What Is Bitcoin and How Does It Work?
Bitcoin may have begun as an internet phenomenon, but now it's fully legit — and increasingly being compared to one of the most old-school assets of all time.
Though it's not a physical item you can hold, Bitcoin is the latest evolution in a long history of currency, according to Dan Held, head of growth at the exchange Kraken. Our ancestors used shells and beads for transactions, then precious metals, then fiat. In the modern age, cryptocurrency is a natural next step.
“Bitcoin offers a way for people to store value in a completely digital format that isn't centrally controlled. There’s no government that controls it; there’s no group that controls it,” Held says. “It’s all built into Bitcoin’s code.”
That's why Bitcoin makes people think of gold. Both are seen as safe, untouchable investments. A person can squirrel them away for the future without interference.
Interested in getting in on the Bitcoin trend? Here's everything you need to know about the digital currency.
How Bitcoin works
Bitcoin was started in 2009 by a mysterious figure named Satoshi Nakamoto, who wrote a whitepaper about it months earlier. Abbreviated BTC, it's open-source and not linked to any central authority. It's also not easily seizable.
In fact, Nakamoto described Bitcoin in the whitepaper as a “peer-to-peer version of electronic cash that allows payments to be sent directly from one party to another without going through a financial institution.” Bitcoin transactions are recorded via blockchain, which is basically a big online ledger.
Bitcoin transactions get confirmed via mining, an intense problem-solving process done by computer. Miners can earn cryptocurrency if they complete these problems, though Bitcoin.org warns that Bitcoin mining "is not an easy way to make money." (Bitcoin mining is also an energy suck. The Guardian reported recently that Bitcoin mining requires more electricity than whole countries use.)
Bitcoin isn't the only digital currency. Other popular cryptocurrencies include Ethereum, Litecoin, Dogecoin and Zcash. And it's "absolutely not" too late to get involved, according to Claire Lovell, associate director of product at the exchange Gemini.
"We're still really, really early," she says. "I believe strongly that, like everything else has gone digital, money will go digital, as well. There's huge opportunity in this space."
How to use Bitcoin and other cryptocurrencies
People can buy bitcoins on an exchange, collect them in a virtual wallet and use them to pay for things. Sending, or spending, Bitcoin requires a private key, which is a 256-bit randomly generated number that allows access to your cryptocurrency.
Retailers like AT&T, Whole Foods and Shopify accept Bitcoin as payment. In person, you may scan a QR code to use it in a transaction. Online, Bitcoin often comes up as an option in the ordering process — for example, on Overstock, customers simply click "Pay with Bitcoin" instead of "Pay with credit/debit card" like they normally would.
It works similarly at Paypal, which recently announced customers can check out with cryptocurrencies there, too.
"You can use your crypto balance as a funding source, like you would your PayPal balance, or your credit card, or your debit card," CEO Dan Schulman said in a video where he used cryptocurrency to purchase cowboy boots. "It's just another funding instrument."
In fact, Coinbase offers the Coinbase Card, a Visa debit card that lets people spend cryptocurrency and earn rewards for it. (It's available in Europe and rolling out in the U.S., where there's a waitlist.)
Bitcoin was used at the Silk Road, an infamous online black market that got shut down in 2013. Because it's not linked to a central bank, Bitcoin has a reputation for being anonymous and untraceable, but be careful. A 2017 paper out of Princeton University found shopping sites often have ads and analytics trackers that can connect customers to their Bitcoin transactions. It's also an area ripe for scams.
How much is Bitcoin worth?
Another factor that makes Bitcoin unique is that there's only a finite amount of coins. Specifically, there are 21 million, which contributes to the belief that the currency is a hedge against inflation.
“It’s not like you can print more of it,” says Daniel Polotsky, CEO of Bitcoin ATM network CoinFlip.
One BTC currently equals about $58,000. But it is possible for someone to buy a part of a Bitcoin. The smallest unit is called a satoshi, and it’s equal to 1/100 millionth of a Bitcoin. One satoshi is currently worth about $0.00058.
The price of Bitcoin is notoriously volatile. Last April, for example, one Bitcoin was worth about $7,000. It spent 2020 climbing, breaking records when it crossed the $20,000 mark in December. In late January, the BTC price increased by more than $5,000 in just a few hours when — amid all the GameStop drama — Tesla CEO Elon Musk changed his Twitter bio to “#Bitcoin.”
Polotsky says that, in general, volatility is normal because Bitcoin is still a relatively new currency. But it won’t be like this forever.
“As time goes on, the volatility does decrease,” he says. “It’s becoming more stable because the space is more stable. More people are holding it for the long term, so there’s less supply to be trading back and forth. The space is maturing. There’s more products, more confidence involving Bitcoin than there has ever been in the past.”
He’s not wrong about its growing popularity. An estimated 100 million people have some sort of crypto asset. Even Federal Reserve Chairman Jerome Powell has picked up on the gold comparison,
How to buy Bitcoin
Perhaps the easiest way to get started with cryptocurrency is by visiting an exchange, another term for marketplace. There are tons of Bitcoin exchanges to choose from. But your first step, Coinbase vice president of product Max Branzburg says, should be to educate yourself.
"Bitcoin has the potential to enable a more open financial system for the world and benefit from long-term appreciation, but it’s important to remember that the asset class is still relatively new, prices can be volatile, and there will be new developments as it grows," he adds.
Once you've researched the pros and cons of cryptocurrency, you just have to make an account with your exchange of choice and verify your identity. After you hook up your debit card, credit card or bank account, you're ready to go.
"You can immediately start buying Bitcoin for as little as a few dollars or up to tens of thousands to start building your portfolio," Branzburg adds.
People keep their cryptocurrency in digital wallets. Although there are several kinds of Bitcoin wallets, beginners may want to use a hosted wallet that's linked with an exchange. It's harder to lose the keys that way.
"You can have a wallet on a USB drive or on your phone, but it's relatively complicated," Gemini's Lovell says. "The easiest thing to do is let a secure, regulated custodian hold your funds for you. Then you just need a username and password to access those funds."
Best beginner Bitcoin investment strategy
Bitcoin was the best-performing asset class over the past decade, with an average annualized return of more than 200%, and provides a chance for people to diversify their portfolios. However, you still need to be strategic if you choose to invest in cryptocurrency.
"Just like time in the market is the key indicator of success in most investments, that holds true here, as well," Lovell adds. "A consistent, long-term purchasing strategy tends to be the most fruitful."
Avoid trying to outsmart the market. Instead, come up with a Bitcoin plan. As a Bitcoin beginner, try investing a certain small-dollar amount every month until you feel comfortable. You may want to abide by the old adage that you should only invest what you're willing to lose.
Held recommends looking into what’s called the “HODL” strategy if you want to get involved in Bitcoin. HODL is a cryptocurrency slang term that means to hold onto your assets.
Like with gold or other traditional currencies, you should play the long game.
“Whenever you approach investment, you should develop an investment thesis,” Held says. “You’re buying Bitcoin because you believe it will become gold 2.0: a store of value that's hard to seize and immutable.”