What is Bitcoin?

Bitcoin is a digital currency that was created to establish a peer-to-peer electronic payment system that enables one party to send a payment to another party without having to go through a central authority such as a financial institution. Besides functioning as a currency, some treat Bitcoin as an investment and buy it on exchanges as they would for stocks, expecting its value to increase over time. Given that Bitcoin is a decentralized community and an open-source project, anyone can join and participate in its development.

Bitcoin's origin and evolution

The concept of Bitcoin was published in 2008 in a white paper written by an anonymous figure under the pseudonym Satoshi Nakamoto. No one knows the author’s identity or if it is a single person or a group of people. The paper outlined how Bitcoin would work, and the currency was officially launched on Jan. 3, 2009.

Bitcoin use cases

• Bitcoin is a digital currency that can be used for payments between peers as well as to pay for goods and services.
• Bitcoin is an investment that can be stored for value.
• Bitcoin’s open-source technology makes it a resource and an inspiration for others who want to develop something similar.

How does Bitcoin work?

Bitcoin relies on two underlying mechanisms to function: the blockchain and the mining process.

What is the blockchain?

The blockchain is a shared digital ledger that holds a record of all bitcoin transactions. Recent cryptocurrency transactions are grouped into "blocks" by miners. The blocks are then cryptographically secured before they get linked to the existing blockchain. The blockchain is accessible to everybody at any time but can only be changed with the computing power of the majority of the network.

What is mining?

Mining is the process of securing each block to the existing blockchain. Once a block is secured, new units of cryptocurrency known as “block rewards” get released. Miners can put these units directly back into the market. Due to their key role in the process, miners can exert considerable control over bitcoin.

What is Bitcoin used for?

Bitcoin is primarily used as a peer-to-peer payment system between individuals; however, the places where you can use Bitcoin have expanded in recent years. Businesses, from large corporations like Expedia to small and medium-sized businesses (SMEs), are increasingly accepting Bitcoin as a digital payment. Countries are also slowly embracing Bitcoin. El Salvador is one of the first to have adopted Bitcoin as an official currency. As a form of investment, individuals can invest in Bitcoin to help diversify a portfolio of stocks and bonds.

Bitcoin’s features

Key features

• Distributed: all Bitcoin transactions are recorded on a public ledger that is the “blockchain”. The network relies on people voluntarily storing copies of the ledger and running the Bitcoin protocol software. These “nodes” contribute to the correct propagation of transactions across the network by following the rules of the protocol as defined by the software client. There are currently several thousands of nodes distributed globally, making it virtually impossible for the network to suffer downtime or lost information.
• Transparent: the addition of new transactions to the blockchain ledger and the state of the Bitcoin network at any given time is achieved by consensus and in a transparent manner.
• Peer-to-peer: although nodes store and propagate the state of the network, payments take place directly from one person or business to another. This means there is no need for any “trusted” third party to act as an intermediary.
• Pseudo-anonymous: identity information is not inherently tied to Bitcoin transactions. Instead, transactions are tied to addresses that take the form of randomly generated alphanumeric strings.
• Public: all Bitcoin transactions are recorded and publicly available for anyone to see.

Economic features

• Fixed supply: One of the key parameters in the Bitcoin protocol is that the supply will expand over time to a final total of 21 million coins. This fixed and known total supply is claimed to be one of its several characteristics that have given value as an investment.
• Incentive-driven: the miners, who are considered a core set of participants, are driven by profit to contribute the resources needed to maintain and secure the network. Through a process known as Proof-of-Work (PoW), miners compete to add new blocks to the chain that constitutes the blockchain. Moreover, miners tend to use their profits in bitcoin to cover their mining costs. The mining process is seen as a fair mechanism for widely distributing bitcoin.

Disadvantages of Bitcoin

The biggest risks related to Bitcoin are hacks, fraud and the lack of regulation. The cryptocurrency market is highly volatile, and the Bitcoin price can fluctuate greatly. Due to its unprecedented boom, regulation for Bitcoin and other cryptocurrencies has also been slow to be developed, leaving large portions of the market unregulated.

Can Bitcoin be used for illicit activities?

Like traditional fiat money, Bitcoin can be used by criminals. However, unlike transactions with paper money, Bitcoin transactions can be viewed and traced by anyone. Despite Bitcoin often being associated in the media with the dark net and underground activity, cryptocurrency is poorly suited for such purposes. There are specialized companies that help government agencies track shady cryptocurrency transactions. The fact that the Bitcoin public ledger is transparent and that all transactions are visible creates trust.

The bottom line

Bitcoin was the first cryptocurrency and is intended to be used as a form of payment outside of fiat currencies. Since its introduction in 2009, Bitcoin's popularity has surged and its uses expanded, resulting in the creation of many new competitor cryptocurrencies.

Though the process of generating Bitcoin is complex, investing in it is more straightforward. Investors and speculators can buy and sell Bitcoin on crypto exchanges. As with any investment, particularly one as new and volatile as bitcoin, investors should carefully consider if bitcoin is the right investment for them.