What is Bitcoin and How Does it Work? by Kris-Anita Enyinnaya

As Bitcoin and cryptocurrency continue to rise in popularity, people have increasingly asked the question, what is Bitcoin? Bitcoin (BTC) was the first and remains the most valuable entrant in the emerging assets class known as cryptocurrencies.

Research shows that the BTC price reached an all-time high in 2024, its value exceeding $73,000 in March 2024. Such a crazy figure! 

But, what is Bitcoin? Bitcoin is a form of digital currency that operates blockchain technology to support decentralized exchange. Decentralized exchange primarily aims to eliminate the need for third parties or central authorities such as governments or banks. This is just a foot in the door; there’s so much more to know.

Here, we explain in detail what Bitcoin is and how it works.

What is Bitcoin?

Launched in 2009, Bitcoin is the world’s oldest cryptocurrency. As a digital currency, Bitcoin is stored, managed, and exchanged on a digital computer system.

As a type of cryptocurrency, Bitcoin uses cryptography to ensure the security of the network on which it is built. The Bitcoin network records transactions in the form of encryption on a public ledger, meaning that everyone on the network can access transaction records. By making data easily accessible, it becomes almost impossible to reverse or fake Bitcoin transactions. The verification of Bitcoin transactions is the responsibility of the network participants, and is facilitated through a process known as “mining.” 

Bitcoin mining is the process of creating new bitcoins while ensuring the security of the network. Mining enables the network’s system to arrive at a consensus (agreeing to the accuracy of a transaction) without depending on a centralized authority. This (decentralization) was exactly what Satoshi Nakamoto sought to explain in his white paper – a decentralized currency that bypasses the need for trust; not issued or backed by any bank or government.

In Bitcoin mining, specialized computers solve extremely complex math problems required to verify and add new blocks to the chain. To successfully add a block, Bitcoin miners compete to solve the math problems and be the first to arrive at the correct or closest answer to the question. Miners guess the target hash (correct number) by randomly making as many guesses as quickly as they can, which requires high computing power. The difficulty only increases as more miners join the network. 

The computer hardware required for Bitcoin mining is known as application-specific integrated circuits or ASICs. ASICs aren’t just expensive but also criticized for their huge electricity consumption, which tends to limit the profitability of miners.

Once a miner can successfully add a block to the blockchain, they’re rewarded with 3.125 bitcoins. The reward amount is cut in half roughly every four years, or every 210,000 blocks. In summary, Bitcoin operates a Proof-of-work consensus mechanism, which rewards cryptocurrency miners for validating transactions and adding new blocks to the network.

Bitcoin as well as other cryptocurrencies are powered by a technology known as blockchain. Blockchain technology makes it possible for the Decentralization of Cryptocurrency(ies) – decentralized savings, peer-to-peer transactions, etc. Now, what is blockchain, you may ask?

What Is a Blockchain?

One can barely answer the question, of what is Bitcoin, without talking about the technology that powers it. Blockchain is a distributed database that is shared among the nodes of a computer network. As a database, a blockchain stores information electronically in a digital format.

Blockchains are popular for their crucial role in cryptocurrency systems, such as Bitcoin. They maintain a secure and decentralized record of data. The innovation behind blockchain technology is that it guarantees the security of a record of data. Blockchain also helps to generate trust among the crypto community members without the need for a trusted third party. 

In theory, data could mean any type of contract existing and agreed upon between two parties. In the case of Bitcoin, the information recorded on the blockchain is primarily transactions. For example, Mr. A (Bitcoin holder) sent X (quantity) Bitcoin to Mr. B (Bitcoin holder). Thus, it is correct to say that a blockchain-primarily keeps a record of Bitcoin transactions.

The key difference between a normal database and a blockchain is how the data is structured. A normal database usually structures its data into tables, whereas a blockchain structures its data into chunks (blocks) that are strung together. 

The data structure of a blockchain makes data permanent or irreversible. Once a block is filled, it is set in stone and becomes a part of the timeline. Each block in the chain is given an exact timestamp when it is added to the chain.

A blockchain collects information together in groups, sets of information known as blocks. Blocks have a storage limit, hence, when each block is filled, it is closed and linked to the previously filled block, forming a chain of data. This is the insight behind the name blockchain – a chain of blocks.

Now you’re probably asking who makes these blocks. Here’s the thing; whenever a Crypto trader carries out a transaction in the crypto space, the information is transmitted through nodes. These nodes are what make up and fill a block.

Bitcoin wouldn’t have come into reality without the blockchain. But then, just like digital currencies, blockchain can’t be seen or touched.

Who Created Bitcoin?

Now that we’ve answered the question of what is bitcoin, let’s see the history of this crypto giant. Bitcoin is believed to be the brainchild of the mysterious and pseudonymous Satoshi Nakamoto, captured in his 2008 white paper. Nakamoto’s paper was titled “Bitcoin: A Peer-to-Peer Electronic Cash System.”

According to him, the project was “an electronic payment system based on cryptographic proof instead of trust.” Satoshi Nakamoto wrote: “The root problem with conventional currencies is all the trust that’s required to make it work.” More so, “the central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust.”

Hence, Nakamoto intended to rectify the trust breach which was common with fiat currencies using cryptographic proof. Cryptography adopts the practice of encoding and decoding to store data. This way, it becomes possible to send messages that only the intended recipient can read. Depending on the configuration, cryptography technology can guarantee pseudo or full anonymity. 

Nakamoto sought to design a system for a digital currency, free of control from any organization or government. His theory was developed and on  9 January 2009, the Bitcoin network was launched. However, Nakamoto withdrew from the project in 2010.

Is Bitcoin Money?

Although Bitcoin is yet to be accepted as legal tender in most parts of the world, it remains the most popular and valuable digital currency. Moreover, it set the stage for the creation of a ton of other cryptocurrencies, collectively known as altcoins.

Bitcoin is an acceptable means of exchange for various online businesses, and payments in some countries. When compared with cash transactions, the costs of transactions are cheaper. This makes it a considerable option for small businesses that aim to keep costs low. Bitcoin is also currently one of the credible investment vehicles as it has the potential for significant value appreciation.

What makes Bitcoin a currency?

Bitcoin is global

“Bitcoin is global” is just another way of saying that no limitations exist to the transfer of Bitcoin across nations. You can perform Bitcoin transactions from anywhere and at any time.

Bitcoin is irreversible

Just like cash, once you send a Bitcoin, you cannot reverse the transaction. However, in the case of credit cards and online payment systems, the availability of intermediaries makes the reversal of cash possible.

Bitcoin is private

Transactions with Bitcoin are not a complicated process that requires lots of documents. Although it still requires certain information, that’s only the Bitcoin address and amount of Bitcoin the individual wants to send.

Bitcoin is secure

Cryptography is the security system in the Bitcoin network. With information encoded, there’s no need to release sensitive information over the porous internet. This goes a long way to curb the activities of hackers.

Bitcoin is open 

Bitcoin uses a public ledger where everyone can see the transactions you perform on the network. This is another risk management technique as it makes it highly difficult for anyone to manipulate transactions. A blockchain is open-source software that allows anyone to examine the code.

Bitcoin is safe 

Over ten years of Bitcoin’s existence, the network has not recorded a successful security breach. That can tell that the Bitcoin network has a strong security system.

How to Own Bitcoin

Bitcoin is a digital asset. It can only be bought and sold on a cryptocurrency exchange. Bitcoin can also be held or stored at a crypto exchange or in a digital wallet. There are two types of crypto wallets you could use; a hot wallet and a cold wallet. Basically, a hot wallet is an online wallet, while a cold wallet is an offline wallet. It’s important to decide what type of wallet to use and set up your wallet before you go ahead to buy Bitcoin. 

To buy Bitcoin, simply choose an exchange that’s best suited for you and set up an account. Once your account is up, you can buy Bitcoin with just a few clicks. If it’s your first time, you’ll likely need a detailed guide on how to buy and sell cryptocurrency. 

There are different ways to invest in bitcoin. Similar to company stock, you can buy and hold Bitcoin as a long-term investment. Alternatively, you can buy and aim to sell after a price rally or bet on its price decreasing. The latter is known as bitcoin trading.

Each coin represents the value of Bitcoin’s current price, which is currently over $70,000. However, if you can’t afford to buy a coin, you can own partial shares of each coin. This is known as fractional shares; that’s smaller than a whole share.

The smallest denomination of each Bitcoin is called a Satoshi. Each Satoshi is equivalent to a hundred millionth of one Bitcoin, so owning fractional shares of Bitcoin is something.

Is Bitcoin a Good Investment?

For the likes of Michael Saylor, their success story wouldn’t ever be without Bitcoin. So, yes, Bitcoin does have some (or perhaps, a lot of) potential. Historically, Bitcoin has been known to be a great store of value, a digital gold. Assets such as gold, considered a store of value, retain their purchasing power over time and can be readily exchanged.

Bitcoin tends to meet this criteria, giving people an option to hedge their portfolios for a worst-case scenario. In addition, the currency isn’t backed by a government, allowing you full control of your assets. However, you must understand that Bitcoin investment is risky. Bitcoin, as well as other cryptocurrencies, are highly volatile assets.

For example, Bitcoin which soared in March 2024 to new all-time highs above $73,000 has dropped below $60,000 as of the first week of May; that’s around a 19.59% decline from its peak of $73,750. Yet, as of June 7, the coin value has gone up to above $71,000.

Crypto enthusiasts further foresee a bullish reversal of the market, leading to a giant price action soon. Some analysts believe that Bitcoin could reach a record benchmark of $100,000 by the end of 2024.

Before investing in Bitcoin, ensure to understand its ins and outs. As a general rule, commit only a small portion of a diversified portfolio. Experts advise putting no more than 1% to 10% into Bitcoin if you must invest and never a sizable part of your portfolio. Generally, Bitcoin investment isn’t a bad idea, it all comes down to your circumstances.

Wrapping Up

What is Bitcoin and how does it work? Bitcoin is a digital currency operating on a blockchain network. Bitcoin operates a decentralized system, meaning that no central authority controls the digital currency – Bitcoin is not issued or backed by any bank or government. It instead relies on peer-to-peer software and cryptography.

Bitcoin investing seems to be what everyone is talking about, but Bitcoin is a highly volatile asset. So, if you’re considering owning Bitcoin, keep its volatility in mind while ensuring to have more stable order investments as backup. In all, it’s advisable to have a diversified portfolio, with bitcoin making up a small percentage. 

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