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What is Bitcoin and How Does It Work?

about BitcoinBitcoin is generally associated with cryptocurrency. Some people consider it also as a digital or virtual currency. In other words, Bitcoin represents another type of money with no need to keep it in the wallet. Here we have an online version of traditional physical cash with a chance to store it, receive, send or make purchases on the websites and digital sops with the support for BTC.

Also, it made its debut back in 2009, people still have much to learn about this type of coin. Most users do not understand how it works or how to make transactions with a digital currency. In reality, the process is much simpler than it seems. With so many exchanges, crypto wallets and online services handling transactions are very easy. All you need is to have a clear understanding of how everything is bound together.


The Term “Bitcoin” Explained

Bitcoin was invented 11 years ago by Satoshi Nakamoto to become a new-gen digital asset also known as cryptocurrency. It was launched with the aim to prevent intermediaries (government or banks) from taking part in people’s everyday transactions. The idea was to create a decentralized instrument that is a stand-alone asset in the financial market.

In reality, things are a bit different. Bitcoin represents a blend of peer-to-peer technologies and software-driven cryptography. While these terms may sound weird to the majority of users, let us try to explain them in simple words:

  • Per-to-Peer technology – it combines different individuals that form a decentralized digital network. The peers here are the computers and devices of individuals that are connected through the Global Web to keep the network active. The technology does not require a separate server. Each computer or device becomes a server itself within the network.

  • Software-Driven Cryptography – it is a science-based technique to transfer secret pieces of information and only the receiver or sender is able to access or read it.

As a result, Bitcoin is a code-backed asset that consists of encrypted pieces of information rather than physical dimensions, height or weight like precious metals or banknotes.

All transactions are made electronically. Every time a user wants to buy a product, send or receive coins, the asset will need two parties with computers connected to the internet for a fast and direct interaction without third parties or intermediaries.


Why Was Bitcoin Invented?

To understand the reason or goal behind Bitcoin development, we need to look at the world from the economical point of view. In this world, all people can be divided into three major groups:

  1. A Producer – someone who creates new products or services to sell them.

  2. A Buyer – a consumer who looks for a specific product or service to purchase.

  3. An Intermediary – a third party who collects fees and commissions for every transaction between a producer and buyer.

The fees are sometimes huge and may go up to 40%-50% from the initial price. The idea of Bitcoin was to let producers and buyers interact directly without third parties with their enormous charges and fees.

Example: let’s say, a US-based user needs to transfer $1,000 to his or her friend in Australia. The money will have to make a long path through the bank in the United States, which takes a fee for processing the transaction. Then the money goes to the bank in Australia where a receiver will also have to pay an extra fee to withdraw cash or having a chance to use it.

Fees and commissions are not the major problems here. No one expects financial institutions to work for free. It is natural to establish fees for services they provide. And it is up to you whether to use them or not. The main downside concerns the personal data those institutions collect, store and use. Banks generate tons of personal info including phones, emails, and other details. No one knows whom organizations actually share that data with. The possibility of getting it to the wrong hands is growing each year.

Another problem is the ability of banks to disclose users’ accounts or freeze the funds they have without any reason. As a result, people provide financial institutions with total control over their funds as well as funds movement. Banks always know where to and how much you transfer or receive.

The situation got out of hand during the crisis back in 2008 where banks played a big role. Bitcoin debuted the next year as an ultimate decentralized financial tool. So, the crisis appeared to be the main reason for the BTC introduction.

Note: despite the fact it has an inventor, cryptocurrency does not have any authority in the face of either an individual or an organization (financial or governmental). It means zero commissions, no intermediary banks, no or limited governmental control and, what’s more important, no personal data sharing.  

The only question is how it works.


How Bitcoin Works

First of all, you need to learn how to recognize the currency in the financial market. Bitcoin has some popular trading symbols BTC is the most popular one used by the majority of exchanges. You may also come across the “XBT” symbol that is also associated with Bitcoin.

Each coin you have represents a computer file. Users can keep it on any device (a computer, laptop, smartphone, etc.). However, you will need a Bitcoin wallet as the place to store your digital assets. To understand, how BTC works, let’s try to put everything together and define the key components of the network with all participants:

  • Blockchain – as mentioned earlier, Bitcoin is a computer file or a code. What’s more, it is open-source code. It means that any user within the network can access it. Every time you send or receive coins, you launch a transaction that is a “block” that is “chained” to the code. As a result, the blockchain technology creates a never-ending record of all operations with the currency. Thousands of other cryptocurrencies work the same way.

  • Private and Public Keys – both keys work together within a crypto wallet you use to handle transactions. They allow a user to confirm or “sing” an operation. The digital signature works as authorization approval.

  • Miners – you already know what a peer-to-peer technology is. Every user within the network can be a miner. The idea is to get paid in BTC for every independently confirmed operation and transactions using more powerful hardware.

What Forms the Bitcoin Value

The currency has seen some of its crucial highs and lows over the years. The current price is around $11,460. What factors influence the BTC price? Unlike traditional currencies, Bitcoin does not depend on the geopolitical and economic situation in the world.  

The two major factors for its price are supply and demand. For this reason, cryptocurrency is considered as an asset with extremely high volatility.


How Bitcoin Transaction Happen

After we have learned what Bitcoin is and how it works, it will be easy to understand how the transactions take place.

Every time you want to send or receive coins, you will need to put them in a database. Unlike traditional technologies that use centralized networks, BTC is a decentralized asset that uses databases shared within the peer-to-peer network – a distributed ledger that is powered by blockchain technology.

When a user wants to send coins to another party, he or she needs to write a digital message that says, “Hi, there! I need to send 10 BTC to Sarah”. All computers within the network will see the message and store it in the ledge.

How Safe Are Bitcoin Transactions?

The main question that bothers all users is if someone can fake the identity and steal coins. Everything possible in the modern world. But with BTC, your safety is your major concern. When sending currency to another user, you will have a private and a public key. They can be generated manually or automatically using different online services. Keys consists of multiple letters and numbers (like login or password):

  • A Public Key is used whenever you want to send coins. You can share it instead of providing your personal details (email or phone). It is necessary only for the receiver. What’s more, you can even stay anonymous and no one will ever know that it was you who sent BTC

  • A Private Key is a ticket that helps to spend your coins safely. It also serves as the wallet address and is used whenever you need to receive crypto. Your coins are safe for as long as your private keys are kept in secret.

Note: to ensure enhanced safety, you can store private keys in the local folder or have them printed.

Hot or Cold Bitcoin Wallets

Users will need a digital wallet to store their coins. This is where you will need to decide on which kind of wallet suits your needs most. The two types are as follows:

  • Hot Wallets – cloud-based storage facilities delivered by exchangers. Users may access them right from the browser despite the device type.

  • Cold Wallets – portable devices with encrypted technologies where you can download and keep your coins even without an internet connection.

The fact that cold wallets do not require the Internet, they are considered as a safer way to store funds. However, you will still need to go online to download crypto.


How and Where to Buy Bitcoins

There are three major ways to purchase BTC.

Peer-to-peer (P2P) exchanges are the fastest and the most cost-effective way to buy Bitcoin. The idea is very simple.

Step 1 - user A sends real money to user B.

Step 2 - user B sends BTC to user A.

Every time a user A makes a request to receive Bitcoin, it automatically gets to the escrow service that cannot be controlled by any party of the transaction. This fact ensures fair processing. What’s more. A P2P exchange does not have intermediaries or brokers between users. It means no extra fees or charges. In some cases, you can be asked to provide an ID. However, this mainly refers to big sums. As a rule, each transaction is held anonymously.

Broker exchanges work in almost the same way as P2P. They appear to be even a faster way to buy coins. However, here we have brokers or intermediaries who establish additional fees and commissions for processing. Another downside is that exchanges require additional information (email, phone, ID copy, etc.). They not only collect but also store your perusal info.

The good thing about this method is flexibility. Users will have access to different payment gateways that include traditional debit/credit cards, bank transfer and some of the popular online payment services. You will have multiple ways to exchange BTC into your local currency.

Speaking about commissions, they depend on the amount you want to buy or exchange. As a rule, the fees vary from 1% to 5% per transaction.

Bitcoin ATMs are not as commonly used as the two previous options. Also, finding the one in your country can be quite a challenge. This map will make it easy to find the ATM near you. It is a simple and fast way to purchase BTC using cash. However, the fees here can be very high. In some countries, they go up to 10%.


Bitcoin Pros and Cons

Cryptocurrency is not just digital money that you can spend or transfer. It represents a new type of asset with high volatility. As with any other speculative asset, it may turn out to be a beneficiary trading instrument. So, the main benefits of buying BTC are as follows:

  • High Volatility – with price spikes and leaps, trading Bitcoin can be a good idea for experienced users, especially considering the recent gains. However, you need to know how to use technical analysis, market indicators, and trading charts to succeed. Nevertheless. Investing in BTC is still a good idea taking into account the latest trends.

  • Enhanced Security – using crypto is safer than sending funds from a debit card. Users seldom share personal data unless when dealing with broker exchanges. Besides, blockchain technology comes as a more secure alternative to brick-to-mortar digital money transfers.

  • Wider Coverage – although Bitcoin usage is limited in some countries, it gets wider coverage with more marketplaces and websites to accept payments in crypto. They include such big names as Microsoft, Overstock, and others.

The key benefit of the majority of users is the ability to avoid banks and traditional financial institutions. BTC is not regulated by the government. It helps to avoid additional fees and represents an alternative decentralized asset that is out of third party control.


The Bottom Line

We can hardly say Bitcoin is a new trend. The cryptocurrency was introduced over a decade ago. Despite the price spikes and drops over the years, it is still in demand. BTC is a trendy asset that offers a simpler, safer, and faster way to handle transactions.

People like the fact they do not need banks or the government when storing or transferring BTC. They like being out of financial control that prevents them from sharing their personal info with third parties. Copying coins is extremely hard, while simple precautions will keep your funds away from danger.

The currency has a huge potential as a speculative asset with high volatility. In other words, it can be used as not only digital money but also as a trading instrument to generate additional revenue. 

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