Bitcoin

Bitcoin

What is Bitcoin

In the late 1990s, Nobel Prize-winning economist Milton Friedman predicted the early rise of digital currency.  It’s been only twenty years when an unknown person under the name Satoshi Nakamoto invented Bitcoin, he described it as “A Peer-to-Peer Electronic Cash System”, it follows the ideas set out in a white paper - the document which created the roadmap for Bitcoin. Today, this is still the most simple and accurate description.

Now Bitcoin is a worldwide cryptocurrency and digital payment system also known as the first decentralized digital currency as it is powered by its users with no central authority or middlemen. From a user perspective, Bitcoin is nothing more than a mobile app or computer program that provides a personal Bitcoin wallet and allows a user to send and receive Bitcoins with them. This is how Bitcoin works for most users.

At the end of April 2017, the total value of all existing Bitcoins exceeded 20 billion US dollars, with millions of dollars worth of Bitcoins exchanged daily. Its’ popularity is skyrocketing because it solves many of the problems of other forms of currency. It's created and held electronically and can be used to buy goods and services or transfer money anywhere in the world. Bitcoin is the first currency to be globally accepted and there is no currency exchange, no minimums, no limits and it does not require a bank account. That’s why the number of businesses and individuals using Bitcoins is growing rapidly. This includes brick-and-mortar businesses like restaurants, apartments, and law firms, as well as popular online services.There are no physical Bitcoins, only balances kept on a public ledger in the cloud and paper wallets which actually represent a document containing the information stored in the digital wallet and copy of private and public keys. Bitcoins are not issued or backed by any banks or governments, nor are individual Bitcoins valuable as a commodity. Despite it's not being a legal tender, Bitcoin charts high on popularity, and has triggered the launch of other virtual currencies collectively referred to as Altcoins.  

BREAKING DOWN Bitcoin

Bitcoin is still a cutting-edge experiment in technology and economics. It is known as digital cash, cryptocurrency, an international payment network, the internet of money – but whatever you call it, Bitcoin is a revolution that is changing the way everyone sees and uses the money. 

Bitcoin balances are kept using public and private "keys," which are long strings of numbers and letters linked through the mathematical encryption algorithm that was used to create them. The private key, as its name implies, is kept private and used by the owner to sign any digital file under their name. The public key, which is mathematically related to the private key, verifies that the digital file was, indeed, signed with the private key. Additionally, this public key can and should be shared with anyone who wants to verify ownership claims.

How Bitcoin Works

Bitcoin is a peer-to-peer currency and runs on a system which allows you to send and receive Bitcoins without a third party. To put simply, fiat currencies rely on third parties, such as banks or payment processors like Visa, to verify the transaction. This is how you ensure payment sent was indeed received. However, Bitcoin transactions are recorded in a public ledger called the Bitcoin blockchain. This information is permanent, publicly viewable and cannot be edited or deleted. This means that the transaction records act as proof of transaction. Bitcoin is also programmed to be non-duplicable, which means double spending is highly unlikely.

New Bitcoins are generated by a competitive and decentralized process called "mining". This process involves that individuals are rewarded by the network for their services. Bitcoin miners are processing transactions and securing the network using specialized hardware and are collecting new Bitcoins in exchange. Basically, it involves solving a computationally difficult puzzle to discover a new block, which is added to the blockchain and receiving a reward in the form of few Bitcoins. The block reward was 50 new Bitcoins in 2009; it decreases every four years. The Bitcoin protocol is designed in such a way that new Bitcoins are created at a fixed rate. This makes Bitcoin mining a very competitive business. When more miners join the network, it becomes increasingly difficult to make a profit and miners must seek efficiency to cut their operating costs.The number of new Bitcoins created each year is automatically halved over time until Bitcoin issuance halts completely with a total of 21 million Bitcoins in existence. At this point, Bitcoin miners will probably be supported exclusively by numerous small transaction fees. 

What's Bitcoin Worth?

Like everything else, Bitcoin’s price is determined by the laws of supply and demand. The supply is limited to 21 million Bitcoins, that’s why as more people use Bitcoin the increased demand, combined with the fixed supply, will force the price to go up. As the number of people using Bitcoins in the world is still relatively small, the price of Bitcoin in terms of traditional currency can fluctuate significantly on a daily basis but will continue to increase as more people start to use it. For example, in April 2017, one Bitcoin is worth $1,223 – a considerable jump from late 2016, when it was around $770. In the future, if Bitcoin becomes truly popular, every single Bitcoin will have to be worth at least hundreds of thousands of dollars in order to accommodate this additional demand.

Bitcoin's price is also quite dependent on the size of its mining network since the larger the network is, the more difficult – and thus more costly – it is to produce new Bitcoins. As a result, the price of Bitcoin has to increase as its cost of production also rises. The Bitcoin mining network's aggregate power has more than tripled over the past twelve months.

Who Invented Bitcoin?

The idea of Bitcoin was conceptualized by Satoshi Nakamoto, an anonymous figure. In May 2008, he shared a white paper about Bitcoin, a peer-to-peer cryptocurrency. Without disclosing who he was Satoshi outlined how the currency would work: Bitcoins would be ‘mined’ by computer software, transferred directly amongst users and recorded in a tamper-proof ledger without the need of a third party.

Before Satoshi

Though it is tempting to believe the media's spin that Satoshi Nakamoto is a lone, quixotic genius who created Bitcoin out of thin air, such innovations do not happen in a vacuum. All major scientific discoveries, no matter how original-seeming, were built on previously existing research. There are precursors to Bitcoin: Adam Back’s Hashcash, invented in 1997, and subsequently Wei Dai’s b-money, Nick Szabo’s bit-gold and Hal Finney’s Reusable Proof of Work. The Bitcoin white paper itself cites Hashcash and b-money, as well as various other works spanning several research fields.

Investing in Bitcoins

There are many Bitcoin supporters who believe that digital currency is the future. Those who endorse it are of the view that it facilitates a much faster, no-fee payment system for transactions across the globe. Although it is not itself any backed by any government or central bank, Bitcoin can be exchanged for traditional currencies; in fact, its exchange rate against the dollar attracts potential investors and traders interested in currency plays. Indeed, one of the primary reasons for the growth of digital currencies like Bitcoin is that they can act as an alternative to national fiat money and traditional commodities like gold.

In March 2014, the IRS stated that all virtual currencies, including Bitcoins, would be taxed as property rather than currency. Gains or losses from Bitcoins held as capital will be realized as capital gains or losses, while Bitcoins held as inventory will incur ordinary gains or losses.

Ways to Earn Bitcoins

Receiving As Payment

Some people get paid in Bitcoins, instead of cash currencies. If you have a brick and mortar store, just display a sign saying “Bitcoin Accepted Here” and many of your customers may well take you up on it; the transactions can be handled with the requisite hardware terminal or wallet address through QR codes and touchscreen apps. An online business can easily accept Bitcoins by just adding this payment option to the others it offers, like credit cards, PayPal, etc. Online payments will require a Bitcoin merchant tool (an external processor like Coinbase or BitPay). 

Interest Payments

Another interesting way to earn Bitcoins is by lending them out, and being repaid in the currency. Lending can take three forms – direct lending to someone you know; through a website which facilitates peer-to-peer transactions, pairing borrowers and lenders; or depositing Bitcoins in a virtual bank that offers a certain interest rate for Bitcoin accounts. Some such sites are Bitbond, BitLendingClub and BTCjam. 

Gambling

It’s possible to play at casinos that cater to Bitcoin aficionados, with options like online lotteries, jackpots, spread betting and other games. Of course, the pros and cons and risks that apply to any sort of gambling and betting endeavors are in force here too.

Risks of Investing in Bitcoins

Though Bitcoin was not designed as a normal equity investment (no shares have been issued), some speculative investors were drawn to the digital money after it appreciated rapidly in May 2011 and again in November 2013. Thus, many people purchase Bitcoin for its investment value rather than as a medium of exchange. But their lack of guaranteed value and digital nature means the purchase and use of Bitcoins carry several inherent risks. Many investor alerts have been issued by the Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA), the Consumer Financial Protection Bureau (CFPB), and other agencies.
The concept of a virtual currency is still novel and, compared to traditional investments, Bitcoin doesn't have much of a long-term track record or history of credibility to back it. With their increasing use, Bitcoins are becoming less experimental every day, of course; still, after eight years, they (like all digital currencies) remain in a development phase, still evolving. 
Not for the risk-adverse, in other words. If you are considering investing in Bitcoin, understand these unique investment risks:
Regulatory Risk: Bitcoins are a rival to government currency and may be used for black market transactions, money laundering, illegal activities or tax evasion. As a result, governments may seek to regulate, restrict or ban the use and sale of Bitcoins, and some already have. Others are coming up with various rules. For example, in 2015, the New York State Department of Financial Services finalized regulations that would require companies dealing with the buy, sell, transfer or storage of Bitcoins to record the identity of customers, have a compliance officer and maintain capital reserves. The transactions worth $10,000 or more will have to be recorded and reported.
Security Risk: Bitcoin exchanges are entirely digital and, as with any virtual system, have a risk to be hacked, malware and operational glitches. If a thief gains access to a Bitcoin owner's computer hard drive and steals his private encryption key, he could transfer the stolen Bitcoins to another account. Users can prevent this only if Bitcoins are stored on a computer which is not connected to the internet, or else by choosing to use a paper wallet – printing out the Bitcoin private keys and addresses, and not keeping them on a computer at all. Hackers can also target Bitcoin exchanges, gaining access to thousands of accounts and digital wallets where Bitcoins are stored. 
Insurance Risk: Some investments are insured through the Securities Investor Protection Corporation. Normal bank accounts are insured by the Federal Deposit Insurance Corporation (FDIC) up to a certain amount depending on the jurisdiction. Bitcoin exchanges and Bitcoin accounts are not insured by any type of federal or government program.
Fraud Risk: While Bitcoin uses private key encryption to verify owners and register transactions, fraudsters and scammers may attempt to sell false Bitcoins. For instance, in July 2013, the SEC brought legal action against an operator of a Bitcoin-related Ponzi scheme.
Market Risk:  If fewer people begin to accept Bitcoin as a currency, these digital units may lose value and could become worthless. There is already plenty of competition, and though Bitcoin has a huge lead over the other 100-odd digital currencies that have sprung up, thanks to its brand recognition and venture capital money, a technological break-through in the form of a better virtual coin is always a threat.
Tax Risk:  As Bitcoin is ineligible to be included in any tax-advantaged retirement accounts, there are no good, legal options to shield investments from taxation.
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2021-10-19 • Updated

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