Bitcoin is not only the first blockchain, but it is also the most well-known of the over 5,000 cryptocurrencies currently in use. Bitcoin has become an inextricable aspect of the landscape, with financial media enthusiastically covering each fresh drastic peak and stomach-churning fall.
While the high volatility can make for interesting news, it hardly qualifies Bitcoin as the ideal option for new investors or others seeking a reliable store of value. Understanding the ins and outs of Bitcoin can be challenging, but let’s have a closer peek into how it functions.
What Is Bitcoin?
Bitcoin is a decentralized digital currency that can be bought, sold, and exchanged without the use of a middleman such as a bank. Satoshi Nakamoto, Bitcoin’s founder, first identified the need for “an electronic payment mechanism focused on cryptographic evidence rather than confidence.”
Any Bitcoin transaction that has ever been made is recorded on a public ledger that is open to all, making transactions impossible to reverse and fake. That’s on purpose: Because of their decentralized existence, Bitcoins are not sponsored by the government or other issuing entity, and their worth is only guaranteed by the evidence baked into the framework.
Bitcoin’s valuation has skyrocketed since its initial public offering in 2009. While it once traded for less than $150 a coin, one Bitcoin currently costs nearly $50,000 as of March 1, 2021. Since its supply is capped at 21 million coins, many expect its price to rise steadily over time, particularly as more big, institutional investors begin to see it as a kind of digital gold to protect against market fluctuations and inflation.
Bitcoin is based on a database and is a distributed data ledger. Blockchain is a connected body of data made up of units called blocks that contain information on each and every transaction, such as the date and time, overall amount, buyer and seller, and a special identification code for each sale, as the name suggests. Entries are linked in chronological order, forming a digital blockchain.
According to Stacey Harris, a consultant for Pelicoin, a network of cryptocurrency ATMs, “once a block is connected to the blockchain, it becomes open to anyone who wants to display it, functioning as a public ledger of cryptocurrency transactions.”
Blockchain is decentralized, meaning it is not regulated by a single entity. Buchi Okoro, CEO, and co-founder of African cryptocurrency exchange Quidax compares it to a Google Doc that everyone can edit. “It is not owned by anyone, so anyone with a connection will contribute to it. And as various parties make changes to it, the copy is changed as well.”
Although the thought of anybody being able to edit the blockchain can seem dangerous, that is precisely what makes Bitcoin trustworthy and safe. To be added to the Bitcoin blockchain, a transaction block must be validated by the majority of Bitcoin holders, and the unique codes used to identify users’ wallets and transactions must follow the correct encryption pattern.
Since these codes are lengthy, random numbers, counterfeiting them is extremely difficult. According to Bryan Lotti of Crypto Aquarium, a fraudster guessing the key code to your Bitcoin wallet has about the same odds as winning the Powerball lottery nine times in a row. This degree of statistical randomness in the blockchain encryption codes, which are required for any transaction, significantly reduces the probability of a fraudulent Bitcoin transaction being made by someone.
How Does Bitcoin Mining Work?
The method of introducing new transactions to the Bitcoin database is known as bitcoin mining. It’s a difficult career. Bitcoin miners use a method known as proof of work, in which machines compete to solve mathematical problems that validate transactions.
The Bitcoin code rewards miners with fresh Bitcoins to encourage them to keep racing to solve the puzzles and help the overall system. According to Okoro, “this is how new coins are created” and new transactions are applied to the blockchain.
Mining Bitcoin used to be possible for the ordinary user, but that is no longer the case. The Bitcoin code is written in such a way that solving its puzzles becomes more difficult over time, necessitating more and more computational power. To be competitive today, Bitcoin mining necessitates powerful machines and access to large quantities of cheap electricity.
Bitcoin mining is now less profitable than it once was, making it much more difficult to recoup increasing computing and electricity costs. Flori Marquez, the co-founder of BlockFi, a crypto asset management firm, claims that since this technology first came out in 2009, “every time you got a stamp, you got a much bigger amount of Bitcoin than you do today.” “As the number of purchases increases, the value you get paid on each stamp decreases.” By 2140, it’s expected that all Bitcoins would have been released into circulation, leaving miners with no choice but to focus on transaction fees.
- Bitcoin is often used as an alternative investment in the United States, helping to diversify a portfolio away from stocks and bonds. Bitcoin may also be used to make transactions, but the number of merchants who support it is still small.
- Overstock, AT&T, and Twitch are only a few of the big names that accept Bitcoin. You may even notice that certain small local businesses or websites accept Bitcoin, but you’ll have to look around.
- PayPal, on the other hand, has revealed that it will begin accepting cryptocurrency as a form of payment this year, financing transactions by immediately translating users’ crypto shares to fiat currency.
- According to Spencer Montgomery, founder of Uinta Crypto Consulting, they have 346 million users and are linked to 26 million retailers. “It’s enormous.”
- You can also use a program that allows you to link your crypto account to a debit card, allowing you to use Bitcoin in the same way you would a credit card. This usually entails a finance provider translating the Bitcoin into dollars in real-time. “In the United States, Crypto.com and CoinZoom are two services that are regulated,” Montgomery notes.
- People in other countries, especially those with less secure currencies, have been known to use cryptocurrency in place of their own currency.
“Bitcoin gives users the ability to store money without having to rely on a government-backed currency,” Montgomery says. “It allows people to prepare for the worst-case situation. People are now using Bitcoin in countries like Venezuela, Argentina, and Zimbabwe—in debt-ridden countries, Bitcoin is gaining a lot of traction.”
However, by using Bitcoin as an asset rather than an investment in the United States, you must be mindful of such tax repercussions.
How To Purchase Bitcoin?
The majority of Bitcoin is purchased from exchanges such as Coinbase. You can purchase, sell, and retain cryptocurrencies on exchanges, and opening an account is equivalent to opening a trading account in that you must prove your identification and have a financing mechanism, such as a bank account or debit card. Coinbase, Kraken, and Gemini are also major exchanges. You can also purchase Bitcoin through a broker such as Robinhood.
You’ll need a digital wallet to hold your Bitcoin regardless of where you buy it. This is referred to as a hot wallet or a cold wallet. An exchange or a provider stores a hot wallet (also known as an online wallet) in the cloud. Exodus, Electrum, and Mycelium are examples of online wallet providers. A cold wallet (also known as a mobile wallet) is a Bitcoin storage unit that is not wired to the Internet. Trezor and Ledger are two mobile wallet solutions.
A few crucial points to keep in mind when purchasing Bitcoin: Though Bitcoin is pricey, some vendors offer fractional Bitcoin. Fees, which are often small fractions of the crypto transaction volume but can quickly add up on small-dollar transactions, should also be considered. Finally, keep in mind that Bitcoin sales are not as immediate as many other stock transactions seem to be. Since Bitcoin transactions must be checked by miners, your Bitcoin purchase can take 10-20 minutes to appear in your account.
You can buy and keep Bitcoin as an investment much like a bank. You will now do that in Bitcoin IRAs, which are specialized savings portfolios.
People’s investment philosophies differ depending on where they keep their Bitcoin: Some investors buy for the long run, others buy with the intention of selling after a market rally, and even others gamble on the stock’s price falling. Bitcoin’s price has fluctuated dramatically over time, reaching as low as $5,165 and as high as $28,990 in 2020 alone.
“I believe that people are using Bitcoin to pay for items in some places,” Marquez says, “but the fact is that it is a currency that seems to be growing in value very rapidly for some time.” “So why will you sell something that would be worth ten times as much next year as it is today?” The vast majority of its owners are long-term investors.”
Consumers can also invest in a Bitcoin investment fund by purchasing shares of the Grayscale Bitcoin Trust (GBTC), but it is actually only available to registered owners with a net worth of at least $1 million and an annual income of at least $200,000. This means that the vast majority of Americans would be unable to support it. Diversified Bitcoin trading is becoming more available in Canada.
Purpose Bitcoin ETF (BTCC) began trading as the world’s first Bitcoin ETF in February 2021, and the Ontario Securities Commission has also authorized the Evolve Bitcoin ETF (EBIT). Blockchain ETFs, which invest in the infrastructure that underpins cryptocurrencies, is a good option for American investors looking for Bitcoin or Bitcoin-like exposure.
However, while crypto-based funds can diversify crypto assets and reduce risk marginally, they still bear significantly more risk and charge significantly higher fees than broad-based index funds with a track record of consistent returns. Index-based stock and exchange-traded funds are a good option for investors who want to accumulate their money slowly (ETFs).
In general, many financial advisors encourage their clients’ ability to purchase cryptocurrencies, but they only do so if they show interest. “Our greatest fear is that anyone tries to invest in crypto and the investment they chose doesn’t do well, and then they can’t afford to take their children to college,” says Ian Harvey, a certified financial planner (CFP) in New York City. “Then it wasn’t worth taking the chance.”
Because of the volatile value of cryptocurrencies, some financial advisors consider them as a “side” fund for their clients. “Some people refer to it as a Vegas account,” says Scott Hammel, a Dallas-based CFP. “Let’s keep this out of our actual long-term plans, and make sure it doesn’t take up so much of your portfolio.”
In several ways, Bitcoin is similar to a single asset, and financial advisors will not advise investing a significant portion of the portfolio in a single firm. If you’re serious about Bitcoin, planners recommend investing no more than 1% to 10% of your portfolio in it. “You would never devote any substantial portion of your portfolio to it if it were only one stock,” Hammel says.