What is Bitcoin?

How Bitcoin works

Bitcoin’s decentralisation means that any two people, anywhere in the world, can make payments without the involvement of a bank or payment processor. Instead, it relies on blockchain technology, cryptographic verification, and a global network of participants (called ‘miners’) to securely process and record transactions.

Understanding the blockchain

To understand how Bitcoin works, we first need to understand the blockchain – a public, distributed ledger that records Bitcoin transactions. BTC transactions are grouped into ‘blocks’ that are ‘chained’ together. Each block contains a cryptographic hash of the previous block to prevent tampering. This technology creates a permanent, immutable record of Bitcoin ownership and transfers.

The blockchain can be compared to a bank’s ledger, but instead of being centrally managed, it’s distributed across thousands of computers (called ‘nodes’) across the world. This means that no single entity controls the network, and anyone can view it at any time, making BTC resistant to censorship or manipulation.

For example, trying to alter a past Bitcoin transaction would require changing every subsequent block in the chain – which is practically impossible under the network’s decentralised structure.

Public and private keys

Bitcoin also relies on the use of public and private keys to keep exchanges secure and verifiable. These keys are essentially a randomised string of letters and numbers that serve as a digital passcode to access your Bitcoin holdings:

• The public key functions like a bank account number, allowing others to send Bitcoin to the recipient
• The private key acts like a password, used to digitally sign and authorise transactions.

When making a Bitcoin transaction:

1. The user first initiates the transaction by signing it with their private key
2. The transaction is then broadcast to the Bitcoin network and grouped with other pending transactions
3. Bitcoin miners verify the transaction through a process called mining.

Bitcoin mining

Mining involves validating Bitcoin transactions by solving complex mathematical problems. The first miner to solve the problem gets to add a new block to the blockchain, and as a reward, they receive newly created Bitcoins and transaction fees.

The process of Bitcoin mining increases security by making it computationally expensive for bad actors to manipulate the blockchain. It also prevents users from double spending, or spending Bitcoin they don’t own.

Exploring the history of Bitcoin

Creation of Bitcoin

Bitcoin was introduced in 2008 by an anonymous developer – or group of developers – under the name Satoshi Nakamoto. The goal was to build a peer-to-peer electronic cash system that allowed people to send and receive money without relying on third parties like banks or governments.

The website Bitcoin.org was registered in August 2008, in the wake of the financial crisis. In October 2008, Nakamoto published a white paper called Bitcoin: A Peer-to-Peer Electronic Cash System. This document explained how Bitcoin would use a decentralised network to verify transactions instead of relying on banks.

The first Bitcoin block (Block 0) was mined in January 2009. It contained a hidden message referencing a newspaper headline from that day: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”. This is widely seen as a statement on why Bitcoin was created – to offer an alternative to traditional financial systems.

The first Bitcoin software was released to the public on January 8, 2009. The following day, the second block was mined and Bitcoin’s blockchain officially began.

To this day, nobody knows exactly who Nakamoto is. Although they regularly communicated online, they had disappeared entirely by 2011 and their identity remains a mystery. What makes it even more intriguing is that Nakamoto’s Bitcoin holdings (estimated at over 1 million BTC) have never been spent.

Early growth and adoption

The first Bitcoin transaction took place on January 12, 2009, between Satoshi Nakamoto and developer Hal Finney. This ‘test’ transaction demonstrated that Bitcoin could be sent and received securely. On October 5, 2009, the first known Bitcoin price was established when NewLibertyStandard published an exchange rate of 1 USD = 1,309 BTC. This value was based on the electricity costs of mining.

May 22, 2010 will always go down in history as the famous Bitcoin Pizza Day. On this day, developer Laszlo Hanyecz made the first real-world Bitcoin purchase by buying two pizzas for 10,000 BTC (worth millions today).

2010 was also the year that BitcoinMarket.com was launched – the first official exchange where Bitcoin could be traded for U.S. dollars. This made it easier for people to buy and sell Bitcoin and helped increase its adoption.

In February 2011, Bitcoin reached parity with the U.S. Dollar for the first time (meaning one Bitcoin = $1). At that stage, it was no longer an underground experiment and was gaining attention from mainstream media and investors.

Bitcoin mining

Bitcoin mining involves solving complex mathematical puzzles to verify transactions and add them to the blockchain. Mining serves two purposes:

• Validating BTC transactions to prevent fraud and ensure accuracy
• Creating new Bitcoins in a controlled and decentralised way.

Here’s how Bitcoin mining works:

1. When a Bitcoin transaction is made, it enters a pool of pending transactions waiting to be confirmed
2. Miners compete to solve a cryptographic puzzle that requires significant computing power
3. The first miner to solve the puzzle gets to propose a new block containing the latest transactions
4. Other miners verify the block’s accuracy before it’s added to the blockchain
5. The winning miner earns a block reward (new Bitcoins) and transaction fees.

Bitcoin mining follows a process called ‘Proof of Work (PoW)’. This requires miners to prove they’ve done the computational work before they can add a block to the blockchain. PoW prevents fraud by requiring miners to use real computing power and makes it virtually impossible to alter past transactions, since changing one block would require re-mining all the subsequent blocks in a chain.

This system is essential to Bitcoin’s decentralisation as it ensures no single entity controls the network.

What is required to mine Bitcoin?

In the early days of Bitcoin, anyone with a home computer could participate in mining. But if you want to mine Bitcoin today, you need specialised hardware and software that can solve cryptographic puzzles faster than other miners.

Bitcoin mining hardware

There are two options when it comes to mining hardware:

1. Join a mining pool: This is where multiple miners combine computing power to increase their chances of earning Bitcoin rewards. Popular mining pools include Foundry Digital, Antpool, and Binance Pool.
2. Use application-specific integrated circuits (ASICs): These are custom-built machines designed specifically for Bitcoin mining. They’re much more powerful than standard computers and consume a lot more energy.

Note that Bitcoin mining is extremely competitive, and there are large mining firms operating thousands of ASIC miners. This makes solo mining very difficult (and expensive).

Bitcoin mining software

Mining also requires specialised software to connect to the Bitcoin network. Popular examples are CGMiner, BFGMiner, NiceHash.

Mining energy consumption

Bitcoin mining consumes massive amounts of electricity. ASIC miners run 24/7 and require cooling systems to prevent overheating. These all add to the costs of Bitcoin mining, which is why many miners choose to set up in regions with cheap electricity, like Kazakhstan or Iceland.

The uses of Bitcoin

Payment and transactions

Bitcoin is increasingly being accepted as a form of payment, both online and in physical stores. Some merchants and services currently accepting Bitcoin payments include:

• Apple
• Shopify
• Expedia
• Nike
• GameStop
• Walmart.

Many brick-and-mortar retail stores also accept Bitcoin payments. These stores will often display a sign reading ‘Bitcoin Accepted Here’.

To use Bitcoin for payments, you need a cryptocurrency wallet that stores the private keys required to send Bitcoin. You can complete BTC transactions by:

• Scanning a QR code at checkout
• Manually entering a wallet address
• Using a payment processor like BitPay or Crypto.com.

Investing and speculating

Bitcoin’s significant price increases over the years has made it an attractive vehicle for investment and speculation. It has the potential to deliver high returns, and many investors believe Bitcoin’s limited supply of 21 million BTC will drive up its value over time. Since Bitcoin isn’t controlled by governments, some investors also view it as a way to protect against inflation and currency devaluation.

That said, investing in Bitcoin comes with certain risks. BTC is extremely volatile and capable of fluctuating thousands of dollars in a single day. It’s also still relatively unregulated, with many governments still figuring out how to make sense of cryptocurrency. Bitcoin investors also need to take precautions to protect their holdings from hackers.

Some popular strategies for investing in Bitcoin include:

• Long-term holding (HODLing): Buying Bitcoin and holding it for the long-term
• Day trading: Taking advantage of Bitcoin’s volatility to buy low and sell high within short timeframes
• Buying the dip: Purchasing BTC when prices drop in the hope for future gains.

How to buy and store Bitcoin

How to buy Bitcoin

To buy Bitcoin, you’ll need to use a cryptocurrency exchange, peer-to-peer platform, or Bitcoin ATM.

Buying BTC from an exchange

1. Choose a Bitcoin wallet: Before buying Bitcoin, you’ll need a crypto wallet to store it in. More on that later!
2. Pick a platform to buy Bitcoin: You can buy Bitcoin through cryptocurrency exchanges that allow you to trade fiat currency for BTC. These platforms connect to your bank account, credit card, or debit card.
3. Buy the Bitcoin: Once you’ve purchased the Bitcoin, it’ll be stored in your exchange wallet or can be transferred to a personal wallet.

Buying BTC through a peer-to-peer platform

Peer-to-peer (P2P) platforms connect buyers and sellers directly, without the need for an exchange. Popular P2P platforms include Paxful, LocalCoinSwap, and BitValve.

Buy Bitcoin through an ATM

Bitcoin ATMs are physical kiosks where you can insert cash and receive Bitcoin in your Bitcoin address or wallet. These can be found in various major cities but often have higher fees than buying on an exchange.

How to store Bitcoin

Once you buy Bitcoin, you need a secure place to store it. Because Bitcoin exists digitally, it’s essential to protect it carefully against hackers.

The two options for Bitcoin storage are hot wallets and cold wallets:

Hot wallets

These are digital wallets connected to the internet. They include wallets provided by crypto exchanges or mobile/desktop wallets (e.g. Trust Wallet or MetaMask). Hot wallets are great for beginners and convenient for quick transactions, but they can also be more susceptible to hacking since they’re online. There’s also a risk of losing your Bitcoin if a platform gets hacked or shuts down.

Cold wallets

Cold wallets store Bitcoin offline. They include hardware wallets, which are physical devices used to store Bitcoin keys, or paper wallets, that involve simply printing a QR code or key on a piece of paper. Because they’re not connected to the internet, cold wallets are safer for long-term storage. This makes them ideal for long-term investors and those holding large amounts of Bitcoin. However, losing access to a hardware or paper wallet means losing access to your BTC forever.

Best practices for storing Bitcoin securely

To keep your Bitcoin safe:

• Use two-factor authentication (2FA) to prevent unauthorised access
• Never share your private key with anyone
• Keep backup copies of your keys in a safe place
• Use well-known platforms and exchanges with strong security measures.

Risks and regulations in Bitcoin trading

Risks of investing in Bitcoin

Despite the many advantages it presents, Bitcoin comes with certain unavoidable risks. The first is volatility. Bitcoin’s price is known for massive fluctuations in short periods of time. Some investors can profit from these swings but they can also lead to substantial losses. For example, in November 2021, Bitcoin surged to an all-time-high of $69,000. In 2022, it had dropped to below $16,000.

Bitcoin has seen multiple boom-and-bust cycles, or bubbles, where rapid price increases were followed by major crashes. Many investors buy into the hype during a rally only to face huge losses when prices drop again.

There are also certain security risks when it comes to Bitcoin. While the currency itself is highly secure, the platforms where it’s traded are often targeted by hackers. The crypto space is also prone to phishing and scams. Finally, if you lose access to your private key, you lose access to your BTC – there’s no way to recover it.

Bitcoin regulations

Governments worldwide are still figuring out how to regulate Bitcoin, and its legal status varies from country to country. Countries with favorable Bitcoin regulations include the US, EU, El Salvador, and Switzerland, while those with strict regulations include China, India, Russia, and Turkey.

Regulating Bitcoin can benefit the cryptocurrency world by reducing fraud, encouraging institutional investment, and providing legal clarity for businesses accepting Bitcoin. For example, BTC’s price surged in early 2024 after the U.S. SEC approved spot Bitcoin ETFs.

However, regulation could also limit personal freedoms around self-custody and financial transactions. Some are concerned that overregulation might push Bitcoin trading underground. For example, China has completely banned crypto mining and trading, and Turkey has banned it as a payment method.

Disclaimer: FOREX.com Australia is a Contracts for Difference (CFD) issuer and our products are traded off exchange. We do not offer direct ownership of the product and exposure to bitcoin is available solely via Contracts for Difference (CFDs). This material relates to the underlying asset and does not constitute a recommendation or offer to trade.