By now, I’m sure you’ve heard about Bitcoin. Hell, I bet your 90-year-old grandmother has asked you a couple questions about Bitcoin. It’s been all over the headlines for almost a decade now, and some people hate it, and others absolutely love it.
Before you form your own opinion as to whether Bitcoin really is the new gold, the future replacement of fiat currencies around the world, or just a stupid passing fad that’s going to lose a lot of people a whole lot of money, you probably want to answer the question: what exactly is Bitcoin? And how does it work?
Well, you’re in luck. In this article, I’m going to take you through the basics of Bitcoin and cryptocurrency in general. This is Bitcoin 101, a beginner’s guide to cryptocurrencies! Let’s go!
What Is Currency?
Before you can understand what cryptocurrency is and why people are paying thousands of US dollars for it, we need to start at the beginning and look at what currency is in its simplest form. “Currency” basically just means money that’s currently in use. Most people think of currency as a dollar bill or a handful of quarters, but currency has been many different things over the course of history.
People used to use shells as currency for over 4,000 years, we even used to use wheat as a currency in a large part of the world. Today, and for most of modern history, the majority of the world uses what’s called “fiat currency”. No, it has nothing to do with the Italian car brand. Fiat currency is just a form of money that’s declared legal tender and backed by a government.
As you probably know, a US dollar no longer corresponds to any amount of gold. Instead, its value is determined by our confidence in the US government and US banks. This is how all fiat currency works. The paper itself is more or less worthless, but it represents the faith we have in our governments and banks to uphold the value of that piece of paper.
Cryptocurrencies work in a very similar way, however, it’s no longer the governments and the banks that people are placing their confidence in. With cryptos, the value of the currency is backed by computer code, or more specifically, the peer-to-peer technology that supports cryptocurrencies like Bitcoin.
So, let’s look at what that technology is and why people have become so optimistic about it that they’re willing to pour thousands and thousands of dollars into it.
Blockchain and Bitcoin Mining
Another word that you’ve almost definitely heard in relation to cryptocurrencies is “blockchain”. A blockchain is essentially a decentralized ledger of transactions that’s universally verifiable. Let me put it this way: a blockchain is a way of verifying transactions from any computer anywhere in the world.
Whereas transactions of fiat currency are usually recorded in a centralized ledger, which is usually controlled by a bank or government institution, cryptocurrency transactions are recorded in a blockchain. Every time someone trades a crypto, that transaction is recorded across the entire blockchain network, and every computer across this network serves as a point of verification for that transaction.
Imagine that 10 different computers have the same number recorded in them, and then one computer has a different number because it’s been tampered with. Those 10 other computers are going to see that one different number, and say, “Hey, wait! That’s not right!” Then, they’ll correct that one errant number. In this way, there’s no need for a centralized ledger when every transaction is being verified by the entire network.
Of course, someone must be responsible for inscribing these transactions into the blockchain ledger. These people, or companies, are called “miners”. They’re basically responsible for the upkeep of the blockchain, and for their efforts, they get rewarded with Bitcoin.
The process of mining a Bitcoin involves complex mathematical calculations run from high-speed computers connected to the internet. It’s really complicated stuff that most people will never be able to do unless you have the latest and greatest in computing software and hardware. So, basically, all you really need to know is that miners take the Bitcoin transactions and convert them into code that update the blockchain network and make it so anyone in the world can verify that transaction.
Bitcoin, created in 2009 by a mysterious figure known as Satoshi Nakamoto, is widely regarded as the first ever cryptocurrency, but it’s definitely not the only one that’s supported by blockchain. Ethereum, Litecoin, Chainlink, and many other popular cryptos use blockchain technology. The entire point is basically to move the task of backing currency away from the governments and the banks, and into the hands of the common person, and in doing so, to decrease our reliance on these large institutions who many people view as being overly powerful and controlling.
At the end of the day, though, cryptocurrency really is just computer code, which doesn’t have much inherent value. In much the same way, the paper that fiat money is printed on doesn’t have much inherent value, yet we assign it value based on our confidence in it. Well, crypto is really no different.
What Gives Cryptocurrency Value?
If you want to look at what gives cryptocurrency its value, it’s basically determined by what people will pay for it, just like any other currency. Of course, this is largely dependent on the total supply of that cryptocurrency.
The US Mint makes sure that there are only a certain number of dollars floating around the economy, and the Federal Reserve adjusts the estimated value of a dollar for any inflation. Well, the same kind of thing happens with Bitcoin. When Satoshi Nakamoto first created Bitcoin, he (or they) made sure that there would only ever be 21 million Bitcoins available for mining.
While not all of these Bitcoins have been mined yet, the fact that there is a finite amount allows us to assign them a value. How could you ever give a value to something if there was an infinite amount of them? So, basically, as people begin to have more and more faith in the Bitcoin network as a whole, the value of the entire pool of Bitcoins will increase. If you divide the value of the entire Bitcoin network by the available number of Bitcoins, then you should get the value of one single Bitcoin.
Of course, with Bitcoin and cryptocurrencies being relatively new, the values of these coins and the underlying blockchains that support them are still very much up to speculation. When the value of Bitcoin goes up, it should mean that people believe in the technology behind it, and that they think it could actually become a viable predominant currency in the future. However, some people may invest in Bitcoin because they think they can sell it for a quick profit in the future, and may not actually believe in it as a real currency.
Essentially, like anything else that there’s a market for, cryptocurrencies’ values are based on what people will pay for them, even though their motivations for buying them may differ.
But where do you even buy a cryptocurrency? And where do you store them?
Buying Crypto and Crypto Wallets
While there are ways to buy Bitcoin in person with cash, the vast majority of people choose to buy Bitcoin and other cryptocurrencies through online trading platforms. The most well-known crypto exchange is called Coinbase. It’s been around longer than most of the other exchanges, however, platforms like Binance, Etoro, and BlockFi have gained a great deal of popularity in recent years.
When you use one of these trading apps, you deposit dollars or other fiat currency, which you can then use to buy any of the cryptos traded on their exchanges. Once you purchase a cryptocurrency, the transaction is recorded in a blockchain ledger, and your crypto goes into what’s called a “digital wallet”, which is basically an online portfolio of the cryptos that you own.
Buying and selling crypto is about as easy as trading any stock, but does that mean you should go for it? Should you shovel all your money into Bitcoin right now? Well, it’s really up to you.
Should You Buy Cryptocurrencies?
Whether or not you should invest in cryptocurrencies is entirely up to you, but there are some things you should know first. Prices for cryptos have historically been extremely volatile. From a risk standpoint, buying cryptos is a much bigger gamble than investing in something like an index fund right now. While that can mean far greater rewards, it can also mean far greater losses as well.
There have also been some concerns about hacking when it comes to cryptos. While people may tell you that the blockchains that support cryptos are unhackable, there have been some pretty large hacks in the past.
In May 2019, someone hacked $40 million worth of Bitcoin from the Binance exchange, and losses like that aren’t protected by the Securities Investor Protection Corporation like more traditional investments are.
All that being said, though, as we’ve seen with the price of Bitcoin, which grew from around $6,000 to as high as $60,000 just this past year, cryptocurrencies do have the potential to generate massive returns. And if you like the idea of moving control of currencies away from institutions like governments and banks, then investing in crypto might be a good way to support that.
Bottom line: do your own research and think carefully before deciding whether or not to invest in cryptocurrencies.