How Bitcoin Works: An Introduction For Beginners

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What Is Bitcoin?

Bitcoin is a digital currency based on the increasingly popular blockchain technology. Bitcoin is defined as a cryptocurrency because it utilizes cryptography intrinsically to secure users’ funds and verify transactions. The symbol for Bitcoin is BTC.

A 3D Rendition Of a Circuit Board With The Bitcoin Logo
Table Of Contents
Introduction To Bitcoin
Misc. Details
How Bitcoins Are Stored
Securing Your Bitcoins
What Is The Value Of A Bitcoin
What Can You Do With Bitcoins?
How To Buy Bitcoins
How Bitcoin Works
How Bitcoin Transactions Work
Stores That Accept Bitcoin Payments
How Bitcoins Are Mined
Volatility Of Bitcoin

Introduction To Bitcoin

A Bitcoin is a form of digital currency which is not a physical coin or a bank-issued note, unlike fiat currencies (conventional currencies) such as the US Dollar, Australian Dollar, or the Chinese Yen. This cryptocurrency is not backed by a tangible item of value such as gold. However, neither are fiat currencies (conventional currencies such as the USD used to be backed by items of value such as gold, but they no longer are).

Bitcoins are stored in wallets on the blockchain and divided in the same way as conventional currencies, except there is no equivalent term for cents or pennies. If you want to buy something for half a Bitcoin, that equates to 0.5 BTC, and you can simply enter a transaction amount of 0.5 BTC.

It’s worth noting that coining a term such as ‘Bitcents’ could be convenient for smaller transactions. Remembering a price like 0.01342 BTC is something you have to get used to.

You can divide it further for transactions without even numbers such as 0.3214 BTC as well, and you won’t have to worry about finding change! (one of the benefits of transferring funds digitally, which, to be fair, benefits fiat currencies as well).

On the blockchain, the smallest unit of a Bitcoin is 1 Satoshi (0.00000001 BTC). 1 BTC = 100,000,000 Satoshi (named after Satoshi Nakamoto, the creator of Bitcoin).

Misc. Details

Date Released: January 9, 2009
Consensus Algorithm Proof-Of-Work (PoW)
Hash Algorithm SHA-256
Language C++
Node Software Bitcoin Core/Bitcoin Daemon
Supported OS (for Bitcoin Core) Linux, Windows, MacOS
Blocks Generated Every 10 Minutes
Block Explorer Blockchain.info
Limited Supply Yes: 21 Million BTC
GitHub Bitcoin
Website Bitcoin.org

What Is The Value Of A Bitcoin

The value of a Bitcoin/the Bitcoin exchange rate is determined by supply and demand. Increased demand drives up the price of Bitcoins, considering that it is not an inflationary currency. There is also an energy cost associated with mining these coins, so they aren’t just paper whimsically churned out of a printing press like conventional money. This deters the inflationary practice of dumping excessive amounts of coins into circulation.

Bitcoin Exchange Rate (BTC – USD):

Like fiat currencies, Bitcoins have no intrinsic value. Two former mediums of exchange with intrinsic value are gold and salt. These had intrinsic value because they were useful, regardless of demand or whether they are being traded. People need salt for a variety of purposes such as seasoning, fermentation, and industrial processes, and gold is needed to manufacture electronics, jewelry, among other things.

BTC and dollars are just tokens and notes (respectively). The barter system had one key characteristic over fiat currencies (and cryptocurrencies), and it was that the value of an item was determined primarily by peoples’ wants and needs.

Bitcoin is the mother of cryptocurrencies, as it has inspired the invention of technologies such as Ethereum, which has led to the creation of many innovative cryptocurrencies via its platform.

What Can You Do With Bitcoins?

You can use them to purchase items at stores that accept it as a form of payment. You can also purchase them and hold onto them for now, or while the price of that cryptocurrency continues its upward trend. You can buy or sell Bitcoins on cryptocurrency exchanges at any time.

Users that confide in this cryptocurrency often use it as a store of value, unlike many other cryptocurrencies which may be faster and cheaper mediums of exchange. Despite that, Bitcoin fees are still low compared to some fees associated with conventional currencies such as international wire transfers.

Who Accepts Bitcoin As A Payment Method?

Below is a list of some major stores that accept Bitcoin as a payment method, as well as organizations that accept Bitcoin donations.

Stores That Accept Bitcoin
Overstock
Expedia (travel agency)
Newegg (computer store)
Namecheap (web hosting and domain provider)
Shopify
Dish Network
Organizations That Accept Bitcoin Donations
freeBSD Foundation
Free Software Foundation
Electronic Frontier Foundation
Wikipedia

Getting Started With Bitcoin: How To Buy Bitcoins

Coins can be obtained by purchasing them from a Bitcoin exchange. Exchanges can be centralized or decentralized. The use of centralized exchanges entails depositing your money into an account you create with them. In some cases, you can store your coins on these exchanges, which carries both benefits and disadvantages from a security standpoint.

A key advantage of a centralized exchange such as Coinbase is their ability to assist you if there is a problem. The reason behind that could also be considered a disadvantage, as they are a prime target for hackers, which can rob you by getting into your Coinbase account.

Please use a hardware or other offline wallet to store your coins instead of Coinbase, Coinspot, and any other service that retains possession of your wallet. Another way to buy Bitcoins is to purchase them from a friend that already has them.

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The least trivial way to obtain coins is via mining, which requires specialized hardware such as ASIC miners. Mining entails using your computer’s processing power to assist the network with transaction confirmations.

Exchanges That Sell Bitcoins

You can purchase Bitcoins from a number of exchanges including, but not limited to:

  • Coinbase (centralized cryptocurrency exchange which allows you to buy cryptocurrencies using USD, as well as sell them in certain countries including the U.S.).
  • Coinspot (Australia).
  • ShapeShift (decentralized cryptocurrency exchange, and requires you to buy it with another cryptocurrency, not with USD).
  • Kraken (centralized Bitcoin exchange).
  • Binance (centralized cryptocurrency exchange, and you need another cryptocurrency such as BTC or ETH to buy cryptocurrencies there).

Once you have purchased coins from an exchange such as Coinspot or Coinbase, please send them to a trusted offline wallet such as a hardware wallet or a wallet app, specifically one which does not store your private key in an easily-accessible manner.
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How Bitcoin Works

How Bitcoins Are Stored

Bitcoins are stored in wallets, which are stored on Bitcoin’s blockchain network, which is a distributed network of thousands of nodes that each store a copy of Bitcoin’s blockchain. Each of which contains transaction data.

This is not the digital equivalent of storing your money in a wallet. How it works is, your wallet is used to separate your transactions from everyone else’s. An example of a Bitcoin wallet is an app such as Exodus Wallet, which connects you to the Bitcoin network and makes it easy to initiate transactions.

Exchanges (for example: Coinbase and Coinspot) do not (and cannot) store your coins. They do, however, own and issue wallets (which are stored on the blockchain network like all others).

They provide customers access to those wallets via a username and password (and this is a security vulnerability, because someone just needs to guess your password to access your coins, and of course, your private key and password are stored online on the exchanges’ servers).

What this means, is if someone offers you a hardware wallet or paper wallet, it provides you with access to a wallet on the blockchain. That is not the actual wallet. Paper wallets contain a key pair (your private key, which provides access to your wallet, and your public key, which is your wallet address).

This is why exchanges differ substantially from banks, and should not be treated as banks. Banks serve the purpose of safely storing physical currency.

What Is A Bitcoin Wallet?

A Bitcoin wallet is a pair of cryptographic keys called a private key and a public key. Associated with the public key is all of your transactions. The transactions are stored on a decentralized public ledger (the blockchain), from which your balance is calculated.

This is why one does not simply edit a balance, because there isn’t a balance stored in your wallet. Instead, your wallet app calculates the amount of Bitcoins you can spend based on inbound and outbound transactions. Your public key is your BTC address, which people can send Bitcoins to.

Your wallet’s private key provides access to your funds. Never store your private key anywhere that it can be found. Don’t store it on USB drives that you use for other transfers. It should be stored on a drive which is never used. If you lose your login information, you’re going to need that key to recover your coins. Purchase a drive exclusively for your cryptocurrency wallets and stow it away in a secure place.

This fact is why cryptocurrencies like these are competing with banks, which exist to store fiat currency. With cryptocurrencies, you don’t need a bank to store your money or transfer it.

Two decent wallet apps for desktop computers are Bitcoin Core (you’d also be running a full node with this one, so it will need time to download the blockchain), and Exodus Wallet.

A Few Security Tips

Don’t use an exchange to store all your coins. After buying them on an exchange such as Coinbase or Coinspot, send them to an offline wallet. Always look up reviews and ask around before trying an offline wallet. Not all are legitimate.

Never give anyone your wallet's private key! There is never a good reason to do so.

In order to receive funds, you only need to provide your public key.

Also, don’t buy hardware wallets off Ebay. There are too many fakes there (which will steal your coins). Hardware wallets are actually among the most secure, and you should buy them directly from the manufacturer.

When visiting a website that offers a wallet, or an exchange. Always check the URL in your address bar to ensure it is correct. If you aren’t sure, do a Google search and take a look at all the results, and do your best to ensure it is authentic. There are phishers with fake websites that mimic known exchanges with slightly different URLs.

Also check for SSL and extended validation (or EV, often denoted by a green COMPANY NAME LLC (US) in your browser’s address bar. A green padlock (which is necessary for exchanges, so don’t use any exchange if their website doesn’t have it) in your browser’s address bar indicates that the website you’re visiting has SSL, which encrypts your connection and helps to protect your login credentials from theft.

Go to Binance, Coinbase, and Coinspot, and you’ll see that they all use SSL (denoted by the green padlock mentioned).

Coinbase has extended validation, denoted by Coinbase, Inc. (US) on the left side of your address bar if you use Firefox or Chrome. If you’re visiting the Exodus Wallet website, you’ll see ‘Exodus Movement Inc (US). If you don’t see that, you’re not on the Exodus or Coinbase website. I haven’t seen EV on the Coinspot or Binance website, though, as they don’t appear to have EV.

You may not see an extended validation certificate on every decent website, as it can be expensive, but they must all at least have the green padlock I mentioned above (SSL) to encrypt your credentials before transmitting them to the server.

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Bitcoin Basics: How Bitcoin Transactions Work

A Bitcoin transaction is a wallet-to-wallet transaction (the transfer of wealth from one Bitcoin wallet to another). If someone sends 0.5 BTC to your wallet address (a long code), your wallet app (or the exchange that holds it) will recalculate how much you own and that 0.5 BTC will be added to it. Transactions must be verified by the Bitcoin miners on the network.

Mining secures the Bitcoin network. This is partly due to the fact that mining fees entail paying for transactions, so trying to steal Bitcoins could end up costing you in the form of Bitcoin mining fees.

Bitcoin transactions are irreversible. If you accidentally send someone Bitcoin, you will have to ask them to initiate a new transaction valued at that amount. This isn’t a major problem, but it could be considered a minor inconvenience. Bitcoin transactions are usually much cheaper than wire transfers for small amounts, and also cheaper than PayPal transfers for larger amounts.

Bitcoin transactions are initiated (and will show up in your wallet) in a matter of seconds, and they are confirmed/completed in an average time of 10 minutes. Network delays, however, can increase this time to minutes, or even hours in extreme cases.

In the event of a financial dispute, the ability to trace Bitcoin transactions on the blockchain could be useful.

Further reading on how Bitcoin transactions work

Bitcoin Network Performance And Efficiency

I can’t say much about the performance and efficiency of the Bitcoin network due to the ongoing variation of hash power available on the network, as well as the backlogs caused by usage spikes (caused by people that hysterically buy or sell their coins due to their fears).

However, the Bitcoin network supports 7 transactions per second. This is due to a block size limitation implemented for security purposes. In 2010, a 1MB block size was imposed, and block size increases have been proposed since then. Increasing block size would also increase the hardware requisites for mining.

As it stands now, a single ASIC miner can easily set you back $6,000 USD. If those get more expensive due to an increased block size, that may result in a more centralized network owned by large businesses, due to a higher financial barrier to entry for prospective miners.

Newer cryptocurrencies inspired both by Bitcoin’s technologies and weaknesses have improved on this with the ability to handle up to thousands of transactions per second. For example, the Ethereum network is capable of 15 transactions per second (this may increase with upcoming upgrades), and Raiblocks (XRB) is capable of 7,000 transactions per second.

A key characteristic that separates Raiblocks from Ethereum and Bitcoin is that it is minerless. Although mining has solid benefits, it is hampered by these performance limitations, and it is energy-intensive.

Bitcoin Security: How Bitcoins Are Mined

Bitcoin mining is the process whereby complex cryptographic puzzles are solved using nodes (miners, in this case) on the Bitcoin network. Miners essentially contribute their mining rigs’ (specialized computers) processing power to help secure the Bitcoin network and verify transactions for everyone else. Miners are then rewarded with Bitcoins.

This is called a Proof-of-Work system. Many other cryptocurrencies are mined. However, some may transition to a Proof-of-Stake system due to the high cost of mining.

Bitcoin mining used to be profitable with the use of CPU mining rigs. However, ASIC miners have now superseded them due to significantly higher efficiency. ASIC means Application-specific Integrated Circuit.

Mining has provided many with a way to generate an income without spending money on a tertiary education.

Power Consumption Of Bitcoin Miners

Bitcoin Stability: The Volatility Of Bitcoin

The volatility of Bitcoin and other cryptocurrencies is a concern among many, as it causes uncertainty. For some, the upward trend of Bitcoin prices has compensated for that. Fiat currencies around the world have been losing their value to inflation for years, essentially devaluing peoples’ savings and incomes. That makes it harder to get by if wages don’t catch up accordingly.

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Disclaimer: This article contains two referral links, one for Coinbase and another for Binance to help fund Kompulsa’s expenses.

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