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What Is Bitcoin and How Does It Work

by Sandip Das from
What Is Bitcoin and How Does It Work

Millions of people each day ask “what is Bitcoin and how does it work?” on multiple search engines. Bitcoin is the first and the most prominent cryptocurrency. Read this complete Bitcoin guide for beginners to know the most important details about this innovative digital currency. This Bitcoin guide clarifies all your doubts and questions regarding Bitcoin. It covers:

  • What is Bitcoin?
  • How did Bitcoin start?
  • A brief history of Bitcoin
  • The technology behind Bitcoin
  • So, why do we need Bitcoins in the first place?
  • Features of Bitcoin
  • Where to use Bitcoins?
  • What is Bitcoin mining?
  • Is Bitcoin legal?
  • What are Bitcoin exchanges?
  • What is a Bitcoin wallet?
  • Deflationary effects of Bitcoin
  • How does Bitcoin (BTC) derive its value?
  • Bitcoin (BTC) price chart
  • Why is Bitcoin called digital gold?

Bitcoin is the most valued cryptocurrency. It represents about 50% of the total market value of the entire crypto market. So, many beginners often use the terms ‘crypto’ and ‘Bitcoin’ interchangeably. However, there are more than 9,000 cryptos in the market and Bitcoin is one of them (though, it still remains the most prominent crypto).

1. What is Bitcoin?

Bitcoin.Org, the website maintained by the Bitcoin community, defines Bitcoin as ‘an innovative payment network and a new kind of money.’ So, the most simple definition of Bitcoin is that it’s a digital currency based on cryptography and blockchain. Cryptography is a method of securing information through programming. Blockchain is a database in which information is stored in blocks in chronological order.

At first, understanding what is cryptocurrency and how does it work might sound complicated, however, it is not. To make it simple: digital currencies which operate based on cryptography and blockchain are called cryptocurrencies. So, Bitcoin is a cryptocurrency. It was the first cryptocurrency conceptualized in 2008. Today, in spite of having more than 9,000 active cryptos, Bitcoin still controls its prominent position in the market.

Bitcoin is completely decentralized. This means there is no bank or government agency controlling Bitcoin. Bitcoin transactions are conducted peer-to-peer (P2P). So, you can use Bitcoins to send money directly to someone else without requiring a bank or any other intermediary. This is why Bitcoin is often called the ‘future of money.’

1.1 How Did Bitcoin Start?

Bitcoin has a mysterious beginning. In 2008, a person or a group of people using the pseudonym Satoshi Nakamoto created the initial White Paper on Bitcoin. Satoshi mailed this Bitcoin working paper to a cryptography mailing list. Till now, we have no idea who this Satoshi Nakamoto is or was. Initially, Satoshi Nakamoto was active in further developments on the Bitcoin project. Later, the project was handed over to other developers and contributors, creating Bitcoin as we know it today. By visiting https://bitcoin.org/ we can see that even though Bitcoin didn’t exist before 2008, it builds on various ideas related to cryptography and blockchains developed in the 1980s and 1990s.

1.2 A Brief History of Bitcoin

Bitcoin's working paper (Bitcoin: A Peer-to-Peer Electronic Cash System) was released in October 2008 by a person or group of people referring to themselves by the pseudonym Satoshi Nakamoto. Here is a brief timeline of the key milestones related to Bitcoin:

  • Jan 2008: The first Bitcoin block called Genesis Block was created.
  • May 2010: First Bitcoin-based commercial transaction took place when American programmer Laszlo Hanyecz bought two pizzas valued at $25 using 10,000 BTC (the value of which is above $300 million at today's price).
  • July 2010: Bitcoin started trading for the first time for $0.0008 per Bitcoin.
  • Feb 2011: Bitcoin’s value touched $1 for the first time.
  • 2013: Bitcoin’s value crossed $1,000 for the first time.
  • June 2017: Bitcoin crossed $3,000 in value.
  • November 2021: Bitcoin reached an all-time-high value of $68,990.

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1.3 The Technology Behind Bitcoin

In simple words, Bitcoin is a giant global payment network that doesn’t need any authority or intermediary to function. It’s the ‘Internet of money’. Anybody can use this payment network to make financial transactions without a bank or other payment processing mediums like Visa.

The two main elements of this worldwide payment network are the cryptocurrency Bitcoin (symbol: BTC) and the Bitcoin blockchain that records all transactions. So, the Bitcoin (BTC) cryptocurrency is like the US dollar and the Bitcoin blockchain is like your bank account records maintained by your bank.

Bitcoin blockchain is the technological backbone of the Bitcoin network. It’s a distributed ledger that records all transactions on the Bitcoin network with time stamps. This record is permanent and no one can alter it once the records are stored. The computers connected to the Bitcoin network are called nodes. These nodes keep a copy of the ledger and complete blocks. Anyone with enough computing power can join the Bitcoin network to validate transactions and maintain the distributed ledger.

Transactions on the Bitcoin network are validated and recorded by network participants (nodes) on the basis of a consensus protocol named Proof of Work (PoW). All transactions using Bitcoin are secure, private, fast, and conducted in a peer-to-peer environment. To understand better the difference between proof of work and proof of stake, read our article on the topic by following through the link.

2. So, Why Do We Need Bitcoins In the First Place?

You may be thinking if Bitcoin is digital money then why do we need Bitcoins first as there are already various digital payment options like payment apps? What separates Bitcoin from all other types of digital payment modes are security, decentralization, and permanent record.

Bitcoin network uses advanced cryptography, which makes payments highly secure and fast. Secondly, decentralization means unlike other payment mechanisms, Bitcoins don't need any intermediary to process payments. Currently, making cross-border financial transactions is a hassle because of the number of intermediaries involved.

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Bitcoin offers a completely peer-to-peer (P2P) payment mechanism for financial transactions across the world. Thirdly, all Bitcoin transactions are permanently recorded in the Bitcoin blockchain. This makes tracing transaction trails possible, which provides added security and transparency.

3. Features of Bitcoin

Another important factor in understanding what is Bitcoin and how does it work are its features. Bitcoin has a number of key features to learn about and consider. Let’s look at the main features of Bitcoin that set it apart from other digital or fiat currencies:

  • Decentralization: Bitcoin doesn’t have any central controlling authority. It’s maintained by millions of network participants (nodes, miners, developers, etc.) around the world.
  • Digital: Bitcoin is a digital currency and unlike banknotes and coins, Bitcoin doesn’t exist in physical forms.
  • No intermediary: Bitcoin doesn’t need intermediaries like banks or other financial institutions for processing financial transactions.
  • P2P transactions: In Bitcoin, all transactions are done peer-to-peer without any agency between them.
  • Transparency: Bitcoin transactions are recorded on a distributed public ledger visible to the members of the public. So, it’s extremely transparent.
  • Immutability: Transactions once recorded on the Bitcoin network can’t be altered. They are permanently stored on the network.
  • Security: Financial transactions on the Bitcoin network are extremely safe because of the applications of advanced cryptography.
  • Speed: Bitcoin transactions are settled fast as they don't need other agencies for transaction settlement.
  • Limited supply: Bitcoin has a limited total supply. There can be a maximum of 21 million Bitcoins, out of which 19.42 million Bitcoins are already in supply.
  • Privacy: Bitcoin protects the anonymity of the parties involved in financial transactions.

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3.1 Where to Use Bitcoins?

Bitcoin is designed to be used as a mode of payment or a store of value. So, it enables you to make payments for goods and services (like paying for coffee or movie tickets), send money to others, or use it as a savings instrument.

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Currently, a number of major companies like Microsoft, AT&T, Burger King, KFC, Subway, Norwegian Air, and AMC accept Bitcoin as a valid payment mode in selected locations. In 2021, the Central American country El Salvador became the first nation to accept Bitcoin as a legal tender.

As Bitcoins become more widely used, the value of Bitcoin is expected to rise. This creates an investment opportunity in Bitcoins for its potential price appreciation.

3.2 What is Bitcoin Mining?

Simply stated, Bitcoin mining is the process of creating new Bitcoins. Since Bitcoin has no central authority like a central bank, new Bitcoins are ‘minted’ through a computational process called mining.

As we mentioned earlier, the Bitcoin blockchain records all transaction data in chronological blocks. Bitcoin miners validate these transactions using a consensus mechanism named Proof-of-Work (PoW).

However, in order to do so, Bitcoin miners need to solve complex mathematical puzzles to ‘guess’ a 64-digit hexadecimal number (a "hash"). The first miner to come up with the hash gets a chance to complete the next block. As a reward, the miner gets a certain amount of Bitcoin, which gets released into circulation.

Going by the current rate, each time a miner completes a block, it receives 6.25 Bitcoins as a reward. This reward is halved every 4 years to keep the maximum supply of Bitcoins at 21 million.

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Bitcoin mining is an increasingly complex process. It requires sophisticated computer systems that can guess trillions of hashes per second. However, such computer power requires an immense amount of electricity. Bitcoin mining requires about 27 terawatt-hours (TWh) of energy a year. This is higher than the annual energy needs of Argentina - a country of about 46 million people.

3.3 Is Bitcoin Legal?

Bitcoin is a novel technology and there is no comprehensive regulatory framework for it in most countries. However, Bitcoin transactions are not illegal in most jurisdictions across the world be it the US, UK, Canada, Europe, and most countries in Asia and Africa. However, China is an exception. Bitcoin transactions are not legal in China. We suggest purchasing Bitcoin at a dedicated crypto exchange like BTSE. After reading this article, we suggest checking out our referral code BTSE for an exclusive welcome bonus for new users.

Most countries around the world are working on comprehensive crypto regulations, which will help in the faster adoption of cryptos by building trust. Also, proper regulations and crypto laws will help protect investors and promoting the growth of the crypto market.

3.4 What are Bitcoin Exchanges?

Bitcoin exchanges are online marketplaces through which you can buy and sell cryptos. You need to create an account with a crypto exchange and verify KYC to start investing in Bitcoins. There are numerous Bitcoin exchanges in the market. You need to make sure that you choose the best crypto exchanges available after considering factors like trading costs, ease of use, no. of users, and reputation.

Your Bitcoin trading experience depends a lot on the exchange you choose. So, it’s better to stick to the most reputed exchanges. Some of the prominent Bitcoin exchanges are Binance, Coinbase, Kraken, KuCoin, Bybit, OKX, Bitfinex, Bitget, Gemini, and Lbank.

3.5 What is a Bitcoin Wallet?

Bitcoins don't exist in physical forms. So, you need special wallets to store your Bitcoins. A Bitcoin wallet is a digital wallet that stores your Bitcoins. There are different types of Bitcoin wallets, like hot wallets (connected to the Internet) and cold wallets (offline wallets).

4. Deflationary Effects of Bitcoin

In an economy, inflation mainly takes place because the central bank prints more money relative to economic growth. This leads to an increase in the general price level. As more and more money chase a limited supply of goods and services, the purchasing power of a currency falls. We call this situation inflationary.

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To answer the question ''what is Bitcoin and how does it work?'' it is very important to notice that Bitcoin is deflationary. That is the case, because the total number of Bitcoins is limited in supply. There can be a maximum of 21 million Bitcoins only. Once this upper limit is reached, no more Bitcoin can be in circulation. This limited supply of Bitcoin is mathematically achieved by halving the mining rewards every 4 years. So, the reward is designed in a way that once 21 million Bitcoins are in circulation, miners will have zero incentive to mine more Bitcoins. This is also relevant and should be taken into consideration when creating an investment strategy. We have highlighter some essential steps of creating the perfect strategy in our guide on crypto trading strategies for beginners.

5. How Does Bitcoin Derive Its Value?

Bitcoin is intended to be used as a medium of exchange and a store of economic value. As Bitcoin becomes more mainstream and more merchants start accepting Bitcoins, there will be greater demand for Bitcoins. Also, as Bitcoin has a limited supply, greater demand would lead to an appreciation in Bitcoin’s price.

5.1 Bitcoin Price Chart

To understand what is Bitcoin and how does it work it is also important to know the history of its price, which is rather volatile. It started trading for $0.0008 for the first time in 2010. Bitcoin’s value reached $1 in 2011 and $1,000 in 2013. In November 2021, Bitcoin reached an all-time high value of $68,990.

6. Why is Bitcoin Called Digital Gold?

Historically, gold has served as an alternative investment option for hedging against inflation or recessions or even for diversifying risks. Bitcoin helps in achieving many of these investment goals.

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Also, the deflationary effects of Bitcoin make it an excellent hedge against inflation. Because of all these, many investors call Bitcoin the digital gold. If you want to learn more on how to buy Bitcoin follow through the link to our article on the subject.

7. Bitcoin - FAQ

7.1 💵 Where can I buy Bitcoin?

You can purchase Bitcoin at crypto exchanges, such as Huobi, Gemini, or Coinbase.

7.2 📈 What is the maximum supply of Bitcoins?

The maximum number of Bitcoins (BTC) is set at 21 million.

7.3 📖 Where can I learn more about Bitcoin?

Read our “What Is Bitcoin and How Does It Work?” article to learn everything you need to know about Bitcoin.

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