Takeaways
- Bitcoin was launched in 2009 and is the largest cryptocurrency by market capitalization.
- Bitcoin can be purchased and traded on various cryptocurrency exchanges.
- Bitcoin is held as a store of value, traded as an investment, and used as currency.
- Blockchain technology helps keep decentralized ledger systems for Bitcoin.
- Bitcoin is mined, created, and traded among investors seeking a haven from inflation.
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What is Bitcoin?
Bitcoin, or BTC, is the first decentralized digital currency based on cryptography. Bitcoin is the first cryptocurrency to facilitate peer-to-peer payments and is a ubiquitous digital money form. Bitcoin is a decentralized form of payment, which means it is outside the control of a central regulator like the Federal Reserve. Bitcoin has exploded in popularity since its inception and has become a household name because of its aim to become the cash for the internet. Bitcoin is the world’s largest cryptocurrency by market capitalization [1].
The story of Bitcoin’s origin is vague; many believe this opaqueness is by design. Bitcoin debuted in 2009, and its proof-of-concept was created by a developer or developers using the alias Satoshi Nakamoto. Since then, other developers have been working on expanding the original Bitcoin capacity and technology.
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Bitcoin was the first cryptocurrency and remains the most widely used, as well as the yardstick for measuring the success of other cryptocurrencies. It popularized the idea of operating on blockchain technology, which keeps a public record of each transaction with a Bitcoin. Thousands of nodes maintain the Bitcoin ledger and monitor the limited supply of 21 million coins. The finite supply of coins has attracted investors who want digital money to hedge against rising inflation.
Each time Bitcoins are mined, distributed, or received, they become part of a verified transaction network and are secured by complicated cryptographic operations. Cryptography is what gives Bitcoin such high levels of security and anonymity. Over the years, hedging against inflation and stock market turbulence has become a popular investment. Bitcoins have fluctuated in value significantly, which has drawn in speculators, investors, and Bitcoin enthusiasts.
How Bitcoin Works
Bitcoin runs on a decentralized network using blockchain technology. This means thousands of computers operate as nodes on a network, maintaining the immutable record of every Bitcoin transaction.
When someone sends Bitcoin, the transaction is broadcast to the network and combined with other transactions until it reaches a particular size to optimize the network economy. Then, it is committed to the blockchain in a block, verified and authorized by a consensus of Bitcoin nodes. These nodes verify the transaction using cryptographic rules to ensure no counterfeiting or fraudulent activity. After the transaction is verified, it is added to the official copy of the blockchain.
The process of adding transactions to the blockchain is called mining. Most miners operate massive arrays of powerful processing units to solve complex mathematical problems. These solutions act as transaction validations, referred to as blocks. The data in these blocks are encrypted using the SHA-256 hashing algorithm [2]. When a solution to the current equation is found, the system mints new Bitcoins. Everyone who worked on helping to find that solution is rewarded with a portion of the transaction fees and the Bitcoins created in the block. This payment is known as the "block reward."
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The decentralized nature of Bitcoin ensures that no single entity can control the currency unless it operates most of the network, making security far greater and nearly eliminating the potential for rampant fraud. Bitcoins can only be spent by the ledger-proven rightful owner, making the system "trustless" by removing the need for a third party to verify or even allow transactions.
Because Bitcoin has become a popular form of digital payment, you can purchase it on cryptocurrency exchanges like CoinBase. Many online and offline businesses now accept Bitcoin as a form of payment. You can also pay for goods and services with a mobile app or your hot wallet (more below).
Mining and Investing in Bitcoin
Bitcoin’s potential to generate money for investors comes from either mining or investment appreciation.
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Mining for Bitcoin
In the early days of Bitcoin, you could mine for coins with your personal computer. However, the computational power capabilities increased as the competition and network to mine for Bitcoin increased.
Individuals or companies use graphic processing units (GPUs) and specialized hardware to solve incredibly complex math problems. These solutions help validate transactions and contribute to the security of the network.
Successful miners earn Bitcoin as a reward for their computational contribution and a portion of transaction fees that help support the network. Mining is highly competitive and resource-intensive, requiring massive investment into state of the art computers with high-end cooling and power equipment.
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You can purchase miner equipment, like the ASIC miner, to start mining for Bitcoin. Remember that as an individual miner, you will now compete with mining farmers where hundreds or thousands of miners are aiming to mine for Bitcoin, too. An alternative is to join a miner pool, which is sort of like a mutual fund for Bitcoin miners. There are pre-set rewards, fees, and payouts.
Once you mine Bitcoins, you can sell them, use them as digital currency, or keep them for capital appreciation.
Capital Appreciation
Investing in Bitcoin can have many benefits. For most investors (who don’t want to dirty their hands with mining), you can simply purchase Bitcoin on an exchange like CoinBase. Many investors treat owning Bitcoin as a hedge against inflation and consider it a long-term investment.
Whether you get capital appreciation from an investment in Bitcoin depends on the price of BTC. It is important to note that most financial advisors and investors still believe that Bitcoin is a highly speculative investment compared to other asset classes, like real estate. However, Bitcoin is still in its early days, and there has been a serious cash infusion and investment in this cryptocurrency.
In early 2024, the Securities and Exchange Commission approved the first spot Bitcoin ETFs [3]. These spot Bitcoin ETFs were issued from Blackrock, Invesco, Fidelity, Ark Investments, and others. As a result, large money managers have started to pay serious attention to Bitcoin. The historical trend of Bitcoin ownership shows the potential for significant long-term growth, which has attracted institutional and retail investors alike.
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Advantages of Bitcoin
There have been volumes written about the benefits of Bitcoin, but we will cover a few here for you:
- Digital Currency: The cryptographic features ensure that only the wallet’s private key owner can spend Bitcoin in their wallet. Bitcoin also uses the SHA-526 algorithm for encryption.
- Price Growth: In the early days of Bitcoin, coins were only of limited value because of their limited utility and popularity. Demand and prices have soared as more investors become familiar with crypto.
- Transparent Records: The decentralized nature is designed to keep it free and autonomous. Transactions are secure and irreversible, which reduces the risk of fraud and chargebacks.
- Inflation Hedge: The hard-coded scarcity of 21 million coins creates an opportunity for a decentralized store of value. Economists and crypto enthusiasts advocate for this limited supply as a measure against central banks printing money and inflating the money supply, which can trigger inflation.
- Decentralization: One remarkable aspect of Bitcoin is that it is the first decentralized peer-to-peer digital currency. The idea is that no government agency can control or adjust the supply of coins, and Bitcoin can act as the cash of the internet. A large-scale adoption would make Bitcoin the top currency for financial transactions.
Disadvantages of Bitcoin
Owning cryptocurrencies can be advantageous for your portfolio because it injects alpha into your portfolio or the measure of active return on investment. However, like with any investment, Bitcoin has some potential disadvantages. Here are several to consider:
- Price Volatility: Bitcoin's spectacular story and fast rise in demand have made it popular. This has caused incredible price volatility as investors flood and flee cryptocurrency. The market price of BTCs can move up or down thousands of dollars quickly.
- Hacking: Bitcoin's decentralized nature also makes it a go-to for illicit businesses, raising regulatory and potential legal issues. There have been reports of hackers stealing over $4 billion in cryptocurrencies in 2022 and $2 billion in 2023 [4][5].
- No Regulation: In the original Bitcoin white paper, the developers mapped out a future for a digital cash payment system not built on trust. Instead, it was built on transparency and decentralization. No regulation means no gatekeepers maintain the system, which has risks. Ensure you have the proper risk appetite to invest in Bitcoin.
- Currency Infancy: Bitcoin has only been around since 2009. This short time frame makes it difficult to assess how far into the future Bitcoin will last or if another more secure and profitable cryptocurrency will usurp it.
How to Store Bitcoin
When storing your Bitcoin, chances are good that you will use a hot wallet to facilitate day-to-day usage. Alternatively, you can use a cold wallet. Here are the differences:
- Hot wallets are a means of storing Bitcoin connected to the internet. A hot wallet could be an app on your phone or computer where you receive crypto from transactions or mining. Hot wallets are super convenient but are less secure than cold wallets.
- Cold wallets allow you to store your Bitcoin offline. A cold wallet is generally a piece of physical hardware stored safely, virtually eliminating the risk of being hacked. It can help you transport currency around the world.
If you want to use Bitcoin for regular transactions, you will keep your coins in a hot wallet on your phone. Practically speaking, this works like having a debit card linked to Apple Pay or another form of mobile payment.
Smart Summary
Whether you are a beginner investor or a seasoned pro, investing in cryptocurrencies has its nuances as an asset class. Finance professionals recommend becoming very familiar with all things crypto before buying your first Bitcoin, such as understanding how stocks, bonds, and real estate work. However, there is a growing sentiment among crypto enthusiasts, investors, and economists that Bitcoin might be here to stay. The tsunami of demand for Bitcoin and cryptocurrencies is not slowing down anytime soon. Get up to speed with Cryptocurrency 101.
(1) Statista. Bitcoin (BTC), Ethereum (ETH) dominance – their market cap relative to the market cap of all other cryptocurrencies in the world – on January 29, 2024. Last Accessed April 5, 2024.
(2) Bitcoin.org. Bitcoin: A Peer-to-Peer Electronic Cash System. Last Accessed April 5, 2024.
(3) Securities and Exchange Commission. Statement on the Approval of Spot Bitcoin Exchange-Traded Products. Last Accessed April 5, 2024.
(4) CBSNews. Hackers stole record $4 billion in cryptocurrency last year. Last Accessed April 5, 2024.
(5) TechCrunch. Hackers stole $2 Billion in crypto in 2023, data shows. Last Accessed April 5, 2024.
