What Is Bitcoin and How Does It Work?

Published: November 5, 2017 - 9:00am EST

Bitcoin symbol on a coin

People haven't always used paper bills and metal coins as money or valued objects of exchange. Many have simply traded livestock, produce, alcohol, guns, jewels or beads, and the like. But have you ever imagined exchanging computer data as a currency? With the introduction of Bitcoin in 2009, that became a reality, and it may become a new standard for how people do business in the future.

What is Bitcoin?

Bitcoin is a completely digital cryptocurrency based on a blockchain database, a computer filing system meant to store encrypted, tamper-resistant records of information. As such, Bitcoin transactions are semi-anonymous, secure, and often difficult to reverse without affecting the entire database.

The invention of Bitcoin and the blockchain database structure that makes it possible are still somewhat shrouded in mystery. Both are credited to a Japanese man named Satoshi Nakamoto in 2008-2009, but many have concluded that he is merely an alias for Bitcoin's true inventor (whom they suspect is actually someone from Europe or the United States). To this day, there is still debate over who Satoshi Nakamoto really is, including if they are a singular person or actually a group of people working together.

What are "bitcoins"?

Bitcoins are units of value created when new transactions are added and verified on the Bitcoin blockchain database. They can be bought, spent, and traded for other cryptocurrencies. There are also millibitcoins (0.001 bitcoins), microbitcoins (0.000001 bitcoins), and satoshis (0.00000001 bitcoins).

How does Bitcoin work?

Bitcoin works via an encrypted public transaction database that keeps track of whenever someone buys, sells, or trades bitcoins. When data on new transactions is added to this database, it is then verified by independent third parties, and some of the leftover data becomes new bitcoins.

To understand how Bitcoin works, it can be helpful to understand how cryptocurrencies in general work, as well as how the blockchain computer database structure that underlies them works.

What is a "blockchain"?

A "blockchain" is an ever-growing database of sequential encrypted computer data records (or "blocks").  Each block is connected to the one before it on the chain by an encrypted "transaction" record. Blockchains can be public or private, but they never have a single central administrator.

Squares overlapping

Each block is resistant to having the information inside it changed without changing all the blocks before it in the sequence, which requires the permission of a majority of other database users. This makes it difficult to add new data when it shouldn't be added, or to reuse previously-added data.

For more on how blockchains work, see these informational articles on BlockGeeks.com and CoinDesk.com.

What is a "cryptocurrency"?

A "cryptocurrency" is a system of value based on how blockchain databases work. Basically, whenever someone makes a transaction using a cryptocurrency, a record of it has to be made. And when a new record is added and verified on the blockchain, the leftover data becomes new units of cryptocurrency.

Websites like BlockGeeks.com and CryptocurrencyFacts.com can tell you much more about the ins and outs of how cryptocurrencies work.

What is a bitcoin worth?

The value of a bitcoin can vary greatly by month – or even by day – because it isn't tied to the value of any other currency. Instead, its value is similar to that of a company stock on the stock market. If a lot of people want to buy it, the price of a bitcoin goes up. If not, the price falls.

The current value of a bitcoin can be found on websites such as XE.com or BitPay.com.

What can you buy with bitcoins?

There are many companies and institutions around the world that now accept bitcoins as payment for products, services, or donations. These include online marketplaces, retail outlets, booking agencies, social networks, educational institutions, political parties, activist groups, and more.

According to the website 99Bitcoins.com, as of mid-2016, over 100 major institutions around the globe accept bitcoins. Here are some of the more recognizable ones:


Institution Name

Description
Subway Restaurant chain specializing in submarine sandwiches
Microsoft General technology company
Virgin Group Multi-national company, currently most famous for its airlines and mobile phone services
Steam Online digital game management platform by Valve Corporation
OkCupid/Badoo Online dating
platforms
Massachusetts Institute of Technology/Simon Fraser
University
Educational
institutions
The Internet
Archive
Internet-based repository of World Wide Web documentation
Wikipedia Internet-based
collaborative encyclopedia
Expedia Travel accommodations booking company
Overstock/Newegg/Etsy/
Rakuten/Fancy/eBay
Online marketplaces
Dell Personal computer
manufacturer
PayPal Online secure
payment service

 

How do I get bitcoins?

You can buy bitcoins with real money, or trade other cryptocurrencies for them, at online currency exchanges like CoinBase.com. You can also earn bitcoins by participating in bitcoin mining or by using bitcoin faucets. However, you need a cryptocurrency wallet in order to store and use bitcoins.

What is a cryptocurrency wallet?

A cryptocurrency wallet is basically a set of one or more pairs of key codes. One is a public code, which is known as your "Bitcoin address" and identifies you as a unique user of the Bitcoin network. The other is a private key that controls access to the Bitcoin transactions associated with your public code.

Wallet

In other words, your Bitcoin address lets other Bitcoin users know where you are in the system, so they know that it's you and nobody else whom they're receiving bitcoins from (or sending bitcoins to). Your private key code acts as a lock on your Bitcoin address, so others can't simply transfer bitcoins from your Bitcoin address to theirs (or vice-versa) without your approval first.

Some cryptocurrency wallets are computer programs, while other ones are physical cards or memory storage devices. Heck, even a piece of paper can be a cryptocurrency wallet if it has a pair of keys on it (but we wouldn't suggest using it, as it won't be very secure)! A list of recommended cryptocurrency wallets for using Bitcoin can be found here.

What is "bitcoin mining" and how does it work? What is a "bitcoin miner"?

"Bitcoin mining" involves verifying that new blocks have been added to the Bitcoin blockchain database, as well as making sure that the information contained within those blocks is correct. Users within the Bitcoin network compete to complete these processes as early and as fast as possible.

Miner

These "bitcoin miners," as they are called, use specialized computers to detect and verify new blocks and transactions added to the Bitcoin network. Basically, this involves solving a series of difficult math puzzles. In doing so, they get paid a portion of the new bitcoins created from a block if they successfully "mine" it.

This system works to make sure that each block in the Bitcoin blockchain is independently verified by multiple users. And, by offering a competitive incentive, it discourages users from teaming up to deliberately misreport information for their collective gain.

If you'd like to learn how to mine bitcoins for yourself, check out this complete beginner's guide on 99Bitcoins.com.

What is a "bitcoin faucet"?

A bitcoin faucet is website or app that allows you to perform repetitive, menial tasks in order to gradually earn bitcoins. Usually, this involves completing a visual puzzle or referring a friend to the service. Then, at predetermined intervals, you get paid bitcoins based on your performance.

Water faucet

Bitcoin faucets are often a great way to introduce yourself to how Bitcoin works. They often contain basic information about Bitcoin (or other cryptocurrencies), give you a small number of free units, and let you perform some test transactions. This lets you get a feel for how Bitcoin operates if you're nervous about spending real money on it yet.

We would recommend exercising caution, however. Not all bitcoin faucets are legitimate; some may simply be decoys for stealing your personal information or infecting your computer with malware. Refer to our tips on avoiding phishing scams for staying away from fake faucets. Also keep in mind that bitcoin faucets are basically giving away free money, so they're popular targets for hackers.

Is Bitcoin safe to use?

Bitcoin is safe for a few reasons. First, it's encrypted, so it's difficult to get information on transactions. Second, it's somewhat private because you're only identified by your Bitcoin address. Third, transactions can't be altered or reversed without the approval of the majority of Bitcoin users.

There are a few things to keep in mind when using Bitcoin, however. First and foremost, the security of the Bitcoin network is reliant on bitcoin miners, multiple independently-operating system users who verify the accuracy of transactions. They usually are honest in their work, because doing their job properly earns them more bitcoins. However, there is the possibility for them to hack the system and steal bitcoins; it's rare, but it has happened.

Bank vault

Also important to note is that Bitcoin is not a completely anonymous system. You are represented on the network by your Bitcoin address and not any meaningful personally-identifiable information. However, it is possible for people with the coding know-how (including bitcoin miners) to check a series of transactions on the network, since the Bitcoin system is publicly-available (but still encrypted).

If someone sees a pattern of dates, times, places, etc. where one Bitcoin address interacts with another, they may be able to use that as a clue to guess who the person behind a Bitcoin address is in real life. This is why it can be useful to use multiple cryptocurrency wallets to store and spend your bitcoins. That way, you're using multiple Bitcoin addresses for your transactions, which make them more difficult to trace back to you as an individual person.

And, of course, protect your cryptocurrency wallets! If someone knows your Bitcoin address, all they need to know in addition is your private key in order to spend or steal your bitcoins! For this reason, it's usually more secure to use a physical cryptocurrency wallet, or a computer-desktop-based wallet program, than an Internet-based wallet program. Remember, the further away from the Internet you keep your wallet, the harder it is to hack. 

Is Bitcoin legal?

Bitcoin is currently legal in North America, as well as many other places around the world. However, since it's such a radical new idea, specific regulations regarding it are often changing. Some countries have passed legislation that restricts or outright criminalizes its use or trade.

There are a number of concerns surrounding Bitcoin as an alternative money system, such as:

  • Most obviously, if its use becomes widespread, it may threaten to undermine the value and legitimacy of government-controlled national currencies.
     
  • It's decentralized, meaning that everyone who uses the system plays a part in maintaining it. No single person or group regulates Bitcoin; changes to the system must be made with the approval of the majority of users.
     
  • Though its data is publicly available, it's an encrypted system, so making sense of the data on any transaction takes time.
     
  • It's a semi-anonymous system; users are identified by their coded Bitcoin addresses, not by any commonly-recognizable personal information.
     
  • It's a tamper-resistant system; changes to any transaction require changing all of the transactions before it and the consent of the majority of the Bitcoin network.

All of these things make Bitcoin – and other cryptocurrencies in general – attractive to criminals, since it's time-consuming to get meaningful information on a transaction (or series of them), and it's very difficult to reverse a transaction once it's done. It's feared that this will make cryptocurrencies popular for illegal activities such as money laundering, Ponzi schemes, and purchasing contraband items.

According to the website CoinDance, Bitcoin is currently restricted or banned in the following countries:


Restricted

Banned
American Samoa Afghanistan
China Bangladesh
Egypt Bolivia
Mexico Ecuador
Saudi Arabia Kyrgyzstan
Zambia Macedonia

 

We hope you now understand a little bit more about Bitcoin, as well as how it and other cryptocurrencies work in general. Remember that, like with any system of exchange, it's important to know that you're getting a square deal when using bitcoins. Check out our list of safe online shopping tips for more information!

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