The content of this article is provided for informational purposes only. You should always obtain your own independent, tax, financial, and legal advice before making any material decision.
Many people have heard of Bitcoin, but can they define what it is or how it works? What makes it popular or, at times, controversial? Regardless of why Bitcoin makes headlines every now and then, it’s important to know its ins and outs as a cryptocurrency. Read on to learn more about Bitcoin.
Bitcoin is a type of cryptocurrency, or digital money, that can be shared securely with anyone, anywhere in the world. These transactions take place on a blockchain, or a digital ledger, that logs all network transactions. This information is often copied and shared across computer systems to secure information.
Bitcoin was introduced as a new system for peer-to-peer electronic cash in 2008 by a person or group operating under the pseudonym Satoshi Nakamoto. Bitcoin was designed to be “sound money”, or another way for people to send each other digital cash without a central third party.
Bitcoin is secured through cryptography. There are two parts to this system: a private key, known only to the wallet that holds the Bitcoin, and a public key, that when combined with the private key can be validated as authentic without revealing the secret private key.
A public key is sort of like a cell phone number or mailing address that allows anyone to properly identify who they’re sending money to or receiving money from. Public keys are also used to help funnel money received into an account. Keep in mind that while public keys make it easy for anyone to send another person money, it does not mean that anyone can pull money from someone else’s account.
A private key is also known as the “password” to a crypto wallet and shouldn’t be shared with anyone. It allows nodes on the network to verify transactions and whether or not the cryptocurrency being spent is owned by the wallet the user is using. Much like sensitive passwords for banking or medical accounts, a private key unlocks all the information related to a crypto wallet. This means it’s best to keep a private key under wraps. The best way to secure it is by writing it down and storing it in a place where others are unlikely to find it. Screenshots and similar digital files aren’t recommended as they’re sought after by hackers.
In modern crypto wallets, a private key is encoded using a series of words. These words (usually 12 or 24 of them) are just as important as the key or any other password, as anyone who has them can spend any crypto that’s in the same wallet that created them.
Since there is no central authority or government that issues Bitcoin, the network needs rules that govern how many to issue, who gets that issuance, and how often this happens. In Bitcoin, the process of creating new coins is called mining.
Let’s first establish what it means to mine Bitcoin. Mining simply means to create valid blocks that accurately add transaction records to a larger ledger, or blockchain. In other words, mining builds and protects the transaction history between Bitcoin users to build trust with each other and avoid “double spending” — where a user spends Bitcoin twice or Bitcoin they aren’t authorized to spend.
The records are managed by the rules of the system. The system, comprised of millions of computers running the Bitcoin network, all have a set of rules programmed in. If someone added new rules to their software, the rest of the network would ignore it unless the majority of them had that rule. This protects the network by making sure no single entity can control Bitcoin.
A user that wants to send Bitcoin performs that action in their wallet. Their wallet then uses the private keys it stores to digitally sign that transaction and broadcast it to the network. The network will add that transaction to the pool of all transactions who haven’t been added to the official ledger in a block. A miner, who is also connected to the network, will take as many of these transactions as they can and try to organize them into a new block.
A miner then runs a program that encodes key data elements about the block it is proposing — and all the transactions that are a part of that block — into a cryptographic hash. Each hash will have a unique set of characters based on the unique data in that hash. Regardless of the number of transactions that the miner is hashing, the end result is always a 256 set of letters and numbers. These hashes must have a certain pattern: in Bitcoin, that pattern is a number of zeroes at the start of the display of the hash. To get a hash like this, miners add random data to the transactions they are encoding and compute trillions of hashes a second. When they find one that meets the pattern, they announce it to the network. If the rest of the network validates their work, that becomes a new block or page in the ledger. All other miners must shift to working on transactions under that new page. As a result of spending the energy to find the block, the miner is rewarded newly generated Bitcoin as well as the fees users have as an incentive to include their transaction in the next blocks.
Because Bitcoin has a rule saying only 21 million will ever exist, new Bitcoin issued through mining becomes lower every 210,000 mined. To protect against a new type of computer coming online and mining blocks too fast, the Bitcoin network adjusts the valid pattern every 2,016 blocks based on how often blocks were produced over the last 2,016 blocks. The target rate is 10 minutes per block — if blocks came faster, the network makes it harder to produce new blocks. If it was lower, the network makes it slightly easier. The only way to produce a block, however, is to do the repetitive work to find a matching pattern when producing a hash of the transactions to be sent on the network.
Bitcoin can be used to pay for goods and services from merchants that accept it as payment. The following are the general steps one would take to acquire Bitcoin:
As with any financial decision, it’s important to weigh the pros and cons of a purchase, especially cryptocurrency. While Bitcoin is a popular option in the crypto world, anyone looking to buy it should ensure it falls within their means, aligns with their financial goals, and learn the potential benefits and downsides before making a decision.
Learn about buying, holding, and selling crypto with PayPal.
We use cookies to improve your experience on our site. May we use marketing cookies to show you personalized ads? Manage all cookies