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BitCoin

What Is Bitcoin And How Does It Work?

ٌWhat Is Bitcoin?

Bitcoin is a decentralized digital currency that you can buy, sell and exchange directly, without an intermediary like a bank. Bitcoin’s creator, Satoshi Nakamoto, originally described the need for “an electronic payment system based on cryptographic proof instead of trust.”

Each and every Bitcoin transaction that’s ever been made exists on a public ledger accessible to everyone. Making transactions hard to reverse and difficult to fake. That’s by design: Core to their decentralized nature, Bitcoins aren’t backed by the government or any issuing institution. And there’s nothing to guarantee their value besides the proof baked in the heart of the system.

How Does It Work?

Bitcoin is built on a distribute digital record called a blockchain. As the name implies, blockchain is a linked body of data, made up of units called blocks that contain information about each and every transaction. Including date and time, total value, buyer and seller, and a unique identifying code for each exchange. Entries are strung together in chronological order, creating a digital chain of blocks.

“Once a block is added to the blockchain. It becomes accessible to anyone who wishes to view it, acting as a public ledger of cryptocurrency transactions,” says Stacey Harris, consultant for Pelicoin, a network of cryptocurrency ATMs.

Blockchain is decentralize, which means it’s not control by any one organization. “It’s like a Google Doc that anyone can work on,” says Buchi Okoro, CEO and co-founder of African cryptocurrency exchange Quidax. “Nobody owns it, but anyone who has a link can contribute to it. And as different people update it, your copy also gets update.”

While the idea that anyone can edit the blockchain might sound risky, it’s actually what makes bitcoin trustworthy and secure. In order for a transaction block to be add to the It blockchain. It must be verified by the majority of all Bitcoin holders. And the unique codes used to recognize users’ wallets and transactions must conform to the right encryption pattern.

How Does Bitcoin Mining Work?

Bitcoin mining is the process of adding new transactions to the Bitcoin blockchain. Also It’s a tough job. People who choose to mine It use a process called proof of work, deploying computers in a race to solve mathematical puzzles that verify transactions.

So To entice miners to keep racing to solve the puzzles and support the overall system. The Bitcoin code rewards miners with new Bitcoins. “This is how new coins are create” and new transactions are add to the blockchain, says Okoro.

In the early days, it was possible for the average person to mine It, but that’s no longer the case. The Bitcoin code is written to make solving its puzzles more and more challenging over time, requiring more and more computing resources. Today, Bitcoin mining requires powerful computers and access to massive amounts of cheap electricity to be successful.

Bitcoin mining also pays less than it used to, making it even harder to recoup the rising computational and electrical costs. “In 2009, when this technology first came out. Every time you got a stamp, you got a much larger amount of Bitcoin than you do today.” Says Flori Marquez, co-founder of BlockFi, a crypto wealth management company. “There are more and more transactions [now, so] the amount you get paid for each stamp is less and less.” By 2140, it’s estimated all Bitcoins will have entered circulation, meaning mining will release no new coins, and miners may instead have to rely on transaction fees.

How to Buy It

Most people buy Bitcoin via exchanges, such as Coinbase. Exchanges allow you to buy, sell and hold cryptocurrency, and setting up an account is similar to opening a brokerage account—you’ll need to verify your identity and provide some kind of funding source, such as a bank account or debit card.

Major exchanges include Coinbase, Kraken, and Gemini. You can also buy Bitcoin at a broker like Robinhood.

Regardless of where you buy your Bitcoin, you’ll need a digital wallet in which to store it. This might be what’s called a hot wallet or a cold wallet. A hot wallet (also called an online wallet) is stored by an exchange or a provider in the cloud. Providers of online wallets include Exodus, Electrum and Mycelium. A cold wallet (or mobile wallet) is an offline device used to store Bitcoin and is not connected to the Internet. Some mobile wallet options include Trezor and Ledger.

A few important notes about buying Bitcoin: While It is expensive, you can buy fractional Bitcoin from some vendors. You’ll also need to look out for fees, which are generally small percentages of your crypto transaction amount but can really add up on small-dollar purchases. Finally, be aware that it’s purchases are not instantaneous like many other equity purchases seemingly are. Because It’s transactions must be verified by miners, it may take you at least 10-20 minutes to see your It  purchase in your account.

How to Invest in Bitcoin

Like a stock, you can buy and hold Bitcoin as an investment. You can even now do so in special retirement accounts called Bitcoin IRAs.

No matter where you choose to hold your Bitcoin, people’s philosophies on how to invest it vary: Some buy and hold long term, some buy and aim to sell after a price rally, and others bet on its price decreasing. Bitcoin’s price over time has experienced big price swings, going as low as $5,165 and as high as $28,990 in 2020 alone.

“I think in some places, people might be using Bitcoin to pay for things, but the truth is that it’s an asset that looks like it’s going to be increasing in value relatively quickly for some time,” Marquez says. “So why would you sell something that’s going to be worth so much more next year than it is today? The majority of people that hold it are long-term investors.”

Consumers can also invest in a Bitcoin mutual fund by buying shares of the Grayscale Bitcoin Trust (GBTC), though it’s currently only open to accredited investors who make at least $200,000 or have net worths of at least $1 million. This means the majority of Americans aren’t able to buy into it. In Canada, however, diversified Bitcoin investing is becoming more accessible. In February 2021, Purpose Bitcoin ETF (BTCC) started trading as the world’s first Bitcoin ETF. And the Evolve Bitcoin ETF (EBIT) has also been approve by the Ontario Securities Commission. American investors looking for Bitcoin or Bitcoin-like exposure may consider blockchain ETFs that invest in the technology underlying cryptocurrencies.

Should we buy It?

In general, many financial experts support their clients’ desire to buy cryptocurrency. But they don’t recommend it unless clients express interest. “The biggest concern for us is if someone wants to invest in crypto and the investment they choose doesn’t do well. And then all of a sudden they can’t send their kids to college,” says Ian Harvey, a certified financial planner (CFP) in New York City. “Then it wasn’t worth the risk.”

In a very real sense, Bitcoin is like a single stock. And advisors wouldn’t recommend putting a sizable part of your portfolio into any one company. At most, planners suggest putting no more than 1% to 10% into Bitcoin if you’re passionate about it. “If it was one stock, you would never allocate any significant portion of your portfolio to it,”