Bitcoin seemed like something out of a science fiction novel when it was first introduced in 2008 in a white paper published in a cryptography mailing list at metzdowd.com
From being a niche interest of cryptography enthusiasts, Bitcoin has now entered the mainstream financial sphere as a valuable digital asset. But the working and functionality of Bitcoin still seem to elude many people.
This article attempts to answer all those questions that you ever had or have, about Bitcoin.
What is Bitcoin?
Simply put, Bitcoin(BTC) is a digital token. It is a type of cryptocurrency– virtual currencies that are decentralized and not backed by any government or central bank. Bitcoin was officially introduced in 2009 by a person(or persons) under the name Satoshi Nakamoto.
Bitcoin is not regulated by any third party and instead relies on a peer-to-peer network to conduct and confirm transactions. It is the original and as such, the most popular cryptocurrency to date.
The success of Bitcoin spurred the creation of other coins popularly called Altcoins though none of them managed to achieve the success that Bitcoin enjoyed. Ethereum and Litecoin are examples of such Altcoins.
A Brief History
Bitcoin emerged in the wake of the 2008 Global Financial Crisis- the worst recession since the Great Depression in 1929. In September 2008, Lehman Brothers declared bankruptcy considered to be the cause of the subsequent international banking crisis.
Governments had to deploy massive bail-outs and stimulus measures to prevent economies from collapsing.
In the wake of these events, a white paper called “Bitcoin: A Peer-to-Peer Electronic Cash System” was published on 31 October 2008 by a person or group of people under the pseudonym Satoshi Nakamoto.
“Commerce on the internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments” Nakamoto stated in the white paper.
The white paper further declared that there was a need for an electronic payment system. The novel thing about this payment system conceptualized by Nakamoto was that it was based on cryptographic proof instead of trust. This would allow two parties to transact with each other without the need for a trusted third party.
Bitcoin officially came into being on 3 January 2009 when Satoshi Nakamoto himself mined the first 50 Bitcoins or the starting block called the Genesis Block. It had the following text embedded into the data “The Times 03/Jan/2009 Chancellor on brink of the second bailout for banks.”
Later, in 2010, Nakamoto simply vanished. This mysterious founder of an extraordinary digital currency posted his final message and gradually stopped responding. To date, no one knows who Satoshi Nakamoto was and his(or their) identity remains shrouded in mystery.
As for Nakamoto’s creation itself, Bitcoin has exhibited extreme price volatility throughout the years. Digital currency barely had any value in the early days of its inception. One BTC was estimated to be around 14 cents in April 2010.
It achieved dollar parity in February 2011.
It experienced ups and downs in the coming years but its popularity started increasing around 2016-17. The value of Bitcoin surged from $2,000 in May 2017 to more than $19,000 in December of the same year.
The Covid-19 pandemic and lockdowns helped in accelerating the value and interest surrounding Bitcoin.
Bitcoin prices reached a peak of over $68,000 in November 2021. However, just a month later, they dropped to $46,000 in December. The decline continued in 2022 and as of November 2022, Bitcoin was trading at less than $17,000.
How Does Bitcoin Work?
Bitcoin is a virtual currency that is free from the oversight and control of any central entity. Unlike fiat currencies which are guaranteed by governments, Bitcoin relies on a technology called Blockchain to validate transactions on a peer-to-peer network.
Bitcoin and Blockchain
Blockchain is a decentralized, open-source public ledger. It uses a peer-to-peer network to ensure the accuracy of transactions and in order to maintain transparency.
Bitcoin, which is an electronic decentralized currency, is built upon blockchain technology. In fact, Bitcoin can be said to be the first widespread application of blockchain.
Blockchain technology is like a bunch of blocks linked together by a chain. Every block has some data, its own hash, and the hash of the previous block. Hash is like a unique identity of the block that protects it from tampering by anyone.
Bitcoin’s hash, for instance, is SHA-256. This means that data stored in a block is encrypted into an eight 32-bit number. Any attempts to modify the hash of a block would be immediately caught due to a mismatch in the network records. This ensures the security of Bitcoin.
Bitcoin and Cryptocurrency
Cryptocurrencies are digital currencies that have been proposed as an alternative form of payment as compared to traditional fiat currencies. Cryptocurrencies are based on a highly secure blockchain network, decentralized and free from the control of any government or central bank.
Bitcoin is the most famous example of cryptocurrency. It is the oldest and the largest cryptocurrency by market value. Even when it witnessed a slide in its value, Bitcoin’s price was much higher than its nearest rivals.
Bitcoin’s success led to the creation of other coins which are popularly known as Altcoins. Ethereum, Cardano, and Luna are some well-known Altcoins.
It should be noted here that cryptocurrency is a broader term and Bitcoin is only a type of cryptocurrency. There are other categories of cryptocurrency such as Altcoins(like Ethereum), meme coins(eg, Shiba Inu), and Stablecoins(eg, Tether).
What is Bitcoin Mining?
Bitcoin, like other cryptocurrencies, is built upon the blockchain network. It is consensus-based and depends on the nodes to validate transactions i.e. create a consensus to add a new block to the chain.
For their efforts, the nodes are rewarded with Bitcoin. This process of verifying transactions after which new Bitcoin is circulated is known as Bitcoin Mining.
Bitcoin uses a mechanism called Proof-of-Work(PoW) to validate transactions. Here, miners compete in a sort of lottery to solve a complex mathematical puzzle. The first person to solve the puzzle gets to validate the transaction and is rewarded with bitcoin.
Is Bitcoin Mining Profitable?
With so many people competing to mine bitcoins, the central question that arises is- is Bitcoin mining profitable? The answer is multifaceted. Bitcoin mining is a cost and energy-intensive process; it is not even guaranteed that you would get the reward.
Presently, a miner gets 6.25 BTC for mining a block. This is down from 50 BTC that a miner would’ve earned in 2009 when Bitcoin first started. This reduction in rewards is done through a process called Bitcoin Halving which is explained later in the article.
As Bitcoin has grown, the infrastructure required to maintain and mine it has also grown. Today, the possibility of an amateur hobbyist successfully mining Bitcoin is quite low. Institutions and miner groups deploy sophisticated Graphics Processing Units(GPUs) and Application-Specific Integrated Circuits(ASICs) to mine Bitcoin.
Increased competition, the requirement of costly hardware, and sky-high electricity bills have reduced the profitability of Bitcoin mining.
Nevertheless, Bitcoin mining continues to be an attractive option for investors and successful miners do manage to rake in profits by mining Bitcoin.
Bitcoin Halving Explained
After having talked about Bitcoin mining, it is important to understand the concept of Bitcoin Halving which is perhaps the most significant event for Bitcoin miners.
Bitcoin Halving refers to the process by which the reward for mining Bitcoin is reduced. Since the value of the reward is halved, the event is known as Bitcoin Halving. It takes place after every 210,000 blocks mined which is roughly equivalent to every four years.
The purpose of Bitcoin Halving is to counter the effect of inflation. Since the supply of Bitcoin is fixed at 21 million BTC, every halving will reduce the number of new bitcoins in circulation. Assuming that demand remains high while the supply of Bitcoin is reduced, the price of Bitcoin will go up.
Thus, even with a reduced reward, miners would have the incentive to mine Bitcoin due to the increased demand.
The reward for mining each block was 50 BTC in 2009 during the early stages of Bitcoin development. It reduced to 6.25 BTC for every mined block after the third halving on May 11, 2020. The next halving is expected to take place in 2140.
This process will continue till 2140 when the limit of 21 million Bitcoin in circulation is reached. After this, miners would get a fee for their mining efforts rather than being rewarded in BTC.
Investing in Bitcoin
Though Bitcoin was initially meant to be an alternate method of payment, it soon became popular as an investment option. The rapid fluctuations in the value of Bitcoin provided opportunities to reap a heavy profit from Bitcoin speculation.
Hence, the rise of crypto exchanges where users can buy and sell cryptocurrencies including Bitcoin like traditional stocks.
Is Investing in Bitcoin Safe?
Succinctly, Bitcoin is a risky investment due to its extreme price volatility. For example, Bitcoin was trading at a peak of around $68,000 in November 2021. A year later, its value fell to less than $17,000 in November 2022. Unless you can take that level of risk, it is better not to invest huge amounts into Bitcoin.
Which is a Better Investment-Bitcoin or Gold?
Gold has traditionally been considered a safe haven asset due to its relative stability. Investors often flock to gold whenever there is a downward trend in the stock market.
Compared to that, Bitcoin is a relatively new asset with erratic trends in its value. While Bitcoin is more convenient and there is potential to reap huge profits, it does not yet command the trust and stability that gold has.
Which of the two is a better investment depends on your financial goals and risk-taking capabilities.
Should I Invest in Bitcoin?
Due to the vast price fluctuations experienced by it, Bitcoin can be a rather risky investment. You need to do proper research before investing in it. Whether you should invest in Bitcoin or not depends on your goals, financial portfolio, and risk-taking capability.
It is better to consult with a professional before diving headfirst into Bitcoin Investment.
What is a Bitcoin Wallet?
Just like you store your cash in a wallet you can keep your Bitcoin in a wallet. Since Bitcoin is a digital currency, the wallet to store it is also digital. A bitcoin wallet is simply an electronic storage place where your Bitcoin is kept and with the help of which you can validate your transactions.
Bitcoin wallets contain Bitcoin as well as a private key that is used to validate transactions. This key is highly secure and prevents other people from using your Bitcoin. Generally, crypto exchanges offer wallet facilities for Bitcoin when you sign up with them.
Bitcoin Wallets are of two types:
1. Hot Wallet
Bitcoin Wallets connected to the internet 24/7 are called hot wallets. These are software wallets that are always connected to the cryptocurrency network through your phone or computer. Hot wallets offer ease of transaction as there is no need to connect the wallet to the internet and by extension to the crypto ecosystem again and again.
MetaMask, Edge Wallet, and CoinBase Wallet are some examples of hot wallets.
2. Cold Wallet
Cold wallets are offline wallets i.e. they are not connected to the internet. These are hardware wallets and the bitcoins are stored offline. While cold wallets offer more security compared to hot wallets, users have to go through an additional step of connecting to the internet when making transactions. This can be an inconvenience for a lot of people.
Which is Safer- a Hot Wallet or a Cold Wallet?
When it comes to security, cold wallets win hands down. Since hot wallets store bitcoins online and are always connected to the internet, they are more vulnerable to hacking attempts. On the other hand, hot wallets are more convenient to carry out transactions.
When it comes to choosing between the security of cold wallets and the functionality of hot wallets, finding a balance is key. Most crypto traders prefer to keep long-term investments in a cold wallet while keeping some amount in a hot wallet for conducting transactions.
Converting Bitcoin to Cash
Is it possible to convert Bitcoin into cash? Yes, it is. Though not directly, you can use a crypto exchange or a peer-to-peer network to exchange your Bitcoin for fiat currency which would then be deposited into your account. Bitcoin ATMs and Bitcoin Debit Cards are also an option though they charge a high transaction fee.
1. Bitcoin to Cash via Cryptocurrency Exchange
You can convert your Bitcoin into cash by signing up with a crypto exchange or third-party broker. It is a safe and secure method though the conversion may take some time.
Step 1: Select the broker or exchange where you want to sell your convert your Bitcoin.
Step 2: Sign up on the platform and complete the verification details.
Step 3: Deposit Bitcoin into your account. Depending on the platform, there might be a fee for the same.
Step 4: You can either sell your Bitcoin for fiat currency or choose the cash-out option.
Step 5: The exchange will transfer the amount to your linked bank account. This process is generally completed in about 4-6 days.
2. Bitcoin to Cash via Peer-to-Peer Network
Peer-to-Peer Network is the way to go if you want faster and more anonymous transactions. Though it would be advisable to adopt best security practices in order to avoid fraud on a P2P Network.
Binance P2P is a reputed network for exchanging Bitcoin for cash.
Step 1: Choose your preferred Peer-to-Peer Network and sign up.
Step 2: Decide the amount of Bitcoin you want to sell and select your preferred currency and payment method.
Step 3: Choose the location of your buyer and select a buyer from the marketplace. Some networks allow you to put up ads for the trade but it might involve some additional fees.
Step 4: Select the buyer and place a trade request. For additional security, networks like Binance P2P escrow the crypto i.e. bitcoins are released to the buyer only when you’ve confirmed receipt of payment.
Step 5: Once you confirm the payment receipt, the bitcoins are released to the buyer.
Is Bitcoin Taxable?
The legal status of Bitcoin varies from region to region. Subsequently, the taxation policy of different states regarding Bitcoin also varies. While some places(El Salvador and the Central African Republic) have made Bitcoin legal tender, others have completely outlawed it. Some other countries classify Bitcoin as a digital asset and tax the gains from it accordingly.
Is Bitcoin Taxable in the USA?
Bitcoin is considered property for taxation purposes in the USA. Citizens have to pay tax on any capital gains from crypto trading. However, the Internal Revenue Service(IRS) has not yet clarified whether minting tokens is a taxable event or not.
Is Bitcoin Taxable in China?
Bitcoin and all other cryptocurrencies are illegal in China. The People’s Bank of China(PBOC) banned all cryptocurrency transactions in the country in September 2021. Since crypto itself is illegal, there is no tax imposed on it in China.
Is Bitcoin Taxed in El Salvador?
El Salvador is the country in the world to grant the status of legal tender to Bitcoin. Because the country wants to project itself as a crypto haven, it has exempted foreigners from paying any tax on gains from Bitcoin trading and speculation.
Does Japan Tax Bitcoin?
Cryptocurrencies are taxed under the head Miscellaneous Income under Japan’s Payment Services Act(PSA) and the Financial Instruments and Exchange Act(FIEA).
The country requires any gains above 200,000 Japanese Yen(JPY) from crypto trading to be disclosed in Income Tax returns.
Bitcoin Tax in the UK
There is no specific tax on cryptocurrencies in the UK. The existing tax norms are applied to crypto income. Capital Gains Tax has to be paid on gains from crypto trading while income from crypto mining is taxed under Income Tax laws.
Notably, no tax has to be paid if the income or capital gains are below a certain threshold.
Though the idea of digital currencies is not new, Bitcoin was the first such technology that brought the concept into the mainstream. It generated a sustained interest in the field of cryptocurrencies.
Many other cryptocurrencies such as altcoins and meme coins were developed after Bitcoin’s success but none were able to mimic its legacy.
Bitcoin has gone through many ups and downs since its inception in 2009. Though its value sharply tumbled in the 2022 crypto winter, hopes are there that the largest cryptocurrency will eventually bounce back.