How Does Cryptocurrency Work- What Is Bitcoin?

How does cryptocurrency work- coins

Bitcoin is on a record pacing rise. What, exactly, is Bitcoin, and where does it get its value? How does Cryptocurrency work? Will Bitcoin be interesting conversation years from now or just a thing of the past? Will it become a staple in a very diversified investment portfolio? There are still some questions. But, the past 10 years have given us a much better indication of the role Bitcoin might play. Within the portfolios of retail investors and institutions alike.

What Is Bitcoin?

Bitcoin was first launched in 2009 and is considered the original cryptocurrency. What is Bitcoins and how does Cryptocurrency work? Many people have wondered. Bitcoin is a decentralized variety of digital cash. That eliminates the requirement for traditional intermediaries like banks and governments to generate financial transactions. Still, feeling a bit confused? Don’t worry, it’s perfectly normal.

Fiat money (like the U.S. dollars in your bank account) is backed and controlled by the government that issues it. Bitcoin, is different, in that it is powered through a mixture of peer-to-peer technology. A network of people and software-driven cryptography.

The science of passing secret information that may only be read by the sender and receiver. This creates a currency backed by code instead of the physical value of items. Such as gold or silver, or by trust in central authorities just like the U.S. dollar or Japanese yen. 

“What is required is an electronic form of payment system supported by cryptographic proof rather than trust. Allowing any two willing parties to transact directly with each other. Without the requirement for a trusted third party,” wrote Satoshi Nakamoto.

The pseudonym of the mysterious Bitcoin creator. Who remains unknown. During a white book introducing the open-source technology. It’s come an extended way since then, now accepted as payment by many businesses worldwide.

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How Does Cryptocurrency Work?

Bitcoin 101

Every bitcoin (trading symbol “BTC,” and “XBT”) is a computer file that is stored inside a digital wallet. On a computer or smartphone.To grasp how cryptocurrency works, it helps to know the following terms.

  • Blockchain: Bitcoin is powered by open-source code which is referred to as blockchain. Which creates a shared public ledger. Each transaction creates a “block” that’s “chained” to the code, creating a permanent record of every transaction. Blockchain technology is at the forefront of 6,000 cryptocurrencies that have followed in Bitcoin’s wake.
  • Private and public keys: A bitcoin wallet contains both a public key and a private key. Which work together to permit the owner to initiate and digitally sign transactions, providing proof of authorization.
  • Bitcoin miners: Miners, or members of the peer-to-peer platform. Then independently confirm the transaction using high-speed computers, usually within 10-20 minutes. Miners are paid in Bitcoin for their efforts. 

 How Does Bitcoin Make Money?

Bitcoin value follows the law of supply and demand. And since demand waxes and wanes, there’s plenty of volatility within the cryptocurrency’s price. Besides mining bitcoin, which needs technical expertise and an investment in high-performance computers. The majority purchase bitcoins as a kind of currency speculation. Betting that the U.S. dollar value of 1 bitcoin is going to be higher in the future than it is today.

How Does Cryptocurrency Work- Digital Wallets

Bitcoins are stored in two styles of digital wallets:

Hot wallet: Digital currency is stored within the cloud on a trusted exchange or provider. And accessed through a computer browser, desktop or smartphone app.

Cold wallet: An encrypted portable device very similar to a thumb drive. That enables you to download and carry your bitcoins. Basically, a hot wallet is connected to the internet; a cold wallet isn’t. But you need a hot wallet to download bitcoins into a conveyable cold wallet.

How does cryptocurrency work- bitcoin picture

How Does Cryptocurrency Work- Bitcoin Transactions

Bitcoin transactions are more complex behind the scenes than you would possibly think. You would rarely if any, send an amount of bitcoin in one go. Instead, your bitcoin wallet and therefore the bitcoin network. Need to go through a group of steps. To make sure that the proper amount of electronic money gets to the recipient.

To begin with, it’s important to understand what a bitcoin is. It’s not a single record of a coin, as you may find on an accounting ledger. Or on your financial statement. Instead, it’s basically a file (referred to as money hereafter). With a price that registers as a transaction once you initiate a payment or receipt.

How does Cryptocurrency work? There are three elements involved in a standard bitcoin transaction: a transaction input, a transaction output, and an amount. The transaction input is the bitcoin address from which the cash was sent. The transaction output is the bitcoin address to which the cash was sent. If the bitcoin is in your wallet, your address would then be the transaction output.

How A Bitcoin Transaction Works

The bitcoins that you just sent to someone were sent to you from somebody else. After they sent them to you, the address that they sent it from was registered on the bitcoin blockchain (encrypted and unaccessible register). As the transaction input, and your address (the address they sent it to). Was registered on the bitcoin network as the transaction output.

When you send that same bitcoin to someone else, your wallet creates a transaction output. Which of course, is the address of the person you’re sending the bitcoin to. That transaction will then be registered on the bitcoin network along with your bitcoin address as being the transaction input.

When that person sends those bitcoins to some other person, their address will, in turn, become the transaction input. The other person’s bitcoin address will register as the transaction output.

Using this technique, people can trace bitcoin transactions all the way back to when the bitcoin was first created. Understanding who sent it to who at any point in time. This creates a totally transparent system within which all transactions can be checked at any time.

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Bitcoin Has It’s Challenges

A nagging problem with bitcoin is that the amounts attached to transactions with their inputs and outputs aren’t divisible. For example, if Alice contains a bitcoin address with one bitcoin in it, and she wants to send Bob half a bitcoin. Then she would need to send Bob that entire bitcoin. 

The bitcoin network would automatically create half a bitcoin in change from the bitcoin Alice sent. Then it would be sent to the third address in Alice’s control. That third address will be a transaction output, meaning that the address will have multiple transaction outputs.

Over time, this suggests that bitcoin wallets find themselves with plenty of addresses containing varying amounts of bitcoin and change. From various bitcoin transactions. When you send bitcoins to someone, your wallet will try its best to piece together the required funds. Using the addresses containing the various amounts.

That ends up in transactions that may have several different inputs. Different addresses with different amounts. It’s unlikely that these inputs will deliver precisely the correct amount, so you normally find yourself with change.

Sending Smaller Amounts of Bitcoin

How does Cryptocurrency work with smaller amounts? What if you wanted to send just a small amount of bitcoin? Luckily, you’ll be able to slice bitcoins very thinly indeed. The tiniest divisible, a part of a bitcoin is named a satoshi. It amounts to only 1/100 millionth of 1 bitcoin!

You can’t send only one satoshi over the network, though. That’s too small and would obstruct the network with tiny transactions. The tiniest transaction value is 546 satoshis, which is still pretty small.

To complicate matters still further, many bitcoin transactions involve a transaction fee. Which then means, that you must add a specific amount of bitcoin. On top of the number you’re trying to send. 

If you don’t the bitcoin transaction will likely fail. This is something to think about, especially when sending tiny fractions of a bitcoin. So, after you open your bitcoin wallet after a few transactions. And start to determine multiple addresses containing many tiny amounts, you now know what’s happening.

It isn’t particularly easy to read and makes bookkeeping a touch annoying. But it does make it possible to trace bitcoin transactions through the complete network. Which is vital, given bitcoin’s mantra of transparency and immutability.

How does cryptocurrency work- bitcoin chart

Bitcoin Cons

  • Price volatility: The recent gains are excellent news if you purchased Bitcoin in December 2018; people who bought in 2017 when Bitcoin’s price was racing toward $20,000. Had to attend until December 2020 to recover their losses.
  • Hacking concerns: While backers say the blockchain technology behind bitcoin is even safer than traditional electronic money transfers. Bitcoin hot wallets are a pretty target for hackers. There are a variety of high-profile hacks, like the news in May 2019. That $40 million+ in bitcoin was stolen from several high-net-worth accounts on cryptocurrency exchange Binance (the company covered the losses).
  • Limited use: In May 2019, the telecommunications giant AT&T joined companies like Overstock.com, Microsoft and Dish Network in accepting Bitcoin payments.

Bitcoin Pros 

  • Secure transactions with fewer potential fees: Once you own bitcoins, you’ll transfer them anytime, anywhere. Reducing the time and potential expense of any transaction. Transactions don’t contain personal information such as a name or Credit Card number. Which eliminates the chance of consumer information being stolen for fraudulent purchases or ID theft. Keep in mind, though, that to get bitcoins on an exchange, generally you’ll first need to link a bank account.
  • Potential for huge growth: Some investors who buy and hold the currency are betting that when Bitcoin matures. Greater trust and more widespread use will follow, and so Bitcoin’s value will grow.
  • The ability to avoid traditional banks and government intermediaries: After the financial crisis and therefore the Great Recession. Some investors are desperate to embrace another, decentralized currency. One that’s essentially outside the control of normal banks, governing authorities, or other third parties.

Where Can You Purchase Bitcoin?

Five ways to get bitcoins:

  • Cryptocurrency exchanges: There are a variety of exchanges within the U.S. and abroad. Coinbase is the biggest cryptocurrency exchange in the U.S., trading over 30 cryptocurrencies.
  • Investment brokerages: Robinhood was the primary mainstream investment broker to offer Bitcoin and other cryptocurrencies. (Robinhood Crypto is on the market in most, but not all, U.S. states). Tradestation and Sofi Active Investing offer Cryptocurrency trading in most U.S. states.
  • Bitcoin ATMs: There are over 7,000 bitcoin ATMs within the U.S. (search Coin ATM Radar to seek out one near you).
  • Peer-to-peer purchases: You can buy bitcoins directly from other bitcoin owners through peer-to-peer tools like Bisq, Bitquick and LocalBitcoins.com.
  • Bitcoin mining: You can earn bitcoins through mining. But the technical expertise required and the computer costs involved puts this option out of reach for most.

Conclusion

Bitcoin can be an incredibly speculative and volatile buy. This article answers the question. How does Cryptocurrency work? Remember that stock trading can be just as rewarding. Investing in stocks of established companies. Is generally less risky than investing in Bitcoin. A good rule of thumb is to devote less than 10% of your overall portfolio. To individual stocks or speculative assets like Bitcoin.

MisterShaka

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