What Is Bitcoin: Everything You Need To Know About How Bitcoin Works

Bitcoin, Crypto and NFT's are all the rage but trying to wrap your head around what they are can be a little challenging. We're here to help demystify these concepts with our newly launched cryptocurrency series.

In this guide, you'll get an overview of how Bitcoin came about, what Bitcoin is, how it works and how to trade bitcoin. 

But first we have to ask… what is money, really? 

Before diving into the details of what Bitcoin is, we should start with understanding the concept of money and traditional or Fiat currencies. 

Money is an asset that functions as a generally recognized medium of exchange used to transact goods and services in an economy. 

  • It evolved from the bartering economy where people would trade-specific goods or services for another faced the "double coincidence of wants" issue. Where to trade – each party has to have something the other wants (such as writing this article in exchange for a dozen eggs).

  • Money solves this issue by providing a centralized medium of exchange that both parties agree to for buying and selling in a market.

Bitcoin vs. Traditional/Fiat Money

Traditional or Fiat money is a currency that is government-issued and is not backed by a physical commodity such as silver or gold. Its value is derived from supply and demand and the perceived trustworthiness of the issuing government to guarantee its value. Such examples are the U.S. Dollar, the Canadian dollar, the Japanese Yen or any other global currency. 

  • Trust is the name of the game as governments guarantee the value of its currency and manages it through a central authority (usually a central bank). The banks would then allow users to access this system.

  • The emergence of e-commerce in the late 2000s resulted in financial institutions serving as the trusted intermediaries to process these electronic payments.

  • But, a currency could risk losing its value over time due to inflation (the process of increasing prices while being able to buy less with the same amount of money) or hyperinflation (inflation on steroids when prices increase so much so quickly that your currency cannot keep up). 

  • As governments and banks act as gatekeepers to this system, they could also limit who can use their currency or has access to this system. 

  • The dependence on trust could be problematic as it makes systems brittle, opaque and costly to operate – especially if you live in a country with less trustworthy governments. 

What is Bitcoin, then? 

Bitcoin is the "OG" decentralized digital currency. It was first conceptualized as a white paper in 2008 and created in 2009 by an individual under the pseudo name of Satoshi Nakamoto. It is essentially a computer file stored in a digital wallet verified by a digital record of ownership. Bitcoin aimed to facilitate electronic transactions and allow anyone to send or receive currency without intermediaries or trusted third parties (such as financial institutions) using a currency created by a computer program. 

A major problem though: Since digital currencies are electronically produced without a centralized issuing agency, they could be digitally reproduced – resulting in "double spending" where a holder of a digital token makes a copy of the token, sending one to another party while retaining the original as it is essentially impossible to know as a user. 

  • To solve this, the bitcoin system uses a peer-to-peer (P2P) network that records and validates transactions that prevent double-spending. 

How Does Bitcoin Work?

It helps to break bitcoin down into its three core components: 

  1. Blockchain: An open-source computer program that is a distributed public ledger of transactions. Transactions act as "blocks" connected or "chained" in the code to create an immutable record. 

  2. Public and Private Keys: A bitcoin wallet contains a public and private key (essentially a series of numbers) that allow the owner to digitally sign and prove authorization for transactions. 

  3. Bitcoin Miners: Operate the peer-to-peer platform that runs the blockchain network and confirms the validity of the transactions by solving complex math problems.

A typical Bitcoin transaction happens like this: 

  1. Two users create and validate a transaction using their digital signatures. 

  2. The transaction is sent to the Bitcoin network 

  3. Miners running the system add and validate the transaction into the network using complex math. 

  4. Different systems around the world check each other’s work to ensure the information is correct.

A system of computers (also known as "miners") run Bitcoin's code and maintain the blockchain ledger. When a transaction is made between two users, they record the information on the blockchain and confirm the transaction. 

  • A process of "mining" occurs where the computers add a record of the past transactions to the blockchain and confirm the transaction's legitimacy by solving complex math problems – earning transaction fees and Bitcoins. 

  • Any computer running this code should all have duplicate records – as the current transaction is dependent on the previous one to validate it and prevent falsification or transaction disputes.

  • By design, only 21 million Bitcoins will ever be produced, guaranteeing their scarcity as a unit of value. 

How does Bitcoin trading work? 

Since the initial development of Bitcoin in 2009, cryptocurrency exchanges have emerged to allow users to trade these digital tokens like any other exchange stock or commodity exchange.

Although bitcoin was conceptualized as a medium of exchange and widely discussed to replace fiat currency, it has emerged to become more as an asset class like any traditional stock or traded commodity.

It is a relatively simple asset compared to other financial products or instruments but is a speculative asset with high price volatility. A simple online search will point you towards Bitcoin trading platforms, but a more specific guide to buying Bitcoin can be found here

What's Next? 

Now that you know how Bitcoin works and how blockchain underpins this system, you now understand the decentralised structure that powers cryptocurrency and NFT’s. 

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