What is Bitcoin? | Cryptoradar's Beginners Guide to Bitcoin
Mar 3, 2021
On January 3, 2009, an unknown developer with the pseudonym Satoshi Nakamoto released the digital currency bitcoin. The first mined bitcoin block contains the message of The Times on that day: "Chancellor on brink of second bailout for banks". Even today, this message is a symbol for the bitcoin community's dream of a new and better monetary system.
But what is bitcoin really and why has it attracted the interest of millions?
What is bitcoin?
Simply put, bitcoin is digital currency which relies on a database of transactions. This database, which is based on a novel technology called blockchain, boasts many advantages over tradtional ones: it is decentral, anonymous and tamper-proof. (We will discuss later on, why this matters.)
Unlike traditional fiat currencies like the dollar or euro, bitcoin is purely digital and does not exist physically. Bitcoins are also created electronically, through a process called mining.
Today, bitcoin is used by millions for payments and as a store of value. Because of the latter it is often referred to as digital gold. Similar to gold (which is naturally limited), the maximum supply of bitcoin is electronically limited to 21 million bitcoins.
How does bitcoin work?
Bitcoin is purely digital and only exists on computers and computer networks. This may sound disconcerting at first. But if you think about it, most of the money we use today is digitally stored on bank accounts, debit cards or credit cars. And even if you withdraw cash, the paper a 50 dollar bill is printed on is worth next to nothing. Consequently, almost all our currencies today are backed by a single factor: our trust.
Trust in the bitcoin network is established through math (sound strange, but it's true!). More specifically, bitcoin makes use of cryptography to secure transactions and its network. Bitcoin's encryption is strong and has never been hacked.
Furthermore, the bitcoin software is available open source, which means that everyone can look into its source code and propose improvements.
Moreover, bitcoin is trusted because of its blockchain which is a special kind of database that records all bitcoin transactions. The blockchain is immutable and distributed to thousands (if not millions) of computers worldwide.
A blockchain consists of a chain of cryptographically secured blocks (hence the name blockchain). Each block thereby contains all the transaction data that took place within a 10 minute timeframe. Once a block is written to the blockchain, it can never be changed again.
The bitcoin blockchain is saved on tens of thousands so called nodes worldwide. This redundancy makes it almost impossible to tamper with the transaction data. And up until today, there was not a single incident where a bitcoin transaction was manipulated.
Bitcoin use in practice
This all sounds nice and well, but what does this mean in practice?
Actually, you do not need to know exactly how bitcoins' underlying technology works. After all, you also don't know how your TV works. But you know how to use it.
Bitcoin and satoshi
As of writing of this article, each bitcoin is worth around $8,900. It's easy to see that this unit is not really practical in everyday life. Therefore, it is also possible to use fractions of a bitcoin.
The name of the smallest bitcoin unit is satoshi. The satoshi is to the bitcoin, what the cent is to the dollar. Each bitcoin can be split into 100,000,000 satoshi (1,000 satoshi are currently worth around $0.089).
Bitcoins are securely stored in a so called wallet. Before you can receive or make payments, you need to set up a bitcoin wallet. Bitcoin wallets can be web apps or apps on your computer and phone, but also hardware devices or even a piece of paper. If this sounds a bit complicated, also check our our article on cryptocurrency wallets.
There are several ways to get bitcoins. The most common one is to buy bitcoin on a cryptocurrency exchange. Cryptoradar lists many popular exchanges where you can buy bitcoins through bank transfer, credit card or other payment methods.
Most of these exchanges also come with a built-in bitcoin wallet, so you don't need to worry about setting up a wallet before your first purchase. However, please do not store larger amounts in the wallets of cryptocurrency exchanges, because they are known to be targeted by hackers.
Receiving and making payments
Using a bitcoin wallet to receive or make payments is fairly simple. It's actually quite similar to using a bank account.
If you want to receive a payment, all you need to do is to provide the sender your wallet address (which can be seen as the equivalent of a bank account number). In turn, to make payments, you only need the wallet address of the recipient.
It's important to understand that bitcoin payments are irreversible. Therefore, always be cautious when entering bitcoin addresses — if you send your bitcoins to the wrong address, they will be lost forever.
Advantages of bitcoin
When you're think about bitcoin, you'll probably think that bitcoin's biggest advantage is security and anonymity. But while these are important features, Satoshi Nakamoto envisioned bitcoin to be far more than this: his goal was to create a low-cost, open, and democratic monetary system.
Traditionally, data is stored in central databases which are managed by one or few entities. For instance, all transaction records on your bank account are safeguarded by your bank. This makes centralized systems vulnerable to malicious actors like hackers. But also human error can result in massive damages.
By contrast, bitcoin's blockchain is an open record of every single transaction which is mirrored to tens of thousands of computers. As a result, an attacker must manipulate transactions on thousands of different systems.
Furthermore, since bitcoin's source code is open, vulnerabilities that might theoretically lead to a loss of data are discovered and resolved faster than in a centralized institution which only has limited capacity dedicated towards information security.
Even though transactions are recorded on the blockchain for everyone to see, bitcoin is practically anonymous. The only piece of information that links a satoshi to its owner is his or her wallet address.
Nevertheless, bitcoin is often not completely anonymous. When you register an account on a bitcoin exchange, you usually are asked to verify your identity (as part of anti money laundering procedures). Consequently, the wallet address used with this exchange is linked to your name.
The bitcoin network is peer-to-peer. This means that actors on the bitcoin network can make transactions directly with each other and without a trusted third party.
While this may not sound spectacular, it's actually somewhat of a break-through in payment technologies. For centuries, people have trusted banks to safeguard their money and make payments on their behalf, or notaries to certify transactions such as property purchases.
These trusted middle man take a big pie in the economic system. For instance, every time you swipe your credit card at a merchant, the merchant pays between 2% and 5% of the revenue to the payment processor.
With bitcoin, there's no need for a middle man. You can easily manage your account (i.e. your bitcoin wallet) on your own and there's no need for a payment processor. This makes payments cheaper. For instance, if you would transfer $1,000,000 worth of bitcoin at the time of writing, it would cost you only 33 cents.
Even things like the cadaster could one day be managed by a blockchain, facilitating property purchases through so called smart contracts. These smart contracts would be programmed to contain the transaction details. Once a payment is made into the smart contract, the property ownership is changed in the cadaster.
Monetary policy in today's world is controlled by central banks and nation states. Single entities like the central bank of the United States, the Federal Reserve (Fed) or the Europan Central Bank (ECB) can make huge decision over our money overnight. Such as setting interest rates, increasing money supply or enforcing capital movement restrictions.
The chairmen and chairwomen of these institutions are, unfortunately, not elected by the people, but appointed by presidents and prime ministers. This means that, they may not serve the people, but politicians.
Bitcoin is completely different. Nobody is heading bitcoin, and all decisions are made based on a democratic consensus of all miners in the bitcoin networks. As a result, it is not possible that a single entity, or even a single politician, can influence the trajectory of the cryptocurrency.
Unfortunately, politicians sometimes abuse their power over monetary policy to achieve personal objectives (or objectives of an elite class).
This can especially be observed in dictatorships like Venezuela. But even in the Western World monetary policy is more and more used to achieve political objectives. For instance, citizens of Greece from 2010 to 2018 were only allowed to withdraw limited amounts of cash from their bank accounts in order to limit the strain on the Greek financial system.
Bitcoin is in stark contrast to these developments. Being a global and digital currency, bitcoin is not subject to daily politics or national borders. Bitcoin is not controlled by a single entity, cannot be banned (as acknowledged by the US Congress), and is accessible by everyone — all you need is an internet connection.
The money supply in today's world is controlled by central banks and banks. A single entity like the central bank of the United States, the Federal Reserve, can decide to increase the monetary supply by trillions of dollars — as seen during the 2020 coronavirus pandemic.
But not only the Fed can increase the money supply, also banks can do so. This process is called credit creation. What this means is that banks can create money by lending it to persons and businesses. To secure this money, the bank has to make a cash deposit of a small fraction of the credit at the Federal Reserve.
The result of this monetary system is inflation. While a certain amount of inflation is not bad at all, the current financial system encourages credit over savings. What's more, big lenders (and the biggest being the nation states) have an incentive to increase money supply in order to reduce their debt. In the past, this resulted into numerous instances of hyperinflation, where currencies became essentially worthless.
By contrast, bitcoin's money supply is fixed. There will never exist more than 21 million bitcoins. (except if the bitcoin community decides in a democratic decision to increase money supply.) This means that users of bitcoin are rewarded by holding onto their coins, instead of spending their coins or taking on debt.
How to invest in bitcoin
Now that you've learned so much about bitcoin, you probably can't wait to start investing in this cryptocurrency. Luckily, we've got your back on this one as well.
Bitcoins are traded on so called bitcoin exchanges. In principle, these platforms work in the same way a stock exchange does — except they only operate on the internet which means that you can trade bitcoin at any time, seven days a week.
However, you shouldn't just jump right in and sign up to the next best cryptocurrency exchange. Instead, you should look for an exchange that fits to you and your needs. Things to consider are:
- Payment methods: make sure that your preferred payment method is supported.
- Fees and rates: exchanges earn money through trading fees or markups on the market price. These can generally range between 0.1% to over 10% per transaction. Hence, it's important to look for a good trade-off between convenience and fees.
- User experience: if you're new to bitcoin, it might be a good idea to choose an exchange that offers as easy-to-user user interface. This helps you make better informed investment decisions and reduces the risks of making mistakes.
- Security & trust: you probably wouldn't entrust a shady salesman you meet in a dark alley with your life savings. Neither should you online. Make sure to do your due diligence and check your preferred exchanges have a good security track record and read reviews by other customers on platforms like Cryptoradar or Trustpilot.
Cryptoradar helps you finding a trustworthy bitcoin exchange through its bitcoin price comparison feature. Simply use the filters on the left side to manage your search criteria and scroll through the list of exchanges that suit your needs.
Signing up for an exchange
Once you've selected a bitcoin exchange, it's time to signup. This usually is as easy as signing up to any other internet platform: you only need to enter basic details like your name and your email address.
However, most of times, you will need to verify your identity before you can buy bitcoin. The exchange will ask you to upload identity documents (such as a copy of your passport and a recent utility bill) or to hop on a video chat with a support agent.
Buying bitcoin is actually the easiest part of the whole process. Once you've verified your identity, all you need to do is go to the buy or trade section of your exchange, and buy bitcoin.
Depending on the exchange, you will be able to pay with credit card at the time of purchase, or you will need to deposit money beforehand via bank transfer.
One more thing...
Congratulations to making your first bitcoin purchase! However, work doesn't end here.
See, big cryptocurrency exchanges are a popular target for hackers. There's huge financial rewards in hacking an exchange, potentially raking in billions of dollars from one successful hack.
Therefore, you should withdraw long-term investments to a bitcoin wallet that you manage on your own. We've covered cryptocurrency wallets in another article, explaining everything from the very basics to providing information which wallets are secure and might be a good fit for you.