We’re hearing lots in the news about Bitcoin. But what exactly is it, how does it work, and what impact will it have in the wider world? Here’s everything you need to know
Invented in 2009, Bitcoin is the world’s oldest and best-known cryptocurrency. Like its various crypto counterparts, it’s also extremely volatile. While many Australian investors are drawn to its fortune-generating potential, it’s rarely a smooth or even successful path to wealth building.
Cryptocurrencies are also a popular haunting ground for scammers, and a number of Australians have lost tens of thousands of dollars in crypto scams.
What is a bitcoin?
People once traded physical assets such as gold and silver for goods and services. But these were hard to carry and vulnerable to theft and loss, so banks offered to hold them for us, issuing notes that proved the wealth we had in the bank.
Eventually, the link between these notes and the commodities they represented was broken. Instead, governments said the notes themselves had value.
We trust banks to honor the value of our currency so that we can accept cash as payment and trust others will accept it from us.
A cryptocurrency is essentially a digital version of cash that exists outside the established framework of national governments and central and private banks. It enables two people to exchange it or buy and sell with it without the likes of Westpac or NAB needing to facilitate the payment.
In other words, each party to the transaction trusts that the asset being exchanged has inherent value.
How do Bitcoin payments work?
Making a Bitcoin payment is as simple as sending an email. You transfer Bitcoins from your digital wallet (obtained when you buy the currency from a crypto exchange) to someone else’s using an app or website and the person’s unique Bitcoin address.
Payments are processed and verified by a network of ordinary people with computers running specialist software.
These volunteers are called Bitcoin miners. They use high-end computer hardware to crack increasingly complex, mathematical verification problems generated by Bitcoin’s source code – its computing DNA.
The hardware is expensive, immensely powerful and uses huge amounts of energy. More on this later.
Once a payment is verified, the miner adds a record of the transaction to a shared online ledger. The record includes the sender and recipients’ Bitcoin addresses and the amount transferred.
Entries into the ledger cannot be amended or deleted. And since everyone’s copy of the ledger must match, it makes it extremely hard for someone to claim they have more Bitcoin than they really own, as everyone else’s copy of the ledger would contradict them.
Miners don’t verify one transaction at a time. Transactions are grouped into ‘blocks’ which have a limited amount of space. When a block is ‘full’, a new, empty block is created.
Each new block links back to the previous block containing information about older transactions. The blocks form a chain that links back all the way to the very first Bitcoin transaction.
This public ‘blockchain’ ledger provides an indelible, definitive and transparent account of which wallets hold Bitcoin and how much each holds at any given time – with the receipts to prove it.
What is bitcoin mining?
A Bitcoin miner who adds a block to the chain is issued with one new Bitcoin worth thousands of dollars. It sounds like free money, but the investment required to build and run a machine capable of processing a block is significant and increases over time.
Around 900 bitcoins are minted every day. At today’s prices, their total value is more than $US18 million. The total supply of Bitcoins is limited to 21 million. Once the limit is reached, it won’t be possible to mint any more.
Also, the reward for mining a Bitcoin halves every four years. At the current trajectory, it’s predicted the last Bitcoin will be mined by 2140 unless current protocols are changed.
How to use Bitcoin?
You can buy it, sell it and use it to purchase goods and services wherever it’s accepted. You don’t have to spend in whole Bitcoins – each one can be subdivided (see below).
Bitcoin payments aren’t exactly mainstream, but big names like Microsoft, Express VPN and Wikipedia take Bitcoin payments.
Many people simply invest in Bitcoin in the hope that it will go up in value. Bitcoin reached almost $US69,000 in November of 2021, but has since fallen by a dramatic 70% in value. At the time of writing, one Bitcoin was valued at around $US20,000. The cryptocurrency continues to fluctuate in value today, with some industry figureheads arguing that the value of Bitcoin could stay well below its peak for the next two years.
This kind of market volatility has raised regulators’ eyebrows. The Federal Government, through its Moneysmart website, points out that crypto is, in most cases, not considered to be a financial product and therefore your crypto platform may not be regulated by the corporate regulator, the Australian Securities and Investments Commission (ASIC).
As Moneysmart states: “When a cryptocurrency fails, investors will most likely lose all the money they put in.”
Who can buy Bitcoin?
Anyone can buy Bitcoin from crypto exchanges such as Binance and Coinbase. According to Roy Morgan research, more than one million Australians aged 18 and over, or 5% of the population, invest in cryptocurrency.
However, unless you have a spare $US20,000 in your account to buy a single token, you’re going to be buying a fraction, or a share, of one Bitcoin.
Smaller denominations of Bitcoin are called Satoshis after the pseudonym used by its anonymous inventor(s). One Satoshi is worth 0.00000001 Bitcoin.
As mentioned previously, Bitcoin and the cryptocurrency market are unregulated. This means there are no rules in place to protect you from losing everything, and no watchdog to ensure everyone involved plays fair.
What do I need to mine Bitcoin?
According to Bitcoin expert and journalist Connor Sephton, miners need three things to succeed: access to cheap electricity, hardware known as application-specific integrated circuits (ASICs), and mining software that connects them to the Bitcoin network.
The most capable ASICs can cost thousands of pounds to buy and run, making them prohibitively expensive for the average person.
Is Bitcoin the only cryptocurrency?
There are countless other cryptocurrencies, collectively referred to as altcoins.
They include well-established altcoins like Ethereum and Litecoin, as well as fledgling altcoins like Elrond and Clover. Each currency has different values and rules, but they all follow the basic precepts of cryptocurrency.
What are the benefits of Bitcoin?
With no intermediary, there’s nobody to take a cut of each transaction. Bitcoin is a global currency that’s also easier to move across borders and, as a relatively anonymous currency, it makes transactions truly private.
It’s also revered by many proponents of ‘DeFi’ — or decentralized finance — because it’s not reliable on human gatekeepers or middlemen.
What are the drawbacks of Bitcoin?
It’s unregulated, volatile and can’t be used as widely as traditional currencies.
The amount of energy used globally to make Bitcoin work is also massive. It has the same carbon footprint as the entire country of Argentina, according to Oxford University researchers in the UK.
This has raised questions about the long-term sustainability of the phenomenon, especially as global economies strive to reduce their greenhouse gas emissions in line with international environmental agreements and associated ‘green’ targets.
This article is not an endorsement of any particular cryptocurrency, broker or exchange nor does it constitute a recommendation of cryptocurrency as an investment class.
Related: How to Buy Bitcoin in 5 Mins