Everything You Need to Know About Bitcoin
If you are on this site, then you are familiar with bitcoin. However, it is difficult to get the information you need about the cryptocurrency, especially if you are new. While bitcoin resembles money in many ways, there are new concepts involved that may be unfamiliar and even a bit intimidating.
This list of frequently asked questions will attempt to answer all your questions about bitcoin.
What is Bitcoin?
Bitcoin is a tokenized, decentralized, peer-to-peer money system. By using cryptography to vouch for the coin’s integrity and transaction security and by delegation monetary policy management to the users, bitcoin does not need a central bank or any other type of controlling authority. Instead, the bitcoin software is the ultimate arbitrator.
This creates a money system that is open, portable, unmalleable, and not dependent on fiat currencies or governmental support. Using a system where it takes more time and energy to fake a transaction than to prove it and where all decisions – from deciding to change the software to approving the sale of a pack of gum in bitcoin – must be ultimately accepted by most users, bitcoin is “trustless” or not dependent on if one can trust another user. All transactions are posted to a distributed ledger called the blockchain for public review, and – to date – there have been no successful attempts to hack the coin.
Bitcoin is the first proof-of-concept of blockchain, a distributed ledger technology that is a direct competitor to enterprise-level databases. As such, even for those that have little faith in the coin as valid money, bitcoin is an essential technical innovation.
Who Created Bitcoin?
The answer to the question “who invented bitcoin” is that no one knows for sure. In 2008, a researcher named Satoshi Nakamoto released a paper based on a system influenced by the proof-of-work email verifier Hashcash. The paper “Bitcoin: A Peer-to-Peer Electronic Cash System” was published on the website of law firm Metzger, Dowdeswell & Co., with a link distributed by mailing link. Today, the paper resides on bitcoin.org, a domain Nakamoto registered quietly earlier in the year.
The thing is, no one knows who Nakamoto is. No one has attested to meeting him/her and all his communications happened by email or social media post. Regardless, Nakamoto stayed involved with the bitcoin project until 2010. In January 2009, he released the bitcoin software and – shortly afterwards – Nakamoto mined the very first bitcoin block, known as the genesis block. On January 12, 2009, the first bitcoin transaction happened, when Nakamoto transferred ten bitcoin to Hal Finney, the developer of the first reusable roof-of-work system and an inspiration behind bitcoin.
In 2010, Nakamoto turned over the network alert key and control of bitcoin’s code repository to Gavin Andresen, who would become lead developer at the Bitcoin Foundation. Following this, Nakamoto disappeared, taking the keys to the over one million bitcoin he mined with him. He has not been seen since, and his bitcoin have not been spent. As of the writing of this article, Nakamoto’s portfolio is worth roughly $6.6 billion dollars, making him one of the richest persons in the world.
Since Nakamoto’s disappearance, bitcoin has been run and modified by its users, led by the Bitcoin Foundation, who develops most bitcoin’s updates as well as wrote and developed the current Bitcoin Core.
While there is a Satoshi Nakamoto living in California that roughly meets what is known of Nakamoto (Japanese, born in Japan on April 5, 1975, a quirky but brilliant programmer), it is commonly believed that Nakamoto is a pseudonym for another programmer, such as Finney or Nick Szabo, or for a group of programmers that came together to solve this problem.
Who Controls Bitcoin?
Bitcoin software users control bitcoin. Any computer that is running a valid, current copy of the Bitcoin Core has a vote on all proposals and on consensus.
As stated in a previous article, consensus is “the process of making decisions for a blockchain. For an open blockchain, each node represents a vote. For some decisions, such as transaction and block confirmations and winning chain calculations, the decision is made by the blockchain software automatically based on the blockchain’s established rules. Other decisions, such as rules or software changes, are proposed, with the blockchain software prompting node operators to vote. Approved proposals cause a fork in the blockchain, with non-complying nodes submitting blocks to the ‘minority’ fork. Under certain circumstances, the ‘minority’ fork is not abandoned, but spun off into a new blockchain with rules and tokens different from the ‘majority’ forks.”
A node is defined by the same article as “a redistribution point or a communication endpoint. In computer networks, it refers to an electronic device that is connected that can create, receive, or transmit relevant data. Regarding blockchains, it is an electronic device running a valid copy of the blockchain software.”
How Do a Bitcoin Transaction Works?
Bitcoin live on their blockchain. At no time is a person in possession to an actual bitcoin. What a person does have is the transferrable private key to that bitcoin. This private key is stored in a wallet, a special file that permits the storage and transfer of these keys.
A transaction happens when one bitcoin user transfers private keys to another user’s wallets. These keys interact with the public keys stored on the blockchain, “unlocking” the bitcoin and allowing the new user to receive a new private key, conferring a transfer of ownership. All of this happens behind the scene. From the user’s point of view, all that happens is that he/she enters the recipient’s wallet address in his/her wallet send page, enter the amount wish to be sent, confirm the decision, and wait for the confirmations.
This transaction is sent to all nodes running the blockchain for confirmation, recording the transaction once the confirmation is completed. While every node must process the transaction eventually, it only takes six confirmations for the transaction to be considered “valid and complete.” This is because it is mathematically insignificant for a transaction to be false following six successful confirmations. A confirmation is the process where a node “proves” the hash for a transaction is legitimate according to the hash algorithm.
Nodes used to process the “first six” transaction confirmations are rewarded for their efforts through transaction fees, or a nominal fee assessed by the blockchain on the transaction. All processing nodes can also participate in the “mining game.”
Per the previously cited article: “To paraphrase, a blockchain works like this: imagine you run an online club that sells sweaters. Every member is not only required to record every transaction, but to verify that they are valid. Your group does this through a complicated register timestamp that is energy-expensive to do and impossible to brute force. However, the veracity of the resulting code can be tested just by plugging the code back into the algorithm. A certain number of members must announce successful completion of the transaction to ship the sweater, although all members must automatically verify the transaction.”
“As an incentive to spend the time and energy to do these confirmations, the club holds a contest. While this is not the case for all blockchains (proof-of-stake blockchains, for example, distribute all their tokens at the launch of the chain and reward nodes with transaction fees, while permissioned blockchains offer no rewards at all), the members could compete for club points based on their confirmation activity. The contest is to guess the address of the next block, based on certain rules such as the address must have at least a certain number of leading zero, must be based on the content hash of the current block, and must be lower than a set target established by the club. The first one to guess a valid answer gets the reward, but only after enough time has passed to avoid fraud.”
The reward is the bitcoin attached to the new block.
Do People Really Use Bitcoin?
In 2010, the first bitcoin transaction happened. Ordering from a Papa John’s pizzeria, a bitcoin programmer named Laszlo Hanyecz bought two pepperoni pizzas at a real-world cost of $20 for 10,000 bitcoin. Those pizzas are now recognized as the most expensive pizzas in history, as they would be worth $66 million today.
Bitcoin, at the time of this article’s writing, has – in a 24-hour period – a trading volume of $468,855,251.66, 247,399 transactions, and a transaction volume of $850,140,240. This is for a currency that only existed for eight years.
So, the answer is yes.
Many companies and stores use bitcoin, including Overstock.com, CheapAir, Subway, and Expedia. Many stores prefer bitcoin to credit cards as the transaction fees are smaller. Despite this, the number of consumers that use bitcoin is small, as bitcoin is not well-suited for everyday purchases. Just as one can use gold as money if they wished, using bitcoin as money is possible but not convenient.
How Can You Get Bitcoin?
The easiest way to get bitcoin is to buy it. One can buy it from anyone offering to sell. However, if you intend to buy bitcoin at the published price, you will need to buy your bitcoin at an exchange such as Coinbase. Most exchanges charge a transaction fee on top of the bitcoin fee. Buying from exchanges can be suspect, as most banks have banned credit card purchasing of bitcoin – although debit purchasing is fine. Peer-to-peer purchasing, like any peer-to-peer activity, may be riskier as hand-transferring of money is involved.
Another way to get bitcoin is to offer a product or service and accept bitcoin as payment. This is likely the most straightforward way to get bitcoin as it only requires a wallet.
The last way to get bitcoin is the hardest. As mentioned earlier, you could get involved in the “mining game.” In exchange for running a full node, your node can compete to guess the address of the next block. Get it right and you will get that block’s bitcoin reward, currently at 12.5 BTC. This, however, would take a very powerful mining rig to succeed. The involvement of Chinese “mega-farms,” where large clusters of specialized mining machines are committed to monopolizing the bitcoin market, created an arms race where a casual miner cannot win the “mining game” alone. One can join a mining pool to improve your odds, but the likelihood of having a positive return-on-investment on bitcoin mining is unlikely without a source of cheap electricity and a significant equipment investment.
How Hard is it to Make Bitcoin Payments?
As there is no credit card processor or issuing bank to deal with, bitcoin payments can be easier to make than a credit card or debit payment. All that is needed is the address of the wallet you wish you send the payment to. You can also make requests for payment via your wallet application.
Depending on your wallet application, you can produce scannable QR codes to simplify transactions or a debit card directly linked to your wallet. Some applications even allow your mobile device’s Near-Field Communication (NFC) to complete transactions simply by touching your device to the recipient’s or sender’s device and confirming the transaction.
What are the Pros of Bitcoin?
Among the many reasons to use bitcoin include:
- Low transaction fees compared to credit cards and built-in fraud protections, permitting merchants to expand into areas of high credit card fraudulent risks,
- Secure transactions where no personal data is transmitted or stored,
- No national currency connections, allowing for cross-border and international payments,
- Irreversible and secure transactions without the risk of chargebacks,
- Full control of wallets, so unauthorized charges are impossible,
- Possible encryption of wallets for backup and protection purposes,
- Transparent transactions that are recorded to a public blockchain, allowing for full auditing of all transactions in real-time,
- All transactions are cryptographically encoded, preventing the possibility of bitcoin hacking, and
- The bitcoin operating software cannot be changed without consensus, meaning that there can be no unannounced changes to monetary policy,
What are the Cons of Bitcoin?
Among the reasons not to use bitcoin include:
- Only a small percentage of consumers and businesses use bitcoin,
- Bitcoin is highly speculative, meaning that the price can and will fluctuate wildly. While these fluctuations may be in the range of commodity speculation, like gold prices, the volatility may be off-putting. Also, as the market is small, any sell or purchase has the potential of significantly influencing the bitcoin price,
- Regulations are still being ironed out for bitcoin use, so it is unclear what will be the legal status of the coin in the future,
- There are other cryptocurrencies that offer better mining support, transaction speeds, and transaction costs than bitcoin,
- Bitcoin is not scalable, meaning that bitcoin’s growth may cause bottlenecks in transmission times. Bitcoin has adapted fixes to remedy this, such as the Lightning Network, but the potential of the problem still exists,
- Users and companies with large bitcoin portfolios – also known as stakeholders – have greater influence on the bitcoin price than other users,
- Bitcoin is risky with no consumer protections. Losses are wholly the end user’s responsibility, and
- The bitcoin code is open-sourced and continuously in edit. As such, there are features that are difficult to use now that will be improved in the future.
Why Should You Trust Bitcoin?
Trust is not the right world, as bitcoin is inherently trustless. What that means is that the use of cryptography makes it so that the two parties in a bitcoin transaction need not trust each other; the software will ensure that all parties act properly.
“Commerce on the Internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments,” Satoshi Nakamoto, the creator of bitcoin, wrote in his paper, “Bitcoin: A Peer-to-Peer Electronic Cash System.” “While the system works well enough for most transactions, it still suffers from the inherent weaknesses of the trust based model. Completely non-reversible transactions are not really possible, since financial institutions cannot avoid mediating disputes. The cost of mediation increases transaction costs, limiting the minimum practical transaction size and cutting off the possibility for small casual transactions, and there is a broader cost in the loss of ability to make non-reversible payments for non-reversible services. With the possibility of reversal, the need for trust spreads. Merchants must be wary of their customers, hassling them for more information than they would otherwise need. A certain percentage of fraud is accepted as unavoidable. These costs and payment uncertainties can be avoided in person by using physical currency, but no mechanism exists to make payments over a communications channel without a trusted party.”
“What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party. Transactions that are computationally impractical to reverse would protect sellers from fraud, and routine escrow mechanisms could easily be implemented to protect buyers. [We] propose a solution to the double-spending problem using a peer-to-peer distributed timestamp server to generate computational proof of the chronological order of transactions. The system is secure as long as honest nodes collectively control more CPU power than any cooperating group of attacker nodes.”
The transparency of the bitcoin blockchain also makes sure that all transactions are available for real-time auditing.
Is Bitcoin a Virtual Currency?
Technically, yes, bitcoin is a virtual currency in the sense that it is currency without a physical presence. A better description would be that bitcoin is virtual money. Bitcoin has inherent value that can be traded for fiat currency or used to buy goods and services. Additionally, most national governments recognize bitcoin as money, but not legal tender.
Can You be Anonymous Using Bitcoin?
No, one should not expect to be anonymous using bitcoin. While no personally-identifiable information is shared while making a transaction, modern forensic methods mean that a transaction can be traced to a specific wallet. The transaction – within itself – is anonymous, but the presence of a permanent record on the blockchain creates a trail that could be exploited.
As such, bitcoin transaction will never be as anonymous as hand-to-hand cash transfers.
There was a time when bitcoin was thought to be anonymous. An original selling point for the coin was its anonymous nature, making it attractive to those seeking to divorce government intervention from their personal lives. The proliferation of money laundering and illicit goods purchasing using bitcoin, however, prompted governments to trailblaze new ways to reverse bitcoin’s anonymity features.
Bitcoin, as recognized money, is subject to the same laws and rules as any other money. This means that bitcoin users must pay capital gain taxes on it in the United States, businesses using bitcoin must conduct anti-money laundering/know your customer protections, and bitcoin can be entered as evidence in criminal investigations and litigations.
There have been proposals to restore bitcoin’s privacy features, but they all have been rejected to date.
Can You Make Money with Bitcoin?
The answer to this is that it depends. Accepting bitcoin as a means of payment is a value-added feature for many retailers. This can result in more customers and more sales.
If your intentions are mining bitcoin, you may be out of luck. From our guide to best tokens to mine: “There is an uncomfortable truth in the bitcoin world. Unless you live in a part of the world with very cheap electricity and unless you have access to a major mining rig, it is impossible to mine bitcoin – or most major coins and tokens – affordably. While there will always be miners willing to mine at a loss for the love of the asset, to maintain the network so that their tokens/coins do not lose value, or just out of curiosity, the notion of the ‘money grab’ that was floated by more naïve types may be out of reach for most, as well as the notion of these cryptocurrencies being open.”
“With most things in life, successful mining means grabbing a stake in opportune territory often. This means paying attention to the ‘minor’ coins and tokens, keeping an eye on their difficulties and return-on-investments, and putting the right resources in on the job. There are miners that successfully mine all new coins once they are announced, but this takes time, patience, a bit of luck, and a lot of skill.”
If you live in the United States or in most of Western Europe, you should forget about bitcoin mining. There is no way one can profitably mine bitcoin today in those regions. However, f you live in an energy-rich area – such as Iceland, Canada, or China – and can create a rig setup that could feasibly compete with the existing systems mining in China, then one may be able to make a run at it.
This leaves investing. It is important to understand one thing about bitcoin: it is extremely high risk. While it is possible to make a great deal of money in bitcoin investing, it is just as possible that you lose a great deal. As a rule, you should invest no more in bitcoin than you are willing to lose.
A case in point to this was the 2017 price spike that saw bitcoin hit $17,000 per coin. It has been argued that the spike was fed in part by suspicious activities from the exchange Bitfinex. “By mapping the blockchains of Bitcoin and Tether, we are able to establish that entities associated with the Bitfinex exchange use Tether to purchase Bitcoin when prices are falling,” John M. Griffin and Amin Shams of the University of Texas at Austin wrote in their paper “Is Bitcoin Really Un-Tethered?”
“Such price supporting activities are successful, as Bitcoin prices rise following the periods of intervention. These effects are present only after negative returns and periods following the printing of Tether. Indeed, even less than 1% of extreme exchange of tether for Bitcoin has substantial aggregate price effects. The buying of Bitcoin with Tether also occurs more aggressively right below salient round-number price thresholds where the price support might be most effective. Negative EOM price pressure on Bitcoin only in months with large Tether issuance indicates a month-end need for dollar reserves related to Tether. Proxies for Tether demand receive little support in the data, but our results are consistent with the supply-driven manipulation hypothesis.”
“Overall, our findings provide substantial support for the view that price manipulation may be behind substantial distortive effects in cryptocurrencies. These findings suggest that external capital market surveillance and monitoring may be necessary to obtain a market that is truly free. More generally, our findings support the historical narrative that dubious activities are not just a by-product of price appreciation, but can substantially contribute to price distortions and capital misallocation.”
While this theory has been thoroughly denounced, it has also triggered an active U.S. Department of Justice investigation. As the bitcoin market is largely unregulated and small, it is extremely unstable. It is advised that you do all due diligence before deciding to dive in.
Can You Lose Bitcoin?
Yes. Yes, you can lose bitcoins. As if you lose your wallet, your money is gone, if you lose access to your wallet or the private keys your wallet holds, your bitcoin is gone. More exact, they are still there on the blockchain, but they are no longer accessible.
Recovering the bitcoin would require “rediscovering” the block, an act that would undo every block that follows it. Such an act would destroy the blockchain. Additionally, there is no way to recover the private keys through brute force or any other circumvention method. However, if your wallet is managed by a third-party, the provider may be able to offer recovery assistance.
How Practical is Bitcoin as a Major Payment Network?
Currently, the bitcoin network is not scalable. This means that the larger it become, the more strains show up in performance. Prior to the advent of the Lightning Network, it was not uncommon for transactions to take up to a day to receive its “first six” confirmations needed for the transaction to be considered valid. Even with the Lightning Network, “first six” confirmation typically takes an hour, which is far too long for casual use. So, as it stands, bitcoin will not be a serious rival for the Visa network or other major payment networks.
This does not mean that it never will be. If the bitcoin community was to accept changes that would make the network more plastic than elastic – such as the establishment of side chains and micropayment networks – and if more server-level nodes were to sign on to expand the network’s backbone, then yes, bitcoin could become a major payment network. This is to say, though, that the bitcoin community has so far rejected many of these proposals.
Is Bitcoin Legal?
In only a few jurisdictions is bitcoin fully banned. Many governments discourage the use of bitcoin and may outlaw the coins’ use by banks and businesses, but do not explicitly ban the coins’ use by individuals.
What is more common is how bitcoin is regulated for taxation or business purposes. Some states and nations require licensure and registering of businesses that use bitcoin or buy and sell bitcoin. Some require cash deposits as security for all bitcoin transactions happening in the region. Other require capital gain taxes on bitcoin profits. Other ban bitcoin investments – particularly initial coin offerings or business seed fundraising using cryptocurrency as a solicitation tool.
Is Bitcoin Used for Illegal Activities?
Yes. As with any monetary system, bitcoin has and is used for illegal activities. It is debatable, though, how big a problem this is.
Per the paper from an Australian research group “Sex, Drugs, and Bitcoin: How Many Illegal Activity is Financed Through Cryptocurrencies?”: “We find that illegal activity accounts for a substantial proportion of the users and trading activity in bitcoin. For example, approximately one-quarter of all users (25%) and close to one-half of bitcoin transactions (44%) are associated with illegal activity. Furthermore, approximately one-fifth (20%) of the total dollar value of transactions and approximately one-half of bitcoin holdings (51%) through time are associated with illegal activity. Our estimates suggest that in the most recent part of our sample (April 2017), there are an estimated 24 million bitcoin market participants that use bitcoin primarily for illegal purposes. These users annually conduct around 36 million transactions, with a value of around $72 billion, and collectively hold around $8 billion worth of bitcoin.”
“To give these numbers some context, a report to the US White House Office of National Drug Control Policy estimates that drug users in the United States in 2010 spend in the order of $100 billion annually on illicit drugs. Using different methods, the size of the European market for illegal drugs is estimated to be at least €24 billion per year.6 While comparisons between such estimates and ours are imprecise for a number of reasons (and the illegal activity captured by our estimates is broader than just illegal drugs), they do provide a sense that the scale of the illegal activity involving bitcoin is not only meaningful as a proportion of bitcoin activity, but also in absolute dollar terms.”
Conversely, from the Center on Sanctions & Illicit Finance: “Through extensive analysis of a narrow data sample of Bitcoin transactions between 2013 and 2016, this study identifies trends in the flow of bitcoins from clearly identified illicit activity to various digital currency conversion services. The parameters of the study were purposefully narrow to keep the data manageable, which likely minimized the volume of illicit bitcoins considered for analysis. The amount of observed Bitcoin laundering was small (less than one percent of all transactions entering conversion services), but what is most relevant are the clear patterns we discovered relating to how illicit bitcoins are laundered. “
“We found that darknet marketplaces such as Silk Road and, later, AlphaBay, were the source of almost all of the illicit bitcoins laundered through conversion services that we identify in our study. Bitcoin exchanges received the greatest amount of identified illicit bitcoins out of all conversion services, but they also processed the majority of Bitcoin transactions overall. The conversion services with the highest proportion of Bitcoin laundering within their platforms were mixers and online gambling sites.”
“Looking at geographic patterns, conversion services based in Europe received the greatest share of illicit bitcoins out of identifiable regions, more than five times as much as North American services. And while Asian conversion services processed the highest share of all incoming Bitcoin transactions in 2015 and 2016, they accounted for a disproportionately small share of Bitcoin laundering during those years. Lastly, a large percentage of conversion services that receive illicit bitcoins appear to conceal their country of operations, making it a challenge to identify the legal jurisdictions responsible for their AML enforcement.”
Can Bitcoin be Regulated?
While bitcoin is decentralized, it is still bound to the laws where it is used. Most jurisdictions impose some form of regulations, typically for businesses that participate in money exchange practices. However, without an effective reporting system (banks, for example, report deposits of a minimum size and all transfers to the IRS), there is no way to make a foolproof taxation system.
It is also possible that much of all bitcoin eventually falls under the control of one party or one group of parties and impose its will on the coin. This can create de facto centralization. Some feel that this has already happen, as most of he current bitcoin hashing power is controlled by a handful of Chinese mining conglomerates. There, however, has been no indication towards a move to centralize as this would be counterproductive toward the network’s future growth.
Can Bitcoin be Taxed?
Most jurisdictions treat bitcoin as a commodity, imposing capital gains tax (or the equivalent) or bitcoin profits. However, as bitcoin are jurisdiction-free, there is no way of assessing sales tax or other forms of tax on bitcoin on a personal level.
Businesses that buy or sell bitcoin for fiat currency may be subject to cryptocurrency taxes.
Are there Bitcoin Consumer Protections?
There are no inherent consumer protections. Attempts to recover lost or pilfered coins are highly frowned upon, as it violates the rule of cryptocurrencies that the software – and not human action – is the law.
It is less likely that a bitcoin investment can be subjected to fraud, compare to other commodities or cash, however. Besides the cryptographical encoding, an investor can set up whatever security measures he/she needs, including requiring a certain number of signatures, requiring dual authentication, or only allowing transactions under specific market conditions. These contracts – no matter how complex – are easily searchable on the blockchain.
Bitcoin also prevent chargebacks, meaning that one party cannot back out of a transaction once it is done. With bitcoin, the deal is the deal and it is backed up by the software code.
How are Bitcoin Generated?
Bitcoin are attached to blocks according to a reward having schedule, which cuts the number of bitcoin in half every 210,000 blocks (approximately every four years). The original reward was 50 bitcoin; today it is 12.5 bitcoin.
The idea is that as the number of coins in circulation increase, CPU power will become cheaper. To control the currency circulation flow, the reward must shrink to make mining less attractive. This introduces scarcity, as the number of new bitcoin will decrease over time. This would make the price of bitcoin grow on a regular curve under normal situations.
There will be 20 million bitcoin in total. When the last bitcoin is mined in 2140, the network will default to transaction rewards to reward miners.
Bitcoin are assigned to miners for successfully finding the address for the bitcoin’s block. Miners – in exchange for validating transaction – get to guess the address of the next block. If the guess meets certain criteria and is first, that miner will get the reward after 100 blocks has been further discovered. In the case of ties, the miner that completed the most verifications get the bitcoin.
How Does Bitcoin Hold Value?
Bitcoin hold value because of demand. On its own, bitcoin is worthless; it is just computer code. What makes it valuable is the fact that someone wants to buy it. Like any other commodity, if the market for bitcoin dries up, so will its price. However, runaway speculation will conversely cause a price spike.
There is currently a minimum limit to bitcoin’s value. This is because of bitcoin ‘s entanglements with other cryptocurrencies and with fiat (national) currency. Many cryptocurrencies hold bitcoin as either a basis or as a reserve currency. Likewise, Tether, which is linked to the value of a United States dollar, is also connected to bitcoin, as many Tether were used to buy bitcoin during the price spike. Finally, many financial institutions have reserves of bitcoin to offer their customers as part of their investment portfolios. All told, this creates a safety net which would slow – if not outright stop – complete deflation of bitcoin’s value.
What Influences the Price of Bitcoin?
Demand. The more people want to buy bitcoin, the more valuable it becomes. As bitcoin is a small market relatively, every purchase or sale of bitcoin affect the value of the coin.
This brings us to an important point: bitcoin is only as valuable as the offering price for it. The published price often touted publicly is actual the current sell price for any given exchange. The various bitcoin publications also have their own price indices. Based on average sell prices from a proprietary sampling of exchanges, the CoinDesk Bitcoin Price Index and Cointelgraph Bitcoin Price Index typically register different prices at the same time. The price may also be different from country to country.
The published prices, like stocks and other commodities, are influenced by the daily trading volume and by company and investor news that may influence the market. Typically, peer-to-peer trading will result in prices vastly different than the published prices.
Can Bitcoin Become Worthless?
Should there be a technical failure in the bitcoin network, then yes, the value of bitcoin will collapse. This can include a corruption of the blockchain, a breakdown of the messaging system, international regulations banning the coin’s use, or simply an abandonment of the network and the software core. While this is unlikely, it should be remembered that this is a technical product and technology fails – sometimes, unexpectedly.
Under normal circumstances, as stated previously, bitcoin has a value floor currently. As such, the value of bitcoin will not dive underneath this minimum, considering that there are no technical faults and that the current ecology of the bitcoin investment web remains intact.
Is Bitcoin Experiencing an Inflation Bubble?
Currently, no. The price spike in late 2017 and early 2018 was a bubble, fed by news reports of increasing coin prices. The more the price grew, the more coverage it received and the faster it grew. This is known as a speculation bubble and for bitcoin, it popped following news of a South Korean exchange being hacked, China clamping down on ICOs, and the CFTC investigating possible price manipulation, losing nearly $11,000 per coin in value in the process.
Bitcoin will form such bubbles occasionally. Typically, they are small and easily avoidable, but the enthusiasm they bring can sometime be hard to ignore. Bitcoin acts like any other type of money; as with investing in any foreign currency, one must be aware of price spikes that may trip you.
As for if the bitcoin market itself is a bubble, the answer to that is no. As stated previously, the market has a floor, so there is little possibility of the market deflating like a bubble. Like a game of Jenga, many the supporting structures must be pulled out before a collapse can feasibly happen.
Isn’t Bitcoin Just Another a Ponzi Scheme?
Again, no. A Ponzi scheme works by paying investors dividends paid from new investors instead from the investments they assume were made on their behalf. There is no one scamming anyone in bitcoin. Basically, it is just you and the code.
When you buy bitcoin, you are buying a product that s secure, whose transaction is recorded on a public ledger, and which can be mathematically verified. While the value of your purchase cannot be locked in, your bitcoin is no different than any other commodity.
It should be noted, though, that there are those that would use bitcoin to con you. You should be aware of the terms of any bitcoin solicitation and use due diligence.
Aren’t Early Adopters Getting More Out of Bitcoin Than Others?
Yes, without a doubt. Those that chose to take on the risk of bitcoin when it started were able to establish significant stakes in the coin at a low price. For example, in 2011, 10,000 bitcoin would have cost about $20. If someone was to buy $100 worth of bitcoin then and hold on to it until today, that person would be able to show $325 million for that $100 investment.
This, however, would require a great deal of faith and personal strength. Bitcoin has been declared dead by the media over the years over one hundred times. Maintaining such a high-risk investment for so long requires absolute confidence in the cryptocurrency and an ability to ignore naysayers.
This is not to say that – as the currency availability shrink – the currency’s value will remain static. It is likely that bitcoin’s positive value curve will start again once the aftershocks of the deflation of the price spike fade away. There are some that are projecting a bitcoin price over $100,000 eventually; this may be the ideal time to position for this.
Isn’t Limiting the Amount of Bitcoin to a Fixed Amount a Bad Idea?
As a rule, setting up a static supply of a currency will lead to runaway inflation. As there is no currency to inject into the economy to modify monetary value, there is no way to prevent a ballooning of the coin’s value.
This is, however, not the end of the world. Under such situation, fractional notes would become commonplace. Bitcoin’s fractional note is the satoshi, which is worth 0.00000001 bitcoin. Bitcoin transaction are measured in satoshis and not bitcoin, as it is more accurate. If the value of bitcoin become too high, satoshis would simply become the tradeable unit.
Aren’t Volatility and Speculation a Huge Problem for Bitcoin?
Yes, it is. As with any commodity, speculation can wreak havoc with pricing, as it did in the 2017 price spike. The lack of a significant investor base makes every transaction significant, increasing the effects of volatility. So, a small amount of speculation – such as a positive post on social media – can create a significant spike in pricing, followed by just as significant a drop in pricing.
This cannot be helped without more people actively involving themselves in the bitcoin market. Adding stabilizing agents, such as tethered cryptocurrencies or institutions holding significant bitcoin reserves, would create a centralized “column” in the market that violates bitcoin’s decentralization. If one want to invest in bitcoin, one will have to accept it will be a bumpy ride.
Can’t a Wealthy Person Buy All the Bitcoin?
The last bitcoin will not be available until 2140. It will not be possible to buy all the bitcoin until then.
As for the bitcoin currently in circulation, they have a market capitalization (as of the time of the writing of this article) of approximately $114 billion. The richest person in the world, Jeff Bezos, has a reported wealth of $112 billion. Buying all the bitcoin would cause the price to spike, as demand is up, so the final price would be many times the current capitalization.
In other words, there is no one with enough money to buy all the bitcoin right now.
Not all the bitcoin are available for sale, though. Some are “lost” – without a private key to make spending them possible. Other are perpetually held in institutional portfolios or with “HODLers” – investors that take a long-term position of bitcoin trading. As such, it is unthinkable that any one person can ever buy all the bitcoin.
If Bitcoin is so Secure, why do I Have to Wait for a Confirmation?
The confirmation is what makes bitcoin so secure. Confirmation is the “first six” verifications your transaction will experience. It is felt that if six miners agree that the transaction is legitimate, it would not be necessary to wait for consensus, as it would be mathematically insignificant that the transaction will be find fraudulent. This is the same as waiting six months for a credit card transaction; chargebacks would be considered impossible at that point. It is up to the parties involved to determine how many verifications are needed to feel safe, but six in the average.
During verification, the miner “proves” that the transaction is valid. At that point, the miner places the transaction into his/her version of the blockchain, permanently recording it. This protects the parties involved, making bitcoin one of the most secure money forms currently available.
How Much Must I Pay in Fees for my Transactions?
Nothing. You don’t have to pay a transaction fee. Transaction fees are not mandatory.
However, if one was to send a transaction for confirmation without a transaction fee, that person shouldn’t expect that confirmation to come in within a week. Transactions fees are “tips” that can be used to entice a miner to choose your transaction to confirm above others. Miners can process confirmations in any order they want, and “first in, first out” tend to create long waits. As the bitcoin core can be configured to pick out the transaction with the largest transaction fee, the larger the fee, the faster the transaction will be confirmed.
These fees are both a reward for mining as well as a check against those that would send out numerous small amount transactions to slow down or crash the network. Such small transactions – fee-less – would end up in the back of the queue, where they can cause little trouble.
The amount one can pay in transaction fees are based on the number of “inputs” the coins have – basically, how many previous transactions they come from – and the age of the coins. Coins from blocks that still have their transaction hashes, for example, will be more expensive than coins from blocks that have only a header hash. The amount one will pay, however, is set by the person’s wallet.
Some wallet providers automatically charge the recommended fee. It is worth checking your wallet’s documentation to see if you can change the fee in your account settings.
What Happens if Someone Sends Bitcoin to My Wallet and I am Offline?
You will receive your coins, regardless of if you are online or off. You will receive your private keys once your wallet syncs with the blockchain.
An important thing to understand is that your private keys are bonded to your wallet address until the public key is used to connect the coin to someone else’s wallet. You cannot “lose” bitcoin from a wallet; if you can access a wallet, your coins will be waiting for you. Every copy of the blockchain show your transfer, so you can breathe easy.
Why does Synchronizing Take So long?
The current blockchain has more than 544,000 blocks and is 184.487 gigabytes in size. This is more than three times the size of a Blu-Ray double-sided disc. This is only a problem is a user is running a full node, where the full blockchain sits on the node’s memory. Most users only use a thin client, which only confirms data relevant to the user. However, some clients may need additional data from the blockchain to determine spendable balances and to determine if and how new bitcoin transactions can be made.
What is the Difference Between Bitcoin and Ethereum?
Ethereum is a separate cryptocurrency, developed to solve some of the problems with bitcoin. “Possibly the most obvious difference between the two cryptocurrencies involve how they were created,” our article on the differences between bitcoin and Ethereum reads. “Bitcoin, for example, was a proof-of-concept for a digital money idea, while Ethereum was meant to be a replacement for bitcoin.”
“The idea for bitcoin was introduced in 2009, when anonymous developer Satoshi Nakamoto wrote the protocol specifications in the paper ‘Bitcoin: A Peer-to-Peer Electronic Cash System.’ Publishing the paper on the Cyberpunks mailing list, the paper expanded on Wei Dai’s 1998 concept of ‘cryptocurrency’ or money that utilizes cryptography to control and limit its creation, distribution, and transactions.”
“Ethereum, on the other hand, came from a direct criticism of bitcoin. In 2013, Vitalik Buterin, a bitcoin researcher and programmer, proposed an initial coin offering – the first of its kind – to fund the development of a new coin. While Ethereum would not be the first post-bitcoin cryptocurrency, it was the first to address critical flaws in the coin’s protocol, such as its lack of scripting capability, its limited coin supply, and its long transaction time. This came to be because Buterin found it impossible to get agreement from the bitcoin community about embracing these changes.”
The biggest differences between the two coins are:
- Ethereum has no set coin supply; bitcoin is limited to 21 million coins;
- Ethereum has native scripting support in multiple programming languages while bitcoin’s scripting capabilities are limited;
- Ethereum’s blockchain can create and be services by “smart contracts.” “A smart contract is a computerized transaction protocol that executes the terms of a contract,” computer scientist Nick Szabo wrote. “The general objectives of smart contract design are to satisfy common contractual conditions (such as payment terms, liens, confidentiality, and even enforcement), minimize exceptions both malicious and accidental, and minimize the need for trusted intermediaries. Related economic goals include lowering fraud loss, arbitration and enforcement costs, and other transaction costs.”
“[W]e can extend the concept of smart contracts to property. Smart property might be created by embedding smart contracts in physical objects. These embedded protocols would automatically give control of the keys for operating the property to the agent who rightfully owns that property, based on the terms of the contract. For example, a car might be rendered inoperable unless the proper challenge-response protocol is completed with its rightful owner, preventing theft. If a loan was taken out to buy that car, and the owner failed to make payments, the smart contract could automatically invoke a lien, which returns control of the car keys to the bank. This smart lien might be much cheaper and more effective than a repo man. Also needed is a protocol to provably remove the lien when the loan has been paid off, as well as hardship and operational exceptions. For example, it would be rude to revoke operation of the car while it’s doing 75 down the freeway.”
These smart contracts, ran by decentralized applications or “dApps” running on the Ethereum Virtual Machine, can approximate any data function, vastly increasing the usefulness of Ethereum beyond just value storing;
- Ethereum uses its abandoned blocks or blocks that did not win the “mining game” as “uncles” to improve transaction speeds. Bitcoin rejects such blocks; and
- When Ethereum runs out, there is a plan to change its consensus plan to “proof-of-stake.” “When the bitcoin supply dries out because the supply limit has been reached or – more likely – bitcoin becomes unprofitable to mine – proof-of-work will cease to work. Mining has dual purposes: besides creating new tokens, it is the confirmation process for the network. Nodes compete to come up with the nonce to solve the next block. The block is not given necessarily to the node that comes up with the nonce first, but the node that both has a valid nonce and completed the most confirmations for the last cycle. The tokens are not just a reward for solving the block, but for also doing the most work to keep the network running.”
“Without mines, there are no verifiers. Either miners would continue to mine at a loss and rely on bitcoin fees to compensate, which – admittedly – will grow as block space becomes rarer, or miners will leave the network, extending confirmation times.”
“Ethereum’s creators foresaw this. When Ethereum’s coin supply finally comes to an end, the network will switch to proof-of-stake, where verifying nodes would need to post a stake of Ethers on an online wallet on the node to confirm its commitment to the system. This stake is effectively collateral against possible fraud by the node.”
What Happens When All the Bitcoin Runs Out?
No one knows. The plan is that the system would run as it is now – minus the mining reward – with verifiers being compensated with transaction fees. The problem is that this does not give an incentive for new miners to come into the system and with the final coin scheduled to be released in 2140, most of the original miners will be dead by then. With no or little incentive for new miners to come onboard, the system will grind to a slow death.
Likely, the bitcoin community will change the rules in anticipation of this well before it happens. One idea is the Ethereum pan, which would see bitcoin become proof-of-stake.
How Likely is it for Another Cryptocurrency to Replace Bitcoin?
This is a loaded question and one that may be impossible to answer. While there are thousands of cryptocurrencies, none have taken whole of the public’s imagination quite like bitcoin. Most ordinary people have never heard of EOS or Litecoin or even Ethereum, but they surely heard of bitcoin.
For a coin to replace bitcoin, it must exceed bitcoin’s coin value for an extended period and have a growth curve that convinced the press that the coin is big news. Additionally, the major institutional stakeholders must be willing to trade bitcoin for this new coin in their portfolios. While it is thought that Ethereum may surpass bitcoin eventually, this seems like a remote possibility.
There is another possibility. As we said previously, bitcoin is not scalable. If enough new users decide to use bitcoin before a growth plan has been implemented, bitcoin could “break” with transactions times and fees skyrocketing. At this point, there may be a bleed-off to a new principal coin.
What Happens if Bitcoin is Banned Tomorrow?
The full banning of bitcoin would mean writing off $114 billion in value, which would cause a global (but temporary) recession. As most governments would want to avoid that, an outright ban is unlikely. It is more likely that regulations banning predatory practices and enforcing proper taxation will happen instead.
However, should bitcoin be banned tomorrow, there would be no relief to those that lost their investment. As such, you should only invest what you can afford to lose.
How Easy is it To Convert Bitcoin into “Real” Money?
If you can find someone willing to buy your bitcoin with “real” money, it is relatively easy. For institutional buyers, you may need to confirm your identity first to satisfy know your customer/anti-money laundering regulations and you may need to pay a transaction fee beyond what the bitcoin network charges. However, this tends to be a quick, automated way of “selling out” your assets.
Regardless of if you go institutional or peer-to-peer, you may be responsible for capital gains taxes of the sale. Make sure to consult your local laws to know your liability.
If No One Owns Bitcoin, Can I Create My Own Bitcoin System?
Yes, you can. There are currently 2,010 active cryptocurrencies and over 800 “dead” ones. Most blockchain software is open-sourced, so anyone that want to start a blockchain is more than welcomed to. However, if you want your cryptocurrency to be worth anything, you need to find a “hook” to get investors interested. Most cryptocurrencies have coin values of less than a penny.
It should be noted that if you plan to start a cryptocurrency as a scam device, you should really think twice. Most national securities regulators have taken an aggressive posture toward fraudulent cryptocurrencies, with the number of seizures and arrests increasing every year.
How Easy it is to Fake or Hack Bitcoin?
It is one of the hardest things to fake. This is in part due to the cryptographical nature of the blockchain’s data structure. It is also due to a bit of clever planning.
New bitcoin are released only after 100 blocks have been discovered after the block the bitcoin are attached to. This means that one must wait about 1,000 minutes (about seventeen hours) to use new bitcoin. If one was to double-spend these bitcoin, the hacker must not only rediscover the affected block, but also rediscover all 100-plus blocks that follows it in less time than it takes for the blockchain to advance one block (which is currently ten minutes). Even then, the hacker will have to get more than half of the active miners to accept the new chain. Any miner that could possibly arrange such a scenario would lose more from the bad faith and the lost of legitimate mining than what could be gained from the hack.
Think about it this way: a miner could gather 50.1 percent of the network’s hashing power to steal a few blocks’ bitcoin, or he/she could just mine his/her own coins, knowing he/she will likely get at least half of them and he/she will not face censure or arrest if caught.
Therefore, there has not been a “51% Attack” with bitcoin, even though other cryptocurrencies have been burdened by them.
What Can You Buy with Bitcoin?
Bitcoin is money. Anything that can be bought can theoretically be bought with bitcoin, if the seller is willing to accept them. There are major retailers, like Microsoft, Subway, Overstock.com, and FTC that accept bitcoin as a method of payment.
While buying with bitcoin is as common as buying with gold bullion, it is possible. There are debit cards that directly connect to your bitcoin wallet to allow everyday purchasing, for example, and bitcoin ATMs are common.