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What is Bitcoin?
Bitcoin is a noncoercive form of hard money – also known as cryptocurrency – that stores economic value across time and space.
There are a fixed number of bitcoin that will ever exist, and new bitcoin that enter its circulating supply adhere to a fixed supply schedule that market participants can review and analyze prior to joining the network.
Bitcoin is not controlled by any one person or central authority; it is decentralized. This permissionless quality makes bitcoin resistant to censorship, and allows any person with an internet connection to use Bitcoin at the network level.
Bitcoin’s ability to credibly enforce a fixed supply of 21 million makes it a suitable form of hard money.
An effective form of money must be desired by others and scarce, among other characteristics that we will examine later.
Desired By Others
Bitcoin has gone from zero to the equivalent of $1 trillion in market value since it was first created in 2009.
Additionally, Bitcoin’s mass adoption is growing at a faster rate than the Internet.
This rapid rate of monetization and user adoption suggests that Bitcoin appears to be sufficiently desired by other market actors.
Bitcoin is the first asset in human history to achieve absolute scarcity.
There will only ever be 21 million bitcoin. Unlike other monetary networks, your percentage of network ownership cannot be arbitrarily and unilaterally debased by some central entity.
Additionally, new bitcoin that do enter the supply follow an open and transparent schedule of issuance that is freely available for all market participants.
There will be 900 new bitcoin issued today. Every four years, that amount is halved until all 21 million have been found.
And regardless of the amount of energy expended to create more bitcoin, the network protocol will adjust to ensure that Bitcoin sticks to its supply schedule.
This robustness, known as the difficulty adjustment, enables bitcoin to exit the cycle of debasement that has plagued other forms of money for thousands of years.
Historically, when the demand for a monetary good increases, market participants expend energy creating or finding more of that specific monetary good, such as sea shells, salt, or rocks. When the supply of the monetary good increases, the purchasing power of the existing circulating supply decreases, and the form of money becomes less desirable.
Bitcoin’s difficulty adjustment solves this problem.
How Bitcoin Works
Bitcoin is a global network of 15,000+ computers called “nodes” that keep track of the Bitcoin ledger. Each individual that runs a node has a copy of the complete history of the 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, audit the circulating supply, and more.
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. A block consists of the previous block’s header + meta data + transactions.
Once a block is appended to the chain and the nodes verify its integrity, the contents of the block cannot be changed without re-doing all of the computational work that was required to create the longest chain.
Miners conduct proof of work to guess a random 32-bit number called the “golden nonce”. This random number is appended to the block that is trying to be found, and hashed through Bitcoin’s cryptography function called SHA256.
If the output of the hash is less than the hash value required by the Bitcoin protocol, then that proposed block is added to the chain.
Essentially, miners are machines that are designed to guess this 32-bit number trillions of times per second. They conduct brute force guesswork to “find” a random number that when added to the block, results in a hash that is less than the difficulty target number.
Mining a block requires large amounts of electricity, which requires large amounts of capital to attain. But verifying the work conducted by miners can be done on a personal computer.
This allows individuals running nodes to easily verify the integrity of a miner’s work, which contributes to Bitcoin’s decentralization and security because the nodes effectively keep the miners in check.
Miners receive a block reward when they find a hash that is below the target hash value. They receive what is called a block subsidy: currently 6.25 BTC plus the associated transaction fees included the block.
The block reward is paid to the miner that gets their block added to the chain. Once a miner finds a block, the race to find the next block starts again.
This race happens about once every ten minutes in accordance with Bitcoin’s design to issue new supply once every ten minutes.
Understanding BTC/USD Volatility
The price of bitcoin changes because buyers and sellers disagree on how much it should be worth in the short-term; macroeconomic forces of supply and demand apply to bitcoin too.
An asset cannot go from zero to trillions in USD without experiencing volatility.
Also, Bitcoin’s volatility to the upside attracts leveraged traders to the market. The USD exchange rate for bitcoin can experience significant volatility when too much leverage builds up in the market and is eventually flushed out.
These liquidations can spark a cascade of more liquidations in leverage at even lower prices, which can cause price to free-fall.
Additionally, more institutional money has began trading bitcoin in recent years. Generally speaking, these fast-money funds view bitcoin as a risk-on asset and trade it as such.
The USD price of bitcoin tends to trade down when market conditions become unfavorable for risk-on assets, i.e. quantitative tightening.
The opposite is also true: the USD price of bitcoin tends to increase when it is a risk-on environment, i.e. quantitative easing.
Last, bitcoin appears to be volatile because it trades in a completely free and open market with no central intervention.
Price can fall 25% and no person or organization can do anything to intervene, unlike traditional finance markets that will pause or halt trading when conditions get too ugly.
It doesn’t stop trading at 4:00 p.m. either. Traders in the Eastern hemisphere are pricing in new information as the traders in the West are going to bed; bitcoin is 24/7/365 market.
In sum, BTC/USD can be volatile in the short-term because market actors with varying time horizons are buying it and selling it for different reasons. The volatility is a byproduct of a relatively small network monetizing in real-time.
What is Bitcoin Mining?
Bitcoin mining is the process of new bitcoin entering the circulating supply in the form of a “block reward” to miners who verify transactions on the Bitcoin Blockchain.
Mining is the industrial infrastructure that allows Bitcoin to function without intermediaries. It requires expensive hardware called application-specific integrated circuits (ASICs) and software specifically designed to mine bitcoin.
Miners maintain the blockchain ledger that records the history of all transactions made on the blockchain, ensuring that no one spends bitcoin that they do not have — also known as “double spend.”
Miners must verify a certain amount of transactions per block (about 1MB worth), then race amongst each other to solve a cryptographic problem that requires massive amounts of computational power from specialized hardware and software.
The first miner to solve the problem shows “Proof of Work” and receives the block reward, and their block is added to the chain.
Then, the race to confirm the next block starts again.
The Bitcoin Protocol designed this process to happen every ten minutes, on average.
The difficulty of these mathematical problems varies to ensure the 10 minute pace is kept, and the rate of new bitcoin entering circulation follows its programmatic supply schedule.
How Does Bitcoin Mining Work?
Miners must meet two conditions to earn the block reward — verify the block’s transactions and find the “nonce” (number only used once) that is less than or equal to the “target hash.” So, how exactly does this work?
Bitcoin uses cryptography to secure its network, specifically SHA-256.
Each confirmed block has a “block header” that uniquely describes the contents of that block. The block header is an 80-byte long string that includes data such as a timestamp, Merkle root, version number, mining difficulty target, and nonce.
The golden nonce is the value the bitcoin miners are solving for — the other information is broadcasted to the network.
Once a miner finds the nonce that is less than or equal to the target hash, the block is complete, and the miner receives the block reward.
All of this data is combined and is the “input” for the cryptographic hash function that creates a digital fingerprint of the mined block to be uniquely distinguished from every other block on the chain.
The output is deterministic, meaning that the resulting hash of the block will always be the same for the given input.
Additionally, the hash function’s output will always be 256 bits regardless of the input size. An “Avalanche Effect” ensures that a minor change in the input results in a vastly different output.
This is one reason why Bitcoin is so secure — cryptography ensures that this communication is a one-way street. It is computationally infeasible to calculate the input if the only information available is the output, thus securing the data in the network.
The smaller the target hash, the more difficult it is to mine a block. Since the nonce could be any string of numbers from 1 to 50 trillion and beyond, there is less probability that a miners guessed nonce is less than the target hash if the target hash is smaller compared to being larger.
It’s like closing your eyes and jumping out of a plane. There’s a better chance you land in the Pacific Ocean than Lake Tahoe.
A smaller target hash means that it will have more leading zeros. All target hashes begin with at least eight zeros and have at most 63 leading zeros. There is no minimum target, but there is a maximum target set by Satoshi and the Bitcoin Protocol.
Mining difficulty is essentially controlled by the number of leading zeros in the target hash.
The Bitcoin protocol updates this mining difficulty every 2,016 blocks, which typically happens every two weeks.
If more blocks are mined over this period than intended by Satoshi, the protocol increases the difficulty of mining.
This reduces the miner’s probability of earning the block reward to the degree that it is not economically worth their time to try.
It works the other way, too. If less blocks are mined over this period, mining becomes easier, and the likelihood of receiving block rewards increases, which attracts additional miners to provide sufficient computing power.
Additionally, the block reward is halved after every 210,000 blocks or approximately every four years.
When Bitcoin first launched, the reward for each mined block was 50 bitcoin. After the first halving, it was 25, and then reduced to 12.5, and on May 11, 2020, it was halved to 6.25 bitcoin.
What Are the Pros and Cons of Bitcoin?
Pros of Bitcoin:
- Preserves economic value across time and space (1 BTC = 1 BTC)
- Fixed supply of bitcoin: your ownership in the network cannot be arbitrarily debased
- Predetermined and unchangeable schedule of new supply issuance
- Arguably perfects the sound money characteristics that gold approximates (improves on divisibility & portability)
- Censorship resistant: you are the owner of your assets and do not require permission from a central entity to exchange economic value
- 24/7/365 market
- Highly portable
- Decentralized: not unilaterally controlled by a central group of planners
- Digital commodity: not an unregistered security like other crypto assets
- Incentivizes entrepreneurs to find and/or create new forms of cheap power production
- Monetizes stranded forms of energy that would otherwise be wasted
Cons of Bitcoin:
Many of the same pros can be perceived as cons depending on the situation, and vice-versa. Several of these disadvantages can be mitigated with proper education and security.
- Vulnerable to damaging regulation in certain geographical areas
- Largely dependent on the Internet
- Exchange fees can be high
- Not globally accepted as a form of payment
- Volatile USD exchange rate
- Low transaction throughput on layer one (the Lightning Network fixes this)
- Potentially high fees on layer one (the Lightning Network fixes this)
- Self-custody requires responsibility
Who Invented Bitcoin?
Satoshi Nakamoto is the pseudonymous person or persons who created bitcoin, published the bitcoin white paper, and deployed the software for its network. Satoshi stated that he started writing bitcoin’s code in 2007.
On August 18, 2008, Satoshi (or his colleague) bought the domain name bitcoin.org. A month later, he published a paper called “Bitcoin: A Peer-to-Peer Electronic Cash System” that outlined his digital cryptocurrency.
The first sentence of Satoshi’s white papers claims bitcoin as, “a purely peer-to-peer version of electronic cash that would allow online payments to be sent directly from one party to another without going through a financial institution.”
Satoshi then explains how a peer-to-peer network can solve the double-spending problem by timestamping transactions and using cryptography to secure its history. Today, we call this blockchain technology.
In January 2009, Satoshi launched the network and mined the genesis block of bitcoin, which had a reward of 50 bitcoins.
Satoshi time stamped block number 0 by adding a message that read, “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks,” quoting The Times headline on that date. A convenient, cheap shot at traditional banking too.
Satoshi was involved in Bitcoin’s development until mid-2010 and then transferred control of the source code repository and network alert key to Gavin Andresen.
Satoshi handed over other related domains to several distinguished members of the Bitcoin community and officially stepped away from the project.
Is Bitcoin Legal?
Bitcoin is 100% legal in the United States and most places on Earth. Only a few countries have outright banned it, while others have made it partly legal.
Authoritarian regimes want maximum control over their people and currency; a freedom technology like Bitcoin may empower the individual a bit too much for their liking.
Some countries have yet to define the legal status of Bitcoin, while others are changing their existing laws.
The Internal Revenue Service (IRS) classifies bitcoin as property rather than currency, meaning you will pay property tax on any bitcoin sale.
Bitcoin is also legal tender in El Salvador and Central African Republic. This means that merchants are required by law to accept it as payment.
It’s probable that more nations continue to adopt this freedom technology to get out from under the thumb of institutions that they have previously relied on.
Understanding Bitcoin as Sound Money
There are a fixed number of characteristics that a form of money must satisfy:
- Difficult to Counterfeit
- Censorship Resistant
- Established History
Except “Established History,” Bitcoin arguably satisfies these monetary criteria better than gold or any fiat form of money.
Bitcoin is a “sound money” or a “hard-money” because it cannot be easily debased by creating more of it.
It’s extremely difficult to create more bitcoin. In fact, the more energy that is expended to mine bitcoin, the harder it is to find them, thanks to Bitcoin’s difficulty adjustment.
Additionally, Bitcoin is a disinflationary asset. This means that its inflation rate decreases over time, and will one day have an inflation rate of zero after all bitcoin have been issued.
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 (in its actualized form) regardless of the USD exchange rate for it today.
The fixed supply and supply schedule allows entities to participate in a monetary system that is transparent and predictable.
What is Bitcoin: Frequently Asked Questions
What is Bitcoin and how does it work?
Bitcoin is a form of money that has a fixed supply and is not controlled by a central entity. Lowercase “b” bitcoin is the digital currency that is exchanged on the capital “B” Bitcoin network. Individuals that choose to join the Bitcoin network agree to a specific rule-set, called the Bitcoin protocol, that establishes the rules of the network, such as bitcoin’s monetary and the method used to track bitcoin’s transaction history.
How does Bitcoin make money?
Bitcoin does not “make” money. The rule-set that Bitcoin follows, called the Bitcoin protocol, awards bitcoin to the miner that gets its block added to the Bitcoin Blockchain. Users also pay the winning miner transaction fees for processing their transactions.
Is Bitcoin real money?
Bitcoin is an alternative to centrally-issued government money that is commonly defined as fiat currency.
Can you convert Bitcoin to cash?
Yes, bitcoin can be converted to cash and other fiat currencies via a cryptocurrency exchange, such as Coinbase or Gemini. These exchanges allow you to sell bitcoin for US dollars (or other fiat currencies supported by the platform) and withdraw the fiat currency to your bank account.
This article is for informational purposes only, and it is not intended to be investment advice. Read our editorial guidelinesto learn more about how we researched Bitcoin.