What is Bitcoin?

Bitcoin is a digital currency created in January 2009. It follows the ideas set out in a whitepaper by the mysterious and pseudonymous developer Satoshi Nakamoto, whose true identity has yet to be verified. Bitcoin offers the promise of lower transaction fees than traditional online payment mechanisms and is operated by a decentralized authority, unlike government-issued currencies.

There are no physical bitcoins, only balances kept on a public ledger in the cloud, that – along with all Bitcoin transactions – is verified by a massive amount of computing power. Bitcoins are not issued or backed by any banks or governments, nor are individual bitcoins valuable as a commodity. Despite it not being legal tender, Bitcoin charts high on popularity, and has triggered the launch of hundreds of other virtual currencies collectively referred to as Altcoins.

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What Is Bitcoin

Key Takeaways

  • Launched in 2009, Bitcoin is the world's largest cryptocurrency by market cap.
  • Unlike fiat currency, Bitcoin is created, distributed, traded and stored with the use of a decentralized ledger system known as blockchain.
  • Bitcoin's history as a store of value has been turbulent; the cryptocurrency skyrocketed up to roughly $20,000 per coin in 2017, but as of two years later, is currency trading for less than half of that.
  • As the earliest cryptocurrency to meet widespread popularity and success, Bitcoin has inspired a host of offshoots and imitators.

Understanding Bitcoin

Bitcoin is a type of cryptocurrency. Balances of Bitcoin tokens are kept using public and private "keys," which are long strings of numbers and letters linked through the mathematical encryption algorithm that was used to create them. The public key (comparable to a bank account number) serves as the address which is published to the world and to which others may send bitcoins. The private key (comparable to an ATM PIN) is meant to be a guarded secret and only used to authorize Bitcoin transmissions. Bitcoin keys should not be confused with a Bitcoin wallet, which is a physical or digital device which facilitates the trading of Bitcoin and allows users to track ownership of coins. The term "wallet" is a bit misleading, as Bitcoin's decentralized nature means that it is never stored "in" a wallet, but rather decentrally on a blockchain.

Style notes: according to the official Bitcoin Foundation, the word "Bitcoin" is capitalized in the context of referring to the entity or concept, whereas "bitcoin" is written in the lower case when referring to a quantity of the currency (e.g. "I traded 20 bitcoin") or the units themselves. The plural form can be either "bitcoin" or "bitcoins." Bitcoin is also commonly abbreviated as "BTC."

How Bitcoin Works

Bitcoin is one of the first digital currencies to use peer-to-peer technology to facilitate instant payments. The independent individuals and companies who own the governing computing power and participate in the Bitcoin network, also known as "miners," are motivated by rewards (the release of new bitcoin) and transaction fees paid in bitcoin. These miners can be thought of as the decentralized authority enforcing the credibility of the Bitcoin network. New bitcoin is being released to the miners at a fixed, but periodically declining rate, such that the total supply of bitcoins approaches 21 million. Currently, there are roughly 3 million bitcoins which have yet to be mined. In this way, Bitcoin (and any cryptocurrency generated through a similar process) operates differently from fiat currency; in centralized banking systems, currency is released at a rate matching the growth in goods in an attempt to maintain price stability, while a decentralized system like Bitcoin sets the release rate ahead of time and according to an algorithm.

Bitcoin mining is the process by which bitcoins are released into circulation. Generally, mining requires the solving of computationally difficult puzzles in order to discover a new block, which is added to the blockchain. In contributing to the blockchain, mining adds and verifies transaction records across the network. For adding blocks to the blockchain, miners receive a reward in the form of a few bitcoins; the reward is halved every 210,000 blocks. The block reward was 50 new bitcoins in 2009 and is currently 12.5. As more and more bitcoins are created, the difficulty of the mining process – that is, the amount of computing power involved – increases. The mining difficulty began at 1.0 with Bitcoin's debut back in 2009; at the end of the year, it was only 1.18. As of October 2019, the mining difficulty is over 12 trillion. Once, an ordinary desktop computer sufficed for the mining process; now, to combat the difficulty level, miners must use expensive, complex hardware like Application-Specific Integrated Circuits (ASIC) and more advanced processing units like Graphic Processing Units (GPUs). These elaborate mining processors are known as "mining rigs."

One bitcoin is divisible to eight decimal places (100 millionths of one bitcoin), and this smallest unit is referred to as a Satoshi. If necessary, and if the participating miners accept the change, Bitcoin could eventually be made divisible to even more decimal places.

What's a Bitcoin Worth?

In 2017 alone, the price of Bitcoin rose from a little under $1,000 at the beginning of the year to close to $19,000, ending the year more than 1,400% higher. More recently, the cryptocurrency has declined in value and more-or-less plateaued, save for a few periods of relatively lower price figures (the early portion of 2019, when prices hovered around $3500) and relatively higher ones (June and July of 2019, when prices briefly peaked at over $13,000). As of October 2019, Bitcoin seems to have found a new price point in the range of $8,000 to $9,000.

Bitcoin's price is quite dependent on the size of its mining network, since the larger the network is, the more difficult – and thus more costly – it is to produce new bitcoins. As a result, the price of bitcoin has to increase as its cost of production also rises. The Bitcoin mining network's aggregate processing power is known as the "hash rate," referring to the number of times per second the network can attempt to complete a hashing puzzle necessary before a block can be added to the blockchain. As of October 23, 2019, the network reached a record high 114 quintillion hashes per second.

How Bitcoin Began

Aug. 18, 2008: The domain name bitcoin.org is registered. Today, at least, this domain is "WhoisGuard Protected," meaning the identity of the person who registered it is not public information.

Oct. 31, 2008: Someone using the name Satoshi Nakamoto makes an announcement on The Cryptography Mailing list at metzdowd.com: "I've been working on a new electronic cash system that's fully peer-to-peer, with no trusted third party. The paper is available at http://www.bitcoin.org/bitcoin.pdf." This link leads to the now-famous whitepaper published on bitcoin.org entitled "Bitcoin: A Peer-to-Peer Electronic Cash System." This paper would become the Magna Carta for how Bitcoin operates today.

Jan. 3, 2009: The first Bitcoin block is mined, Block 0. This is also known as the "genesis block" and contains the text: "The Times 03/Jan/2009 Chancellor on brink of second bailout for banks," perhaps as proof that the block was mined on or after that date, and perhaps also as relevant political commentary.

Jan. 8, 2009: The first version of the Bitcoin software is announced on The Cryptography Mailing list.

Jan. 9, 2009: Block 1 is mined, and Bitcoin mining commences in earnest.

Who Invented Bitcoin?

No one knows who invented Bitcoin, or at least not conclusively. Satoshi Nakamoto is the name associated with the person or group of people who released the original Bitcoin white paper in 2008 and worked on the original Bitcoin software that was released in 2009. The Bitcoin protocol requires users to enter a birthday upon signup, and we know that an individual named Satoshi Nakamoto registered and put down April 5 as a birth date. In the years since that time, many individuals have either claimed to be or have been suggested as the real-life people behind the pseudonym, but as of October 2019, the true identity (or identities) behind Satoshi remains obscured.

Before Satoshi

Though it is tempting to believe the media's spin that Satoshi Nakamoto is a solitary, quixotic genius who created Bitcoin out of thin air, such innovations do not typically happen in a vacuum. All major scientific discoveries, no matter how original-seeming, were built on previously existing research. There are precursors to Bitcoin: Adam Back’s Hashcash, invented in 1997, and subsequently Wei Dai’s b-money, Nick Szabo’s bit gold and Hal Finney’s Reusable Proof of Work. The Bitcoin whitepaper itself cites Hashcash and b-money, as well as various other works spanning several research fields. Perhaps unsurprisingly, many of the individuals behind the other projects named above have been speculated to have also had a part in creating Bitcoin.

Why Is Satoshi Anonymous?

There are two primary motivations for keeping Bitcoin's inventor keeping his or her or their identity secret. One is privacy. As Bitcoin has gained in popularity – becoming something of a worldwide phenomenon – Satoshi Nakamoto would likely garner a lot of attention from the media and from governments.

The other reason is safety. Looking at 2009 alone, 32,489 blocks were mined; at the then-reward rate of 50 BTC per block, the total payout in 2009 was 1,624,500 BTC, which is worth $13.9 billion as of October 25, 2019. One may conclude that only Satoshi and perhaps a few other people were mining through 2009 and that they possess a majority of that stash of BTC. Someone in possession of that much Bitcoin could become a target of criminals, especially since bitcoins are less like stocks and more like cash, where the private keys needed to authorize spending could be printed out and literally kept under a mattress. While it's likely the inventor of Bitcoin would take precautions to make any extortion-induced transfers traceable, remaining anonymous is a good way for Satoshi to limit exposure.

The Suspects

Major media outlets, cryptocurrency experts and other enthusiasts have ventured guesses as to the individual or group behind the persona of Satoshi Nakamoto. On Oct. 10, 2011, The New Yorker published an article speculating that Nakamoto might be Irish cryptography student Michael Clear or economic sociologist Vili Lehdonvirta. A day later, Fast Company suggested that Nakamoto could be a group of three people – Neal King, Vladimir Oksman and Charles Bry – who together appear on a patent related to secure communications that were filed two months before bitcoin.org was registered. A Vice article published in May 2013 added more suspects to the list, including Gavin Andresen, the Bitcoin project’s lead developer; Jed McCaleb, co-founder of now-defunct Bitcoin exchange Mt. Gox; and famed Japanese mathematician Shinichi Mochizuki. 

In December 2013, Techcrunch published an interview with researcher Skye Grey who claimed textual analysis of published writings shows a link between Satoshi and bit-gold creator Nick Szabo. And perhaps most famously, in March 2014, Newsweek ran a cover article claiming that Satoshi is actually an individual named Satoshi Nakamoto – a 64-year-old Japanese-American engineer living in California. More recently, Australian computer scientist and cryptocurrency proponent Craig Wright has claimed to be Satoshi Nakamoto – although Wright also has claimed that Nakamoto plagiarized his 2008 thesis on the topic of crypocurrencies.

After a decade of Bitcoin, the world still does not know who is behind the world's top digital currency, and it's possible that the mystery will never be solved.

Can Satoshi's Identity Be Proven?

It would seem even early collaborators on the project don’t have verifiable proof of Satoshi’s identity. To reveal conclusively who Satoshi Nakamoto is, a definitive link would need to be made between his/her activity with Bitcoin and his/her identity. That could come in the form of linking the party behind the domain registration of bitcoin.org, email and forum accounts used by Satoshi Nakamoto, or ownership of some portion of the earliest mined bitcoins. Even though the bitcoins Satoshi likely possesses are traceable on the blockchain, it seems he/she has yet to cash them out in a way that reveals his/her identity. If Satoshi were to move his/her bitcoins to an exchange today, this might attract attention, but it seems unlikely that a well-funded and successful exchange would betray a customer's privacy.

Receiving Bitcoins As Payment

Bitcoins can be accepted as a means of payment for products sold or services provided. If you have a brick and mortar store, just display a sign saying “Bitcoin Accepted Here” and many of your customers may well take you up on it; the transactions can be handled with the requisite hardware terminal or wallet address through QR codes and touch screen apps. An online business can easily accept bitcoins by just adding this payment option to the others it offers, like credit cards, PayPal, etc. Online payments will require a Bitcoin merchant tool (an external processor like Coinbase or BitPay). 

Working For Bitcoins

Those who are self-employed can get paid for a job in bitcoins. There are several websites/job boards which are dedicated to the digital currency:

  • Cryptogrind brings together work seekers and prospective employers through its website
  • Coinality features jobs – freelance, part-time and full-time – that offer payment in bitcoins, as well as other cryptocurrencies like Dogecoin and Litecoin
  • Jobs4Bitcoins, part of reddit.com
  • BitGigs

Bitcoins From Gambling

It’s possible to play at casinos that cater to Bitcoin aficionados, with options like online lotteries, jackpots, spread betting, and other games. Of course, the pros and cons and risks that apply to any sort of gambling and betting endeavors are in force here too.

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How to Buy Bitcoin

Investing in Bitcoins

There are many Bitcoin supporters who believe that digital currency is the future. Many of those who endorse Bitcoin believe that it facilitates a much faster, no-fee payment system for transactions across the globe. Although it is not backed by any government or central bank, bitcoin can be exchanged for traditional currencies; in fact, its exchange rate against the dollar attracts potential investors and traders interested in currency plays. Indeed, one of the primary reasons for the growth of digital currencies like Bitcoin is that they can act as an alternative to national fiat money and traditional commodities like gold.

In March 2014, the IRS stated that all virtual currencies, including bitcoins, would be taxed as property rather than currency. Gains or losses from bitcoins held as capital will be realized as capital gains or losses, while bitcoins held as inventory will incur ordinary gains or losses. The sale of bitcoins that you mined or purchased from another party, or the use of bitcoins to pay for goods or services are examples of transactions which can be taxed.

Like any other asset, the principle of buying low and selling high applies to bitcoins. The most popular way of amassing the currency is through buying on a Bitcoin exchange, but there are many other ways to earn and own bitcoins.

Risks of Bitcoin Investing

Though Bitcoin was not designed as a normal equity investment (no shares have been issued), some speculative investors were drawn to the digital money after it appreciated rapidly in May 2011 and again in November 2013. Thus, many people purchase bitcoin for its investment value rather than as a medium of exchange.

However, their lack of guaranteed value and digital nature means the purchase and use of bitcoins carries several inherent risks. Many investor alerts have been issued by the Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA), the Consumer Financial Protection Bureau (CFPB), and other agencies.

The concept of a virtual currency is still novel and, compared to traditional investments, Bitcoin doesn't have much of a long-term track record or history of credibility to back it. With their increasing popularity, bitcoins are becoming less experimental every day; still, after 10 years, they (like all digital currencies) remain in a development phase and are consistently evolving. "It is pretty much the highest-risk, highest-return investment that you can possibly make,” says Barry Silbert, CEO of Digital Currency Group, which builds and invests in Bitcoin and blockchain companies.

Bitcoin Regulatory Risk

Investing money into Bitcoin in any of its many guises is not for the risk-averse. Bitcoins are a rival to government currency and may be used for black market transactions, money laundering, illegal activities or tax evasion. As a result, governments may seek to regulate, restrict or ban the use and sale of bitcoins, and some already have. Others are coming up with various rules. For example, in 2015, the New York State Department of Financial Services finalized regulations that would require companies dealing with the buy, sell, transfer or storage of bitcoins to record the identity of customers, have a compliance officer and maintain capital reserves. The transactions worth $10,000 or more will have to be recorded and reported.

The lack of uniform regulations about bitcoins (and other virtual currency) raises questions over their longevity, liquidity, and universality.

Security Risk of Bitcoins

Most individuals who own and use Bitcoin have not acquired their tokens through mining operations. Rather, they buy and sell Bitcoin and other digital currencies on any of a number of popular online markets known as Bitcoin exchanges. Bitcoin exchanges are entirely digital and, as with any virtual system, are at risk from hackers, malware and operational glitches. If a thief gains access to a Bitcoin owner's computer hard drive and steals his private encryption key, he could transfer the stolen Bitcoins to another account. (Users can prevent this only if bitcoins are stored on a computer which is not connected to the internet, or else by choosing to use a paper wallet – printing out the Bitcoin private keys and addresses, and not keeping them on a computer at all.) Hackers can also target Bitcoin exchanges, gaining access to thousands of accounts and digital wallets where bitcoins are stored. One especially notorious hacking incident took place in 2014, when Mt. Gox, a Bitcoin exchange in Japan, was forced to close down after millions of dollars worth of bitcoins were stolen.

This is particularly problematic once you remember that all Bitcoin transactions are permanent and irreversible. It's like dealing with cash: Any transaction carried out with bitcoins can only be reversed if the person who has received them refunds them. There is no third party or a payment processor, as in the case of a debit or credit card – hence, no source of protection or appeal if there is a problem.

Insurance Risk

Some investments are insured through the Securities Investor Protection Corporation. Normal bank accounts are insured through the Federal Deposit Insurance Corporation (FDIC) up to a certain amount depending on the jurisdiction. Generally speaking, Bitcoin exchanges and Bitcoin accounts are not insured by any type of federal or government program. In 2019, prime dealer and trading platform SFOX announced it would be able to provide Bitcoin investors with FDIC insurance, but only for the portion of transactions involving cash.

Risk of Bitcoin Fraud

While Bitcoin uses private key encryption to verify owners and register transactions, fraudsters and scammers may attempt to sell false bitcoins. For instance, in July 2013, the SEC brought legal action against an operator of a Bitcoin-related Ponzi scheme. There have also been documented cases of Bitcoin price manipulation, another common form of fraud.

Market Risk

Like with any investment, Bitcoin values can fluctuate. Indeed, the value of the currency has seen wild swings in price over its short existence. Subject to high volume buying and selling on exchanges, it has a high sensitivity to “news." According to the CFPB, the price of bitcoins fell by 61% in a single day in 2013, while the one-day price drop record in 2014 was as big as 80%.

If fewer people begin to accept Bitcoin as a currency, these digital units may lose value and could become worthless. Indeed, there was speculation that the "Bitcoin bubble" had burst when the price declined from its all-time high during the cryptocurrency rush in late 2017 and early 2018. There is already plenty of competition, and though Bitcoin has a huge lead over the hundreds of other digital currencies that have sprung up, thanks to its brand recognition and venture capital money, a technological break-through in the form of a better virtual coin is always a threat.

Bitcoin's Tax Risk

As bitcoin is ineligible to be included in any tax-advantaged retirement accounts, there are no good, legal options to shield investments from taxation.

Bitcoin Forks

In the years since Bitcoin launched, there have been numerous instances in which disagreements between factions of miners and developers prompted large-scale splits of the cryptocurrency community. In some of these cases, groups of Bitcoin users and miners have changed the protocol of the Bitcoin network itself. This process is known "forking" and usually results in the creation of a new type of Bitcoin with a new name. This split can be a "hard fork," in which a new coin shares transaction history with Bitcoin up until a decisive split point, at which point a new token is created. Examples of cryptocurrencies that have been created as a result of hard forks include Bitcoin Cash (created in August 2017), Bitcoin Gold (created in October 2017) and Bitcoin SV (created in November 2017). A "soft fork" is a change to protocol which is still compatible with the previous system rules. Bitcoin soft forks have increased the total size of blocks, as an example.