If this is your first time paying attention to cryptocurrencies, there are so many obscure terms in this world – blockchain, halving, mining. In this article, we will explain how bitcoin works, in simple words
What is bitcoin
Bitcoin (BTC) is the first and most popular cryptocurrency in the world. As of the beginning of April 2022, the value of one bitcoin is about $44 thousand, and the capitalization of this cryptocurrency is just over $850 trillion.
Despite bitcoin’s popularity, it is still surrounded by many myths and misconceptions – this is also true for the cryptocurrency market as a whole.
That’s why we’ve put together a digest explaining what bitcoin is in simple terms, as well as sharing useful links to our longreads about BTC.
What is cryptocurrency?
In order to understand what bitcoin is, you first need to understand what cryptocurrencies are – we have an ultimatum guide for that.
In brief, cryptocurrency is a digital currency that is decentralized. This means that it does not have a single payment system or body that would regulate its circulation.
Cryptocurrency has no fiat money or commodities behind it, it has no physical expression (coins and bills) – it is essentially a set of mathematical operations.
It is distinguished from other digital currencies by its security and encryption by special algorithms. The main basis of cryptocurrencies is blockchain technology.
All types of cryptocurrencies can be divided into three main types: bitcoins, altcoins (among them stablecoins), tokens (including DeFi tokens). Each of these groups of coins has its own characteristics, which you can read about in our detailed breakdown.
Bitcoin and altcoins themselves are not money in the usual sense, but a complex digital product with its own cryptocode and encrypted record. To obtain the status of money, albeit digital, they go through a complex mechanism of transformation and processing with the help of special technologies.
As of early 2022, there are about 10,000 cryptocurrencies in the world. It is worth noting that many of them, for various reasons, do not work and have no value, i.e. they are “dead coins”.
What is blockchain and how it works
Bitcoin is a complex digital product, which is difficult to understand thoroughly without knowledge of cryptography. It is based on blockchain, a technology for keeping records electronically. Each record is implemented as a block, and each block is connected to each other in a chain in chronological order. Hence the name – “blockchain” literally means “chain of blocks.
Blockchain is one way to store data in a distributed manner. The technology can be used to record and track any kind of information, from medical records to elections.
The use of this technology extends far beyond digital currencies and financial services. Blockchains are used in many areas: healthcare, logistics and intellectual property.
Distributed ledger technology is believed to have been invented by Satoshi Nakamoto in 2008 as a ledger for bitcoin. However, as mentioned earlier, it is not known for sure if a person with that name actually exists or if it is a pseudonym that a whole group of people are hiding behind.
What is bitcoin and how to earn it
For the first time, its mysterious creator (or even mysterious creators) under the pseudonym of Satoshi Nakamoto described the bitcoin working principle in 2008 in a program article about “peer-to-peer electronic payment system”. The so-called Bitcoin white paper appeared in economically difficult times – the global financial crisis began shortly before its publication, and traditional (“fiat”) money was having hard times.
The paper by Satoshi, whose real identity is still unknown, described in technical language how bitcoin works. The paper was the apogee of the development of the idea of a confidential digital payment system that would be independent of states and other institutions.
Undoubtedly, the best way to learn what bitcoin is and how to earn it is to read the white paper itself. But not everyone can understand the document without more explanations – for that, we have a breakdown that explains what bitcoin is in simple terms, the technology behind it, and how the cryptocurrency works.
Bitcoin can be earned in many ways: mining it through mining, buying it on the open market, earning BTC through staking, and – in very rare cases – getting it through promotional campaigns, bonuses, and various games. These ways are described in detail in our feature story.
Let’s look at the two main methods – buying on the open market (trading) and mining – in order.
Bitcoin can be bought with fiat currencies (e.g. dollars, euros or rubles) on cryptocurrency exchange sites.
How bitcoin is mined
Where does bitcoin come from? The most well-known and obvious way to get a cryptocurrency is mining. In English, mining is translated as “mining” – this word used to refer exclusively to mines and ore extraction, but now the first results in search engines for this query refer to the topic of how bitcoin is mined.
Mining works like this: a person or a group of people create a farm – many devices that keep the whole network running. The task of these computers is to solve a cryptographic problem and thereby record data about new transactions on the network in the blockchain. The first device that was able to correctly match the combination to the cryptographic problem is awarded a piece of cryptocurrency.
In the early days of cryptocurrency development, miners received generous payouts – at first, 50 BTC were paid for successfully solving a problem. But every four years, the network goes through a halving process – cutting the reward in half. As of 2022, miners receive 6.25 BTC per task (writing one block in the blockchain). In 2024, that amount will drop to 3.125 BTC. The maximum number of coins in the network is limited – it is assumed that the last bitcoin will be mined by 2140.
Computational complexity increases depending on the total power of all mining devices in the network. And because of the abundance of large companies with the most powerful farms, there is not much chance for single miners to earn bitcoins now. Therefore, many join together in mining pools – networks consisting of different devices around the world. Rewards in pools are divided between all participants.
How many bitcoins are
On April 1, 2022, miners mined the jubilee 19 millionth bitcoin. Thus, almost 90.5% of the maximum issue size of 21 million coins is now in circulation – meaning that only 1.52 million BTC remain to be mined. Because of the mathematical model that governs bitcoin issuance, it will take over 100 more years to mine the remaining 9.5%.
As mentioned above, every four years the number of bitcoins that are paid to miners when a block is mined is halved. Thus, the number of bitcoins in circulation will grow gradually. You can read more about the number of bitcoins in our article.
What Bitcoin is secured with
The question “what bitcoin is backed by” is one of the most discussed about this cryptocurrency. Many factors influence this question – BTC presence on exchanges, as well as exchange rates, published on public platforms. These aspects fuel interest in what the cryptocurrency is backed by and how bitcoin works.
Technically, bitcoin is valued on the same basis as fiat currencies – its price is determined by the balance of supply and demand. In other words, bitcoin is worth as much as people are willing to pay for it. Demand is influenced by many factors: investor faith in the prospects of cryptocurrencies, infrastructure development, the number of market participants, market volume and many others.
Bitcoins can be invested in and profit from BTC exchange rate fluctuations and buy/sell transactions. The presence of a tangible medium and collateral does not matter here – shares have also stopped being transferred in paper form recently (they are sold in the form of an extract from the register of shareholders).
It is worth fixing a number of facts about bitcoin and cryptocurrencies to avoid misconceptions about the “collateral” of BTC:
- Cryptocurrency is money that is not backed by a commensurate supply of gold;
- Bitcoins are not issued and backed by banks or governments around the world, and a single bitcoin has no value as a commodity. For BTC, in principle, there is no requirement to have tangible collateral (because the decentralization principle will be violated);
- Unlike real (fiat) money, digital coins cannot be counterfeited;
- Bitcoin’s value is influenced by the significant amount of fiat assets that are converted into cryptocurrency, as well as the multi-billion dollar mining industry. Impairment of BTC is theoretically possible, but no amount of attempt by the world’s regulators can make bitcoin worthless.
How to store bitcoin
After buying or mining, the question arises how to store bitcoin. Since cryptocurrencies have no physical expression (bills, coins, other types of receipts), you need a safe wallet to store them and use them later.
There are many options for where to store bitcoin – they can be divided into two broad groups: “cold” (physical media) and “hot” wallets.
A cryptocurrency wallet is a mobile app, a special program, or a separate standalone device created to conduct all transactions with electronic money.
There are five types of wallets in the digital world: software wallets, online wallets, hardware wallets, mobile wallets, and paper wallets. Read about which wallet is best for you in our article.
As with fiat currency, there is no “best” way to store BTC – it’s up to the holder to decide where to store bitcoin and what level of risk suits them best.
Why Bitcoins are needed
There are a lot of myths about bitcoin: some people think it is a bubble or a scam, while others think its value is just based on a hype.
There are also misconceptions about why bitcoins are needed: many people think that they are used for illegal activities only (like arms trade). This is not true – bitcoin is gradually beginning to be accepted as a means of payment by companies around the world. Such companies include Microsoft (Skype, Xbox Live), Expedia, AXA Insurance, Polish airlines LOT, Latvian airline airBaltic and many others.
Many also do not understand the point of bitcoin, if there are already national currencies used for centuries.
At this point, bitcoin performs all the same functions as fiat money, only on a decentralized basis – without being tied to any government or central bank. A country’s government cannot set rules for buying and selling bitcoins. Any bitcoin user is free to buy, sell and store bitcoins as they see fit. This creates flexibility and convenience in settlement and transactions for users.
Transactions of major cryptocurrencies (including bitcoin) are protected by blockchain technology, a digital registry that is very difficult to hack. This means that BTC transactions are much safer than fiat ones. Potential attackers would have to launch multiple attacks on multiple devices at once to try to steal your funds.
Added to the security of bitcoins is the fact that they cannot be counterfeited or duplicated, unlike real money.
Bitcoin is also a distributable means of payment, exchange, savings and accumulation, as well as a measure of value, all of which are among the basic functions of money.