We hear a lot in the news about bitcoin. But what exactly is it, how does it work, and what impact will it have in the world? Here’s everything you need to know
Bitcoin was invented in 2009 and is the oldest and most well-known cryptocurrency in the world. Like its various crypto counterparts, it is also extremely volatile. While many Australian investors are drawn to its wealth-generating potential, it’s rarely a smooth or even successful path to wealth-building.
Cryptocurrencies are also a favorite haunt for scammers, and a number of Australians have lost tens of thousands of dollars to crypto scams.
What is a bitcoin?
Once upon a time, people exchanged physical assets such as gold and silver for goods and services. But these were heavy to carry and prone to theft and loss, so banks offered to hold them for us and issued notes proving the wealth we had in the bank.
Eventually, the link between these banknotes and the commodities they represented was severed. Instead, governments said the notes themselves had value.
We trust banks to respect the value of our currency so that we can accept cash as payment, and trust that others will accept it from us.
A cryptocurrency is essentially a digital version of cash that exists outside of the established framework of national governments and central and private banks. It allows two people to exchange it or use it to buy and sell without Westpac or NAB having to facilitate payment.
In other words, each party to the transaction trusts that the asset being exchanged has an inherent value.
How do bitcoin payments work?
Making a bitcoin payment is as easy as sending an email. You transfer bitcoins from your digital wallet (which you get when you buy currency from a crypto exchange) to another person using an app or website and that person’s unique bitcoin address.
Payments are processed and verified by a network of ordinary people with computers running special software.
These volunteers are called bitcoin miners. They use high-end computer hardware to crack increasingly complex math verification problems generated by Bitcoin’s source code – its computer DNA.
The hardware is expensive, extremely powerful and consumes enormous amounts of energy. More on that later.
Once a payment is verified, the miner adds a record of the transaction to a shared online ledger. The record contains the Bitcoin addresses of the sender and recipient as well as the amount transferred.
Entries in the general ledger cannot be modified or deleted. And since everyone else’s ledger copy has to match, it’s extremely difficult for someone to claim that they have more Bitcoin than they actually own, since everyone else’s ledger copy would contradict them.
Miners do not verify one transaction at a time. Transactions are grouped into “blocks” that have a limited amount of space. When a block is “full”, a new, empty block is created.
Each new block is linked to the previous block, which contains information about older transactions. The blocks form a chain that goes back to the very first bitcoin transaction.
This public “blockchain” ledger provides an indelible, final, and transparent record of which wallets hold bitcoin and how much they hold at any given time — with the receipts to prove it.
What is bitcoin mining?
A bitcoin miner who adds a block to the chain gets thousands of dollars worth of new bitcoin. It sounds like free money, but the investment required to build and run a machine that can process one block is significant and increases over time.
Around 900 bitcoins are mined every day. At today’s prices, their combined value is more than $18 million. The total supply of Bitcoins is limited to 21 million. Once the limit is reached, it can no longer be mined.
In addition, the reward for mining a bitcoin is halved every four years. At the current rate, the last bitcoin is predicted to be mined by 2140 unless current protocols are changed.
How to use bitcoin
You can buy it, sell it, and use it to buy goods and services wherever it’s accepted. You don’t have to spend whole bitcoins – each can be subdivided (see below).
Bitcoin payments aren’t exactly mainstream, but big names like Microsoft, Express VPN, and Wikipedia accept bitcoin payments.
Many people simply invest in Bitcoin in the hope that its value will increase. Bitcoin hit nearly $69,000 in November 2021 but has since fallen a dramatic 70% in value. At the time of writing, one bitcoin is valued at around $20,000. The cryptocurrency continues to fluctuate in value today, with some industry figureheads arguing that Bitcoin’s value could remain well below its peak over the next two years.
This type of market volatility has raised the eyebrows of regulators. The federal government points out through their Moneysmart website that in most cases crypto is not considered a financial product and therefore your crypto platform may not be regulated by the company regulator, the Australian Securities and Investments Commission (ASIC).
As Moneysmart notes, “If a cryptocurrency fails, investors will most likely lose all the money they have invested.”
Who can buy bitcoin?
Anyone can buy bitcoin from crypto exchanges like Binance and Coinbase. According to research by Roy Morgan, more than a million Australians aged 18+, or 5% of the population, are investing in cryptocurrency.
However, if you don’t have $20,000 in your account to buy a single token, you will buy a fraction or share of a bitcoin.
Smaller denominations of Bitcoin are called Satoshis after the pseudonym of their anonymous inventors. One satoshi is worth 0.00000001 bitcoin.
As mentioned earlier, Bitcoin and the cryptocurrency market are not regulated. This means there are no rules to protect you from losing everything and no chaperon to ensure everyone involved is playing fairly.
What do I need to mine Bitcoin?
According to Bitcoin expert and journalist Connor Sephton, miners need three things to be successful: access to cheap electricity, hardware known as application-specific integrated circuits (ASICs), and mining software that connects them to the Bitcoin network .
The highest performing ASICs can cost thousands of pounds to buy and run, making them unaffordable for the average person.
Is Bitcoin the Only Cryptocurrency?
There are countless other cryptocurrencies collectively referred to as altcoins.
These include established altcoins like Ethereum and Litecoin, as well as young altcoins like Elrond and Clover. Each currency has different values and rules, but all follow the basic rules of cryptocurrency.
What are the advantages of Bitcoin?
Since there is no intermediary, there is no one to take from every transaction. Bitcoin is a global currency that is also easier to move across borders and, as a relatively anonymous currency, makes transactions truly private.
It’s also revered by many proponents of “DeFi” — or decentralized finance — because it doesn’t rely on human gatekeepers or middlemen.
What are the disadvantages of Bitcoin?
It is unregulated, volatile and cannot be used as frequently as traditional currencies.
The amount of energy used worldwide to make Bitcoin work is also huge. It has the same carbon footprint as the entire country of Argentina, according to researchers at Oxford University in the UK.
This has raised questions about the long-term sustainability of the phenomenon, particularly as the global economy seeks to reduce its greenhouse gas emissions in line with international environmental agreements and associated “green” goals.
This article is not an endorsement of any particular cryptocurrency, broker, or exchange, nor is it a recommendation of cryptocurrency as an asset class.
Related: How to Buy Bitcoin in 5 Minutes