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Learning about Bitcoin can be overwhelming, so let’s start with the basics.
What is Bitcoin?
Bitcoin is a digital currency that was created in 2009 by the anonymous Satoshi Nakamoto.
This person, or group of people, published a whitepaper describing the invention of the first successful digital currency.
Satoshi’s electronic cash system is fully peer-to-peer and does not require a third party oversight from a bank or government to approve transactions.
This decentralization makes makes Bitcoin resistant to censorship and corruption.
Bitcoin users can remain anonymous, even though the network’s transaction history is freely available on a distributed public ledger, known as the blockchain.
The maximum amount of bitcoins that will ever exist is 21 million.
There are currently 18.9 million in the available supply, leaving 2.1 million left to be created, or “mined.”
Bitcoin follows a predetermined supply schedule. Currently, 6.25 new bitcoin enter the supply every 10 minutes, on average.
>> Learn More: How to Buy Bitcoin
Understanding How Bitcoin Works
Bitcoin is a global network of tens of thousands of computers called “nodes” that maintain the public ledger.
This ledger is public and distributed, meaning that every node plugged into the network can access and verify the entire history of bitcoin transactions if they desire.
These transactions are recorded in a decentralized database known as a blockchain, where blocks are filled with transaction data and stuck together in chronological order to form a chain.
Once a block is appended to the chain and other nodes verify its integrity, the contents of the block cannot be changed.
Getting miners, who do not know or directly communicate with each other, to agree on the accuracy of a block requires large amounts of computing power.
Miners reach consensus by conducting “proof of work” to guess the right answer to a cryptographic puzzle.
Miners are essentially trying to guess a hash value that is below the value of the target hash that is set by the Bitcoin protocol.
Their machines conduct brute force guesswork, to the tune of trillions of guesses, to “find” a hash that is below the target hash.
Doing this requires large amounts of capital, but it takes little computing power to verify a miner’s work.
This allows those running nodes to easily verify the integrity of the miner’s work, which contributes to Bitcoin’s decentralization and security.
Miners receive a block reward for their efforts auditing the network, which consists of a block subsidy (currently 6.25 BTC) and the associated transaction fees in the block.
The block reward is awarded to the miner that solves the puzzle first.
Understanding Bitcoin’s Volatility
The price of bitcoin changes because buyers and sellers are constantly disagreeing on how much it should be worth.
The macroeconomic laws of supply and demand apply to bitcoin too.
Price goes up when there are more buyers than sellers, which decreases the available supply and forces participants looking to acquire the asset to pay more than another person going after the same coin.
Price goes down when there are more sellers than buyers. The available supply increases and the asset becomes less scarce.
The varying motivations from one market actor to the next contribute to the asset’s volatility.
Some are long time holders and believe bitcoin will become the global reserve currency.
Others just trade the volatility to make a quick buck. They are agnostic to the asset.
Last, bitcoin experiences severe volatility because it trades freely in an open market. There is no intervention on behalf of an institution to ballast the price, or no circuit breakers to halt trading.
Excessive amounts of leverage also contribute to major swings in price. People can gain leverage in the market by borrowing capital from lenders that is not their own.
When their trade goes against them, their account gets liquidated. A series of liquidations at scale can send the price of BTC in a downward spiral.
Remember, you can buy fractional shares of a bitcoin.
So, while the price of a whole BTC is tens of thousands of dollars, you can own as little as $1 worth of the digital asset.
>> More: Why Is Bitcoin So Volatile?
Pros of Bitcoin
- There is a fixed supply of bitcoin
- Its supply schedule is predetermined and unchangeable
- It shares the same characteristics that make gold sound money, but arguably better
- It is an anonymous peer-to-peer payment network
- You are the owner of your assets and do not require the permission from the government or bank to send and receive it (censorship resistant)
- It is a liquid asset that trades in an open market 24/7/365
- Bitcoin can be sent or received 24/7/365
- It is highly portable asset and cannot be physically seized from you
- You can own fractional shares of Bitcoin
Cons of Bitcoin
Many of the same “pros” can be perceived as “cons” when things do go wrong. Additionally, several of these disadvantages can be mitigated with proper education and security.
- Vulnerable to reckless forms of regulation
- You lose your bitcoin if you lose your private keys
- Dependent on the internet
- Exchanges can have high fees in relation to commission-free stock trading
- Not every service or person accepts bitcoin as payment
- Bitcoin is volatile, and double-digit pullbacks are common
- Transaction speeds can be slow, and fees can be high (not if you use the Lightning Network)
- It takes time to learn about Bitcoin
- Self-custody requires responsibility
Understanding Bitcoin’s Legality
Bitcoin is 100% legal in the United States and in most places on Earth. Only a few countries have outright banned it, while others have made it partly legal.
These countries typically have authoritarian governments that want to maintain maximum control over its people and currency.
A decentralized asset may empower the individual a bit too much for their liking.
Some countries do not define the legal status of Bitcoin and its related crypto instruments, while others are changing their existing laws.
The Internal Revenue Service (IRS) classifies bitcoin as property rather than currency.
This means that you will pay property tax on any bitcoin sale.
Bitcoin is also legal tender in El Salvador, meaning merchants are required by law to accept it as payment.
Bitcoin as Sound Money
Bitcoin is “sound money”, or a hard-money asset, because it is not easily devalued.
It’s extremely difficult to create more bitcoin, and the ones that are minted are created in accordance with a immutable supply schedule.
Bitcoin is a disinflationary asset, meaning its inflation rate decreases over time, and will one day have zero inflation.
This absolute certainty on the supply side preserves the value of the bitcoin currently in circulation. Hence, its strength as a store of value asset.
The fixed supply and supply schedule allows entities to participate in a monetary system that is transparent and predictable.
There are a fixed number of characteristics that a form of money must satisfy:
- Difficult to Counterfeit
- Censorship Resistant
- Established History
With the exception of “Established History”, Bitcoin arguably satisfies these monetary criteria better than gold or any fiat form of money.
>> More: What is Bitcoin Backed By?
Bottom Line: What Is Bitcoin?
Bitcoin education takes time, but hopefully your understanding has improved after reading this article.
Contrary to what people might make you think, you don’t have to have 0% or 100% exposure to bitcoin.
A rising trend in wealth management suggests investors shift 1% to 10% of their portfolio into bitcoin.
It is still largely viewed as risk-on investment, and different investors have varying time preferences and appetites for the volatility.
This article is for informational purposes only. It is not intended to be investment advice.