the network. This factor would allow them to block new transactions from occurring, as well as changing the order of transactions. They could also send money and then reverse the transaction, otherwise known as double-spending. This method of theft is called a 51% attack. A 51% attack on Bitcoin is almost impossible because Bitcoin’s network is so large and so spread out that a group would need a huge amount of resources to carry it out. In terms of equipment, they would need to buy or rent millions of computers. The electricity to power this many computers would be larger than that used by all of New Zealand combined. Even if a group were to obtain this level of resources, they would probably not be able to steal enough Bitcoin to make the attack profitable.
  • Environmental concerns: Bitcoin mining uses a large amount of energy and is not good for the environment. However, the industry is exploring cleaner mining practices –– such as El Salvador’s use of a volcano as an alternate source of energy to mine Bitcoin. The Bitcoin community largely believes that energy consumption is worthwhile, commonly arguing that less-important practices use more energy, such as the use of Christmas lights each year.
  • Phishing and other scams: While the Bitcoin blockchain cannot be hacked itself, individuals are often hacked through software wallets and crypto exchanges. If someone were to acquire your wallet address and private key, they could steal the contents of your wallet by sending it to themselves. This information is often acquired through phishing scams. In the world of crypto, scams typically happen when a user connects their wallet to a site, giving the site their information. The owners of the site then take this information, hack into the wallet and send themselves the contents. Phishing scams are not a fault of the blockchain. They can often be the result of user error. If someone does not research a site before connecting their wallet, then they can have their assets stolen. 

How to Regulate Bitcoin

The regulation of crypto is hazy for reasons including its novelty, global operation and difficulty classifying the assets. Governments hold a wide variety of stances on crypto, such as El Salvador’s extremely open and supportive stance, as well as Saudi Arabia, which has an outright ban on cryptocurrency.

The regulating body in the U.S., the Securities and Exchange Commission (SEC), approved spot Bitcoin exchange-traded funds (ETFs) in early 2024. This landmark decision was one of the first times that the SEC has taken decisive action on the topic of cryptocurrency. However, there is still a large debate surrounding Bitcoin as a whole.

In terms of the current stance, the Biden administration released a regulatory framework in 2022. The framework was somewhat vague, but it supported the idea of aiding the existing financial institutions in facilitating cross-border transactions, as well as cracking down on fraud. This would help alleviate some of the issues Bitcoin is looking to address without any drastic changes. 

Trump’s current stance on Bitcoin is slightly less known. In 2021, he was quoted as saying that cryptocurrency is a “disaster waiting to happen”. However, he has since become more involved in crypto, causing some to wonder what his current stance is. 

Either way, there seem to be conflicting views globally regarding how to regulate Bitcoin, with some on both extremes. It will be important to keep an eye on elections as well as the thoughts of regulators in the coming years.

So, What is the Purpose of Bitcoin?

Satoshi Nakamoto wasn’t the only person upset with the banking industry after the collapse of the housing market in 2008. Many people realized the need for a currency that wasn’t regulated by any centralized organization, but Satoshi Nakamoto was the first to create a solution.

The point of Bitcoin is to create a store of value that is also a practical medium of exchange. The U.S. dollar has value because people all over the world have faith in the United States government to stick around long enough for them to spend their dollars. Bitcoin has value because many people would prefer to rely on a distributed network (blockchain) to back their currency, rather than a centralized bank or government.

The value of Bitcoin is worth what someone is willing to pay for it. The dollar, to some extent, is similar. It comes down to a matter of placing your trust in the blockchain or the government.

Frequently Asked Questions

Q

How much is $1 Bitcoin in U.S. dollars?

A

$1 of Bitcoin is worth $1.

 

Q

Is Bitcoin actual money?

A

Since Bitcoin is used to facilitate transactions, many consider it to be a form of money.

 

Q

How many Bitcoins are left?

A

In February 2024, there are around 19.7 million Bitcoin in circulation, equating to around 94% of the total supply. Once the supply reaches 21 million, it will be capped for good.

 

Q

How does Bitcoin make money?

A

Since Bitcoin is decentralized, all transaction costs are distributed to miners. 

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About Caden Pok

Caden has been involved with cryptocurrency for several years. He began trading and investing in crypto in 2018. Now, we mines multiple coins and holds positions in Cardano and Ethereum. He is very experienced with DeFi technology.