What Is Bitcoin & How Does It Work
Bitcoin is the most widely recognized cryptocurrency in the world. In early 2021, Bitcoin surpassed a $1 trillion dollar market cap, making it one of the fastest currencies to reach such a massive scale. But where does Bitcoin come from; what is the source of origin? Who created this digital currency that is giving central banks a reason to sweat? All excellent questions without simple answers.
A Quick History of Bitcoin
Bitcoin first surfaced publicly in 2008 when an anonymous person or persons identifying themselves by the name of Satoshi Nakamoto published a white paper titled "Bitcoin: A Peer-to-Peer Electronic Cash System." The whitepaper described a cryptographic system Nakamoto created, in part, as a response to the financial collapse of 2008.
Every transaction that occurs on the blockchain is transparent and open to public scrutiny. For these trustless transactions to be confirmed, a series of mathematical equations is conducted by computers worldwide, called nodes. Nodes are operated by "miners" using equations to verify transactions on the blockchain. In exchange for validating transactions, the miner is rewarded with a specific amount of newly discovered Bitcoin.
Bitcoin was programmed with scarcity as a core element of its premise. Miners can unlock only 21 million Bitcoin. The reason for scarcity being programmed into the system was to allow Bitcoin to hedge against inflation, making Bitcoin a powerful tool to protect one's assets against inflation and deteriorating fiat currencies.
A Store of Value or A Currency?
A mainstream debate regarding Bitcoin is the following; is Bitcoin a store of value, or is it a currency? The answer depends on whom you ask. Technically, Bitcoin acts as both a store of value and a currency. Let's look deeper at both of these aspects because understanding both arguments is key to utilizing Bitcoin in your portfolio and understanding the larger debate within society regarding Bitcoin's purpose.
Bitcoin as a Store of Value
As mentioned above, scarcity was programmed into Bitcoin at its inception. There is no way to create more Bitcoin once the 21 million mark is reached. Thus, the value of Bitcoin will only increase over time. As of June 2021, Bitcoin has increased approximately 271% in the past 12 months and approximately 5,292.96% over its entire existence. If an investor purchases Bitcoin, places it in cold storage, and holds it for years, in theory, their investment will only increase dramatically over time.
While the price of Bitcoin fluctuates widely and is considered a volatile asset, when we step out and look at longer time frames, Bitcoin appreciation is much larger and more stable than almost any other investment instrument or asset.
Even the large banking institutions who ignored or openly denounced Bitcoin for years are now investing in Bitcoin, creating crypto investment instruments for their clients, and are stating that Bitcoin has the power to outweigh gold in value.
In 2021, a multitude of large corporations, financial institutions, and high-profile investors announced they began to accumulate Bitcoin as a way to protect their assets from the deflating dollar. Holding Bitcoin on their balance sheets helps offset the deflationary impacts of their capital assets over time and protects against the effects of inflation on their bottom lines.
Another significant aspect of the store of value debate is the ability for unbanked or underserved populations to store their assets in Bitcoin and essentially become their own bankers. Minorities and underserved populations who often can not access traditional banking for many reasons can now purchase and hold Bitcoin or other cryptocurrencies and create generational wealth to pass down to their children and grandchildren.
Bitcoin As Currency
Technically, Bitcoin also functions as a currency. Exchanges of value between two parties can occur using Bitcoin in the same manner as using dollar bills or a debit card. But, the confirmation of the transaction is not instantaneous and can take minutes or hours depending on how many transactions are flowing through the Bitcoin blockchain at that moment.
The bigger question is this; is Bitcoin an efficient currency? Right now, the answer is no. We can not all walk into Starbucks and purchase a coffee and have the transaction confirmation happen fast enough. There are other aspects to Bitcoin, such as the "second-layer" called the Lighting Network, which expedites transactions on the Bitcoin blockchain.
How Bitcoin Works
Now that we've touched on the significant debates surrounding Bitcoin's core financial uses, let's discuss how it works. At the beginning of this article, we explored the technical functionality of Bitcoin, blockchains, and mining. Let's talk about how Bitcoin works for the individual user.
If you are interested in using Bitcoin as part of your investment portfolio, you must start by purchasing Bitcoin. Please keep in mind that we are not giving investment advice. We're just looking at the technical process of buying and using Bitcoin. The easiest way is to purchase Bitcoin using various platforms, including; CashApp, Coinbase, or Gemini.
If you are in the United States, your options will be limited, and each app will require KYC, or Know Your Customer, confirmation similar to that of banking institutions. These apps and platforms make purchasing Bitcoin and other cryptocurrencies relatively easy and straightforward. Once KYC confirmation is complete, connect your app with your bank account and purchase your desired amount of Bitcoin.
Technically, once purchased, your Bitcoin is accessed through a digital wallet that stores the encrypted key that connects you to your coins, which live on the blockchain, not in your wallet. If you possess your encrypted private key, you are the only person who can access your coins. The same applies to all cryptocurrencies and is one of the inherent risks in using cryptocurrencies, and securing your coins in wallets that can not be stolen or hacked falls upon the user.
Investors must practice excellent digital privacy and security to protect their investments and learn how to navigate the technicalities of working with cryptocurrencies. Once Bitcoin is stolen or removed from your wallet by nefarious actors, a rare occurrence, but it does happen, there is no way to restore your coins. Security and restoring lost wallet access are major drawbacks to decentralization.
While the purchasing action itself is straightforward, there are aspects to consider that reach beyond the scope of this article. Such apps are centralized and owned by US corporations. When you purchase cryptocurrencies through a centralized platform, you do not technically own your crypto; it is stored in a general wallet on the platform. The phrase, "not your keys, not your coins," is derived from the fact that you are not technically in possession of the coins unless you have the coin access secured in your wallet and off the centralized platform. To solve this problem, we move into our "Store of Value versus Currency" debate.
Suppose you use Bitcoin as a store of value and wish to hold it (also called HODL in the crypto community). In that case, you will need to move your Bitcoin off of centralized platforms and onto a special wallet, either digital or a physical hardware device, that you own and protect. Once transferred, you leave the Bitcoin in place and do not transfer it.
If you're using Bitcoin as a currency or wish to trade it as it fluctuates in value, you will want to use a digital wallet with easy access for transactions. If you're looking to trade Bitcoin, you will want to use centralized exchanges, such as Binance, Coinbase Pro, or Gemini.
Moving Forward with Bitcoin
Cryptocurrencies, and Bitcoin specifically, are a diverse, dynamic, and exciting aspect of decentralized finance that forces centralized banks and governments to reevaluate the future of currencies. Corporations and institutions now realize that Bitcoin can help them protect capital assets as economic forces and governmental actions impact fiat valuations and the number of fiat in circulation. Individuals and retail investors are turning to Bitcoin and other cryptocurrencies to protect their assets and create generational wealth in ways that were not possible 15 years ago.
Regardless of your reasons for working with Bitcoin, understanding the role this technology plays in the evolution of both the internet and our economic structures is vital to staying ahead of the coming financial trends and instability caused by a rapidly changing world.
Sources:
What Is Bitcoin And How Does It Work?
Bitcoin What Happens to Bitcoin After All 21 Million Are Mined?
JP Morgan says Bitcoin value could triple, challenge gold
Black Americans Are Embracing Stocks and Bitcoin to Make Up for Stolen Time