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What is Bitcoin, And How Does It Work?
1. INVESTING WHAT IS BITCOIN, AND HOW DOES IT WORK?
What is Bitcoin, And How Does It Work?
Bitcoin is regarded as the first cryptocurrency, using computing power rather than governments or banks as
intermediaries.
Kevin Voigt Jul 16, 2021
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Definition: What is Bitcoin?
Bitcoin is decentralized digital cash that eliminates the need for intermediaries like banks
and governments, using instead a peer-to-peer computer network to confirm purchases
directly between users.
Fiat money (like the U.S. dollars in your bank account) is backed and regulated by the
government that issues it. Bitcoin, on the other hand, is powered through a combination of
peer-to-peer technology — a network of individuals, much like the volunteer editors who
create Wikipedia — and software-driven cryptography, the science of passing secret
information that can only be read by the sender and receiver. This creates a currency
backed by code rather than items of physical value, like gold or silver, or by trust in central
authorities like the U.S. dollar or Japanese yen.
» What's BTC's price now? Check the current bitcoin price here.
History of Bitcoin
Bitcoin was launched in 2009 and is regarded as the first cryptocurrency. The concept of
blockchain technology had been discussed in academic papers for decades, but a paper
titled “Bitcoin: A Peer-to-Peer Electronic Cash System” helped launch cryptocurrency into
reality.
“What is needed is an electronic payment system based on cryptographic proof instead of
trust, allowing any two willing parties to transact directly with each other without the need
for a trusted third party,” wrote Satoshi Nakamoto — the pseudonym of the mysterious
author of the Bitcoin paper — in a white paper introducing the open-source technology. It’s
come a long way since then, now accepted as payment by companies such as PayPal,
Microsoft and Whole Foods.
The price of one bitcoin has grown substantially. In April 2011, the price was $1. By April
2021, it reached a record spot price approaching $65,000 before sliding back down. As of
early July, bitcoin was trading in a range between $32,000 and $35,000.
» Ready to invest? Here's our picks for best Bitcoin and cryptocurrency exchanges.
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2. How does Bitcoin work?
Each bitcoin (trading symbol “BTC,” though “XBT” is also used) is a computer file stored in
a digital wallet on a computer or smartphone. To understand how the cryptocurrency
works, it helps to understand these terms and a little context:
•Blockchain: Bitcoin is powered by open-source code known as blockchain, which creates a
shared public ledger. Each transaction is a “block” that is “chained” to the code, creating a
permanent record of each transaction. Blockchain technology is at the heart of more than
10,000 cryptocurrencies that have followed in Bitcoin’s wake.
•Private and public keys: A bitcoin wallet contains a public key and a private key, which
work together to allow the owner to initiate and digitally sign transactions, providing
proof of authorization.
•Bitcoin miners: Miners — or members of the peer-to-peer platform — then independently
confirm the transaction using high-speed computers, typically within 10 to 20 minutes.
Miners are paid in bitcoin for their efforts.
» Ready to buy? Learn how to buy Bitcoin
What is Bitcoin mining?
Bitcoin miners — also known as "nodes — are the owners of high-speed computers which
independently confirm each transaction, and add a completed "block" of transactions to the
ever-growing "chain," which has a complete, public and permanent record of every bitcoin
transaction.
Miners are paid in bitcoin as reward for their efforts, which incentivizes the decentralized
network to independently verify each transaction. This independent network of miners also
decreases the chance for fraud or false information to be recorded, as the majority of
miners need to confirm the authenticity of each block of data before it's added to the
blockchain, in a process known as "proof of work."
» Learn more: What is blockchain, and how does it work?
How does Bitcoin make money?
Bitcoin value follows the law of supply and demand — and because demand waxes and
wanes, there’s a lot of volatility in the cryptocurrency’s price.
Besides mining bitcoin, which requires technical expertise and an investment in high-
performance computers, most people purchase bitcoins as a form of currency
speculation — betting that the U.S. dollar value of one bitcoin will be higher in the future
than it is today. But that's difficult to predict.
» Learn more: What is cryptocurrency?
Storing your bitcoins: Hot wallets vs. cold wallets
Bitcoins can be stored in two kinds of digital wallets:
•Hot wallet: Digital currency is stored in the cloud on a trusted exchange or provider, and
accessed through a computer browser, desktop or smartphone app.
•Cold wallet: An encrypted portable device much like a thumb drive that allows you to
download and carry your bitcoins.
Basically, a hot wallet is connected to the internet; a cold wallet is not. But you need a hot
wallet to download bitcoins into a portable cold wallet.
» Learn more: What's the best bitcoin wallet for you?
Buying Bitcoin: The pros and cons
With a speculative asset class like bitcoin, it’s better to start with why you should be wary:
Bitcoin: The cons
•Price volatility. The 2017 spike in Bitcoin’s price was driven by speculators rushing into the
bitcoin market. The recent gains are good news if you bought Bitcoin in December 2018;
those who bought in 2017 when Bitcoin’s price was racing toward $20,000 had to wait
until December 2020 to recover their losses.
•Hacking concerns. While backers say the blockchain technology behind bitcoin is even
more secure than traditional electronic money transfers, bitcoin hot wallets have been an
attractive target for hackers. There have been a number of high-profile hacks, such as the
news in May 2019 that more than $40 million in bitcoin was stolen from several high-net-
worth accounts on cryptocurrency exchange Binance (the company covered the losses).
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3. •Limited (but growing) use. In May 2019, telecommunications giant AT&T joined companies
such as Overstock.com, Microsoft and Dish Network in accepting bitcoin payments. But
these companies are the exception, not the rule.
•Not protected by SIPC. The Securities Investor Protection Corporation insures investors
up to $500,000 if a brokerage fails or funds are stolen, but that insurance doesn’t cover
cryptocurrency.
» Beyond Bitcoin: What are altcoins, and how do they work?
Bitcoin: The pros
•Private, secure transactions anytime — with fewer potential fees. Once you own bitcoins,
you can transfer them anytime, anywhere, reducing the time and potential expense of any
transaction. Transactions don’t contain personal information like a name or credit card
number, which eliminates the risk of consumer information being stolen for fraudulent
purchases or identity theft. (Keep in mind, though, that to purchase bitcoins on an
exchange, generally you'll first need to link your bank account.)
•The potential for big growth. Some investors who buy and hold the currency are betting
that once Bitcoin matures, greater trust and more widespread use will follow, and
therefore Bitcoin’s value will grow.
•The ability to avoid traditional banks or government intermediaries. After the financial
crisis and the Great Recession, some investors are eager to embrace an alternative,
decentralized currency — one that is essentially outside the control of regular banks,
governing authorities or other third parties. (However, to buy Bitcoin on an exchange with
U.S. dollars, you'll likely need to link your bank account.)
Where can I buy Bitcoin?
There are four ways to get bitcoins:
•Cryptocurrency exchanges. There are a number of exchanges in the U.S. and abroad.
Coinbase is the largest cryptocurrency exchange in the U.S., trading more than 30
cryptocurrencies.
» Learn more: Read our Coinbase review
•Investment brokerages. Robinhood was the first mainstream investment broker to offer
Bitcoin and other cryptocurrencies (Robinhood Crypto is available in most, but not all, U.S.
states). Tradestation, eToro and Sofi Active Investing also offering cryptocurrency trading
in most U.S. states.
•Bitcoin ATMs. There are more than 7,000 bitcoin ATMs in the U.S. (search Coin ATM
Radar to find one near you).
•Peer-to-peer purchases. True to its original spirit, you can buy bitcoins directly from other
bitcoin owners through peer-to-peer tools like Bisq, Bitquick and LocalBitcoins.com.
•Bitcoin mining. You can earn bitcoins through mining, but the technical expertise required
and computer cost puts this option out of reach for most.
Should you buy Bitcoin?
Bitcoin is an incredibly speculative and volatile buy. It’s worth remembering that stock
trading can give you a similar thrill — and picking stocks of established companies is
generally less risky than investing in Bitcoin. (A good rule of thumb is to devote less than
10% of your overall portfolio to individual stocks or speculative assets like Bitcoin.)
» Read our top picks for best online stock brokers
What online brokers offer Bitcoin?
Of the online brokerages and cryptocurrency exchanges that NerdWallet reviews, the
following currently offer Bitcoin.
Available for: Learn more
Binance.US
Access to buy and sell more than 50
cryptocurrencies.
Read review
Coinbase
Access to buy and sell more than 50
cryptocurrencies.
Read review
eToro Trading platform with access to 18 cryptocurrencies. Read review
Gemini Ability to buy and sell 40 cryptocurrencies. Read review
Robinhood
Seven cryptocurrencies including Bitcoin, Bitcoin
Cash and Ethereum.
Read review
SoFi Active
Investing
Offers 20 cryptocurrencies for trading including
Bitcoin, Ethereum and Litecoin.
Read review
TradeStation
Offers trading for five cryptocurrencies, including
Bitcoin, Bitcoin Cash and Ethereum.
Read review
Webull
Offers four cryptocurrencies for trading: Bitcoin,
Bitcoin Cash, Ethereum and Litecoin.
Read review
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4. * These providers are NerdWallet advertising partners.
Disclosure: The author held no positions in the aforementioned securities at the original time
of publication.
About the author: Kevin Voigt is a personal finance writer at NerdWallet. He has covered financial issues for 20
years, including for The Wall Street Journal and CNN.com. Read more
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