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What Is Bitcoin, and How Does It Work?


Written by Tom Tragett  Lead Writer and Analyst at Libertex Group Tom Tragett

You must have heard about it. The first and most famous cryptocurrency has been in the headlines due to a vertiginous increase in value, breaking the threshold of $1,000 for the first time on 1 January 2017. It exceeded $19,000 in December of that year and then lost approximately 50 per cent during the first part of 2018. But Bitcoin's history is much more extensive and isn't limited to headlines about its price fluctuation. It incorporates technology, currency, mathematics, economics and social dynamics.

It's multifaceted, highly technical and continues to evolve very fast. But because it's completely digital and doesn't correspond to any existing fiat currency, it may be hard to understand for new users. This guide intends to clarify some fundamental concepts and answer basic questions about Bitcoin.

Bitcoin was invented in 2009 by a person (or group) called Satoshi Nakamoto. Its declared objective was to create "a new electronic cash system" that was "completely decentralised without a server or central authority". However, after cultivating the concept and technology, in 2011, Nakamoto handed over the source code and domains to other Bitcoin community members and disappeared.

What Is Bitcoin?

Bitcoin is a digital currency. It's a complex concept, not simply an assigned value of money stored in a digital account, such as your bank account or line of credit. Moreover, Bitcoin doesn't have a corresponding physical element, such as coins or paper bills.

How Does Bitcoin Differ from Traditional Currencies?

Bitcoin can be used to pay electronically if both parties wish to do so. In that sense, it's equal to dollars, euros or yen, which are also traded digitally.

But it differs from digital fiat currencies in a few important ways:

How Are Bitcoin Transactions Monitored?

Bitcoin uses an elementary data log file called a blockchain. Each blockchain is unique to each user and their personal Bitcoin wallet. All Bitcoin transactions are recorded and made available in a public ledger, which helps guarantee their authenticity and prevent fraud. This process helps avoid duplicate transactions and people copying BTC.

While each BTC records the digital address of each wallet it touches, the Bitcoin system DOESN'T record the names of people who own wallets. In practical terms, this means that each transaction is digitally confirmed but completely anonymous simultaneously.

So, although people can't easily see their identity, they can see the history of their Bitcoin wallet. This is good since a public history adds transparency and security and prevents people from using BTC for dubious or illegal purposes.

How Does Bitcoin Work?

Compare it to Torrent, the P2P network you definitely never used to download lots of music in the early 2000s. In this case, though, instead of moving files from one place to another, the Bitcoin network generates and verifies that the blocks of information are expressed as a virtual currency.

Bitcoin and its many derivatives are known as cryptocurrencies. The system uses cryptography (extremely advanced cryptography called blockchain) to generate new currencies and verify those transferred from one user to another. Cryptographic sequences serve to:

Before a Bitcoin can be spent, it must be generated by the system or mined. While a fiat currency needs to be minted or printed by a government, the mining aspect of Bitcoin is designed to make the system self-sufficient. People mine BTC by providing processing power from their computers to the distributed network, which generates new data blocks that contain the distributed global record of all transactions.

The coding and decoding process for these blocks requires vast processing power. The user who successfully generates a new block (or, more accurately, the user whose system generated the random number that the system accepts as a new block) is rewarded with some BTCs or a portion of the transaction fees.

In this way, moving BTCs from one user to another creates the demand for more processing power donated to the network on an equal footing, generating new Bitcoins that can then be spent. It's a system of self-replication that generates wealth ... or at least generates cryptographic representations of value that correspond to wealth.

What Is Bitcoin Mining?

Bitcoin mining refers to the process through which new BTCs are created due to the computers that help maintain the network. The computers involved in Bitcoin mining are in a kind of computational race to process the new transactions that enter the network. The winner, usually the person with the fastest computers, receives a portion of new BTCs. There's usually a new winner every 10 minutes. We have already mentioned that there'll be a total number of up to 21 million BTCs worldwide. After reaching this number, no new coins will be created, and it's expected to happen in 2140. So far, around 16 million BTCs have been distributed. Each existing coin was created through this method and was initially granted to a computer that helped maintain these records. Anyone can set up their PC to extract Bitcoin, but these days only people with specialised hardware manage to win the race.

Bitcoin has no official price. Instead, it's established according to what people are willing to pay. The price is usually shown as the cost of an entire Bitcoin. However, exchanges will allow you to buy any amount, and you can buy less than one BTC. The Libertex price index is a good resource for viewing Bitcoin prices in real-time.

When Is The Right Moment to Buy?

As in any market, nothing is certain. Throughout its history, Bitcoin has generally increased its value quickly, followed by a slow and steady decline until it stabilises. Use tools such as the Libertex price index to analyse charts and understand the history of Bitcoin's price. Bitcoin is global and isn't affected by any country's stability or financial situation. For example, speculation about the devaluation of the Chinese yuan has caused greater demand from China, which has also raised the rate in exchanges based in the United States and Europe. Global chaos is generally considered beneficial for the price of Bitcoin since it's apolitical and beyond any government's control or influence.

When thinking about how the economy and politics will affect the price of Bitcoin, it's important to think globally and not only about what is happening in a single country.

Bitcoin Pros and Cons

Strong Points of Bitcoin

However, that doesn't mean that Bitcoin doesn't have its place in the future. Let's talk about some advantages and disadvantages of Bitcoin with respect to traditional currency.

However, you should remember that any conventional income you receive from transactions in Bitcoin will be treated in the usual way. So, if you transfer BTCs worth $10,000 to your bank account through a Bitcoin market, you'll have to declare them as income in your tax forms. In addition, trading Bitcoin doesn't override other standard requirements for taxation: Even if you buy a new car with BTC from a private seller, you'll still have to register that car with the government and pay taxes based on its market value.

Weak Points of Bitcoin

So, if Bitcoin is so good, why doesn't everyone use it? Well, it has some drawbacks too, especially at present.

However, the previous weaknesses aren't that significant if you exchange BTC. As a merchant, you're not the owner of Bitcoins, you don't make payments with them, but you get a reward for a successful investment. So, what is the difference between buying and selling Bitcoins?

When you buy or sell cryptocurrencies, you buy the asset itself. To buy Bitcoin, you need to download a wallet. The Bitcoin wallet looks a bit like the online banking software most traditional commercial banks use for their customers.

Once you have a Bitcoin wallet, use a traditional payment method, such as a credit card, bank transfer or debit card, to buy BTCs on a Bitcoin exchange platform. Then, they are transferred to your wallet. The most important part of any wallet is to keep your passwords (a string of characters) safe. If you lose them, you lose access to the BTCs stored there. Once you have Bitcoins in your wallet, you can make payments or exchanges.

Pros

Cons

What Is Bitcoin Trading?

You can sell and buy Bitcoins not only with fiat money, such as dollars or euros but also by exchanging Bitcoin for other cryptocurrencies, generating profits due to the difference in your costs. This is a way to get involved in the world of cryptocurrencies without having to undermine them.

In margin trading, you'll borrow buying and selling power in exchange for a portion of your funds being reallocated (the margin). This margin will only be accessible again after an operation in which you return the capital that you borrowed.

Pros

Cons

*Multiplier negotiation allows you to negotiate an amount you don't have. Crypto trading services usually offer this feature.

Cryptocurrency CFDs (Contracts for Difference)

Libertex offers BitcoinCFDs that allow you to trade cryptocurrencies without owning them. Crypto CFDs are contracts between buyers and sellers in which sellers pay buyers the difference between the current value of the encryption assets and their value when the contract expires. Please remember that while trading can be worth it for some people, it always comes at a risk.

What Is Bitcoin Cash?

In August of 2017, the Bitcoin community had a disagreement over the rules governing the mining process, specifically about what constitutes the appropriate size (in megabytes) of a block. After the inability to reach a consensus, two sides were formed. On the one hand, the Bitcoin traditionalists and the group that cheered bigger blocks, on the other. Finally, the members of the second side separated to create the Bitcoin Cash.

Although they share a common digital ancestor, each has its own blockchain with slightly different protocols. (For what it's worth, BTC miners are running on 1MB blocks, Bitcoin Cash uses 8MB blocks). The bifurcation is expected to happen again in the future.

Are There Any Other Cryptos? Yes. More than a thousand, with more outbreaking every day. Apart from Bitcoin, which is the true progenitor of all of them, other known alternative currencies include Ethereum, Ripple and Litecoin.

Conclusion

To sum up, we can say that Bitcoin and cryptocurrencies are among the most attractive trade assets. On the other hand, as we can see, investing in Bitcoin involves risks of all kinds, from the volatility issue to the probability of being scammed. Most people trade cryptocurrencies through cryptocurrency exchange platforms; however, there is another option with which one can speculate on price movements. This can be done by using contracts for difference or CFDs. When you have a contract, you do not actually own the underlying asset; instead, you have the right to receive the difference between an asset's current value and its future value. If your prediction about the underlying asset's value is incorrect and the difference is negative, you'll have to cover that loss.

Libertex lets you work with CFD right now and is completely free on the demo account, giving you the option to practise your skills and if you feel ready to start trading CFDs Bitcoin on a real account!

We also offer you free lessons on how to trade CFDs. But please note that trading CFDs with leverage can be risky and can lead to losing all of your invested capital. 

Why trade with Libertex?

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