What is bitcoin and how does it work in simple terms?

Main

• Bitcoin is a decentralized system that runs on a software protocol and is based on the principle of direct exchange between users.
• All transactions in the bitcoin network are recorded in a distributed ledger – a blockchain, a copy of which is stored in a full node connected to the global bitcoin network. Blockchain data is regularly verified using the Proof-of-Work consensus algorithm.
• For settlements in the bitcoin network, the unit of the same name “bitcoin” (BTC ticker) is used – the first and most famous cryptocurrency. Since its inception, Bitcoin has remained the largest cryptocurrency by market capitalization.
• Bitcoin works without the participation of any regulatory authority or central bank, the issue of coins and the processing of transactions are carried out collectively by the participants in the network. Thus, no one can control bitcoin, block or cancel the transaction. However, anyone can join the network, use it for transfers, or develop the bitcoin code.

The main innovation of bitcoin

Bitcoin was created as a digital payment system with open source. The main breakthrough and at the same time the value of this project is that for the first time it was possible to create a self-sufficient, reliable and decentralized system for transfers.

Any bank or other similar financial organization is a centralized structure. The work of its operator, as a rule, is completely or partially closed from users (clients). This leads to the need to trust your money. The centralized structure is vulnerable to error, abuse and fraud.

In bitcoin, all these problems are absent, because it is a decentralized structure that is built and maintained by its participants themselves without the participation of a central operator. The balances of all users are public (although specific identities are hidden), and there are mechanisms in the network protocol that regularly check the correctness of all data.

The bitcoin network consists of nodes (nodes) – computers connected to a single network with special software installed on them. Each node stores and updates a copy of the Bitcoin blockchain. The process of confirming transactions, creating new blocks and validating a single version of the blockchain takes place using a consensus algorithm called Proof-of-Work.

The data of all transfers and the state of the balances of all bitcoin addresses are stored in a decentralized registry – blockchain. This is a database, which is a continuous chain of blocks, in each of which new transactions are recorded.

The Role and Importance of Cryptocurrency

The key element of the traditional economy that the anonymous creator of bitcoin wanted to fix was money. In the modern world, national currencies, or fiat money, are printed by states. They are also a centralized structure with known drawbacks. First of all, the value of money is determined by the actions and trust in the issuer. In addition, fiat money is subject to constant inflation, that is, depreciation.

Therefore, for transfers in the bitcoin blockchain, not fiat money is used, but a special unit of account – cryptocurrency. Its main function is to serve as a means of transferring value in the bitcoin network. This value can be calculated in any convenient form, for example, in the same national currency, hence the price of bitcoin is formed. The cost of the first cryptocurrency, again, is determined not by the central bank or any one organization, but by the users and investors themselves in the open market.

Thus, the price of bitcoin is determined not by the state, the central bank, or any one body, but only by the holders of the coins themselves. Some researchers also propose to determine the intrinsic value of bitcoin.

It is important to note that bitcoin was only initially conceived as a replacement for fiat money. And although the first cryptocurrency is used for payments, today many perceive bitcoin more as a valuable investment asset.

How to “open an account” in bitcoin and make transfers

Joining a project called bitcoin is even easier than becoming a bank customer. First you need to download and set up a wallet – a special program that allows you to create addresses on the Bitcoin network, as well as make transactions, that is, receive coins or send them to other addresses.

To create and manage an address on the Bitcoin blockchain, you do not need to go through cumbersome and lengthy identity verification associated with uploading personal documents. Creating an address takes just a few clicks in the wallet interface.

An address in the Bitcoin network is analogous to a universal bank account. As the protocol has evolved on the Bitcoin blockchain, several new address formats have emerged. Almost all of them, with a few exceptions, are fully compatible with each other. Choosing a more modern format allows you to save on transactions. What bitcoin address format to choose, read the bitcoinlinux article:

However, “under the hood” of this procedure are complex cryptographic methods. When creating a new address, its owner receives a pair of “keys”: public and private. The latter also serves to access the balance and is intended only for its owner.

After setting up a bitcoin wallet and creating an address, you need to buy the first bitcoins. How to do it, read our guide:

For each transaction in the Bitcoin network, you need to pay a small commission, which is distributed among the miners responsible for confirming and executing transfers.

Who invented bitcoin and who is developing it now

The concept of Bitcoin was first described in a whitepaper published on October 31, 2008. Its author was someone under the pseudonym “Satoshi Nakamoto”, but it is still unknown who exactly is behind this name – whether it is one person or a group of developers. All messages, publications and other “digital footprints” of Nakamoto can be read on the website Satoshi Nakamoto Institute (in English).

The bitcoin network was launched on January 3, 2009, but the official birthday of the project is January 9, when the software for the node was released to the public.

Since mid-2010, Nakamoto has ceased to participate in the development of bitcoin. After that, the developer community is now responsible for the further development and coordination of the functioning of the network. The specific proposal to improve the Bitcoin code is called the Bitcoin Improvement Proposal (BIP).

However, this does not mean that only the developers decide in which direction Bitcoin will move. However, any significant changes in the protocol are possible only after the majority of mining pools agree with them.

How has the price of bitcoin changed?

When the Bitcoin blockchain was launched in 2009, the cost of the first cryptocurrency was zero. By May 2010, its value had risen to 10 cents. By the way, every year on May 22, the crypto community celebrates Bitcoin Pizza Day: on this day in 2010, the famous purchase of pizza for 10,000 BTC took place.

In April 2011, 1 BTC was worth $1, but after a couple of months, on June 7, its price reached almost $30. Then the price of bitcoin began to fall, dropping to $2 by mid-November 2011. 2012 was not rich in events, but in 2013 the first “bullish rally” took place: if at the beginning of the year 1 BTC was given a little more than $13, then by December its price soared to a record level of $1237, then rolled back to less than $700. During 2014, the price of bitcoin gradually decreased, reaching $315 by the beginning of 2015.

The second major Bitcoin rally occurred in 2017. If at the beginning of the year 1 BTC was trading at $1,000, then starting from April, its rate began to rise sharply: first to $2,500 by the beginning of June, then above $4,000 in August and $7,000 in October. At the end of 2017 and the beginning of 2018, the cost of the first cryptocurrency on some exchanges almost reached $20,000. However, rather quickly, the price of bitcoin rolled back to $10,000 at first and continued to decline throughout 2018. By December, the bitcoin price bottomed out at just over $3,200. After that, a recovery began in the cryptocurrency market.

By the end of June 2019, 1 BTC was worth almost $12,000. After a few more local falls, which were replaced by an uptrend, bitcoin again “grew up” to $12,000 by October 2020.

After that, a new bullish rally began, which brought the first cryptocurrency to a new peak – $ 63,000 – by April 2021. Three months later, bitcoin lost almost 50% of its value, but then its price began to rise again. As a result, on November 9, 2021, Bitcoin reached a new peak at $69,000. Then a correction began with short recovery periods at the end of March 2022.

Global instability in the economy and politics hit the financial market and negatively affected the price of the first cryptocurrency, which rolled back to about $20,000 by the fall of 2022.

How many bitcoins are there and where do new coins come from

New bitcoins are generated each time a new block is successfully mined on its network. The frequency of creating such blocks is constant: 6 units per hour. The amount of block rewards, and therefore the rate of issuance of new bitcoins, periodically decreases as a result of the so-called halving, which occurs every four years.

Thus, there is a precisely scheduled timetable for the issuance of bitcoin, and the total amount of coins that will ever be issued is also known: 21 million. The last emission should take place around 2140.

The appearance of new bitcoins can be compared with the issue of money, but instead of government agencies printing new banknotes, the users themselves produce cryptocurrency. This process is called “mining”. It is built on solving complex mathematical problems by computers. At the same time, computers are located in various parts of the planet, and miners are combined into pools for greater work efficiency. For their work, they receive a certain reward.

It is precisely the presence of economic incentives in the form of cryptocurrencies distributed automatically among the participants that Bitcoin owes the fact that its network has been running smoothly since its launch in January 2009.

Is it true that bitcoin is a pyramid scheme?

This is wrong. The classic pyramid, which promises unrealistically high profits, assumes that the income of the participants in the structure is provided by constantly attracting funds. Profits are paid out from the contributions of subsequent participants. As soon as the inflow of funds significantly weakens or stops, the whole scheme falls apart, leaving a small number of “chosen ones” “in the fat”.

Bitcoin does not promise any benefits to investors. His only promise is complete control over his own finances. And even if we accept the assumption that the demand for cryptocurrencies from newbies or professional investors can lead to an increase in the price, early participants do not receive any dividends from new ones.

Finally, the very distributed nature of bitcoin suggests the absence of any single central structure that could benefit financially.

What makes up the value of bitcoin

There is an opinion that the price of bitcoin is not supported by anything. According to James Rickards, bestselling author of The Currency Wars, every currency in the history of money is backed by trust, and so are cryptocurrencies. In the bitcoin community, this trust is called consensus.

The value of bitcoin also stems from its network effect: the more participants, the higher the price. As an experimental technology, bitcoin is subject to significant price fluctuations, which are used by traders and ordinary holders.

The value of bitcoin can also be called its limited emission. In addition, the first cryptocurrency opened the world to the blockchain, a distributed ledger technology that is rapidly gaining popularity.

Bitcoin is said to be anonymous. This is true?

This is another widespread misconception. Rather, we can talk about pseudo-anonymity. In other words, the movement of funds and the current balance of the address can be seen by anyone, but it is quite difficult to say who exactly they belong to.

However, with enough will, it is possible to trace the IP address of the sender, even if it is not stored on the blockchain. For example, the owners of the servers of some wallet providers have such information.

To date, quite effective tools for analyzing transactions have already been developed. Their functionality allows cryptocurrency companies to instantly find out how reliable their counterparty is and whether it operates with funds that were previously used in illegal financial transactions.