Understand how Bitcoin works so you can get the most out of your crypto experience.
Invented in 2008 and first mined in 2009, Bitcoin is commonly viewed as the asset that popularized the concept of cryptocurrencies. It’s also the largest cryptocurrency by market capitalization, demonstrating its resilience and longevity. But how does Bitcoin work? And is it the same as other cryptocurrencies?
In this article, we will outline Bitcoin’s origins, how it works, and it’s advantages and disadvantages so you can decide for yourself whether it should be part of your overall crypto strategy.
How Does Bitcoin Work: Cryptocurrency Basics
Bitcoin is both a cryptocurrency and a network. Cryptocurrencies can refer to coins or tokens created and issued by a blockchain, which records transactions and requires a set of keys to complete said transactions.
Coins, Tokens, and Distributed Networks
Grasping what a virtual thing actually is can be challenging. In the world of crypto, names attached to physical things we know can sometimes help. Take coins and tokens, two often confused crypto terms. While coins and tokens are often used interchangeably, they actually refer to two different concepts.
In the physical world, a coin is a unit of currency. It’s real money that can be spent, saved, or exchanged for goods and services. In a similar way, a crypto coin is a unit of an actual cryptocurrency.
A token, on the other hand, usually represents something standing in for a specific type of utility. Take the now-defunct subway token, for example. You could use it for a subway ride, but you couldn’t buy groceries with it. Things work similarly with a crypto token.
The technical differences between the two are also important. Crypto coins operate as a native token on their own unique blockchain (more on blockchain in a bit). A Bitcoin lives on the Bitcoin blockchain and nowhere else.
Simply put, a token is created and issued on another crypto coin’s blockchain. Tokens rely on smart contracts to govern its journey and related transactions.
Whether it’s a coin or token, crypto assets depend on a distributed network of computers to exist and function. The code that governs their existence runs on a decentralized network of computers.
By avoiding reliance on a single centralized computing device, these networks are more resilient, powerful, and secure.
Blockchains and Blocks
Blockchain technology is fundamental to how Bitcoin and other cryptocurrencies operate. A blockchain is a type of distributed database ledger, which keeps an immutable record of validated transactions. The data is then recorded in a “block”, which constitutes individual segments of the blockchain.
Each block added to the blockchain holds important data about transactions, previous blocks, digital addresses, and the code that runs transactions – and the blockchain itself. Each block receives a “hash,” a 256-bit number that encodes this information.
A key to the blockchain’s immutable recording capability is each block holding information about previous blocks. Because the blocks are “chained” by this shared information, trying to alter one would result in it not aligning with its preceding or following blocks.
Public and Private Keys
Each Bitcoin is registered to a Bitcoin address, a number derived from a randomly selected private key number. The computation involved is designed to be simple to calculate — in one direction. With this in mind, it’s easy to calculate the Bitcoin address from the private key, but impossible in practical terms (or within a practical timeline) to derive the private key from a public Bitcoin address.
This enables an owner of a Bitcoin to freely share its address (also known as a “public key”) without revealing the private key needed to authorize transactions (e.g., spend the coin).
Now that we’ve seen some of the basics of how cryptocurrencies function in general, let’s dive deeper into how Bitcoin works.
How Does Bitcoin Work?
While physical currency must be minted by a government, where does Bitcoin originate? How does it get its value? Let’s take a look at this and some of Bitcoin’s other unique characteristics.
Here again, a name drawn from the physical world tries to make the virtual nature of Bitcoin’s existence more understandable.
While paper currency isn’t mined, the precious metals that once gave it value are, as are valuable gems, oil, and other natural resources.
Just as finding a vein of gold and digging it out requires time, effort and expense, creating new Bitcoins can only be done by expending significant computing resources. But instead of moving earth, drilling, and extracting, Bitcoin mining relates directly to how its blockchain functions.
You’ll recall that blockchain transactions must be verified before being immutably recorded. Since blockchain isn’t centralized, who does the verification? Bitcoin miners. They verify blockchain transactions by solving very difficult, resource-intensive math problems.
The reward for their work is earning Bitcoin, and this approach is called proof-of-work.
Since its inception, the reward for mining Bitcoin has progressively been reduced by half for every 210,000 blocks created. This prevents too much Bitcoin from being too rapidly produced, which would undermine its value.
Bitcoin’s Upper Limit
This control mechanism isn’t the only way Bitcoin’s design seeks to prevent its value from decreasing over time. Bitcoin, unlike other cryptocurrencies, has an ultimate ceiling on how many Bitcoin can be created: 21 million.
How might that help sustain its value?
Consider traditional government-backed currencies. In theory, more money can be printed at any time, increasing the amount in circulation. But printing too much devalues what’s already circulating and can trigger spiraling inflation.
By limiting how much Bitcoin can be produced, its creators sought to protect it from that eventual fate. Together with a predictable rate of growth due to the halving of mining rewards, this may make Bitcoin more of a deflationary currency, with buying power that grows.
So how does Bitcoin stack up against other cryptocurrencies? Or even other types of assets?
Bitcoin Advantages and Disadvantages
As the oldest, largest, and most well-known cryptocurrency, Bitcoin certainly has an advantage. It is the most widely accepted cryptocurrency, giving it an edge over many other cryptocurrencies that don’t have the same history or record of longevity.
As with other cryptocurrencies, Bitcoin supports user anonymity and transparency. There is no central authority required to govern its use or development — no government fiscal policy that directly affects its workings or value.
It has also shown the potential for large increases in value over time. From approximately 9 cents in 2009, it has seen its value rise to around $20,000 at the time of writing. And because of its cryptographic coding, it is almost impossible to counterfeit.
The flip side of its impressive increase in value is the volatility that Bitcoin prices have been subject to.
Since Bitcoin itself is devoid of direct government intervention, it is therefore also unregulated. So many investor protections simply do not apply to cryptocurrency, such as protecting investors’ capital if a major trading firm fails or its funds are stolen.
Compared to other cryptocurrencies, it may be widely accepted. But Bitcoin is still not as easy to use for everyday transactions as regular currency. However, more companies and websites are accepting it. El Salvador even accepts it as an official currency along with the U.S. dollar.
Finally, transactions with Bitcoin are irreversible. Unlike the credit cards we’ve become accustomed to, there is no “buyer protection” option when using crypto.
So now that you know how it works, here are a few things to keep in mind if you’re considering using Bitcoin as part of your overall crypto strategy.
Before Buying BitcoinInvesting
When it comes to buying crypto, it’s important to do your research and know the potential risks: understanding risk, determining what kind and how much you’re comfortable with, and how it relates to what you’re trying to accomplish — all of these are essential topics to consider.
Clearly identifying potential risks can help you determine if Bitcoin fits into your plans.
The next thing you’ll need to consider is the right platform for you to buy and sell it on.
Finding the Right Crypto Platform
If you’ve learned how Bitcoin works and decide to trade it, you’ll find many crypto exchanges to choose from. The best platforms, such as Binance.US, make the entire crypto experience straightforward.
For example, you’ll want a platform that has clearly listed, reasonable fees — or zero fees in the case of Binance.US (when it comes to Bitcoin trading). In fact, Binance.US is the only major crypto platform in the U.S. to offer 0% fee Bitcoin trading for eligible pairs. Also, it should be a platform you can trust — you want to make sure your personal information will be secure.
While almost all platforms offer Bitcoin, you may want to choose an exchange with a range of options. This will enable you to diversify your future crypto holdings.
Finally, make sure the platform you choose has a winning user experience. This will help you know exactly what to do when you want to buy, sell, or trade your Bitcoin — and do so easily.
You can discover more than 120 cryptocurrencies on the best exchange for low fees. Get started in minutes at Binance.US.
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