What is Bitcoin and how does it work?

In order to understand Bitcoin, it is important to know why it was created and where it came from. Continue reading for the basics of what Bitcoin actually is and how the cryptocurrency works.

What is Bitcoin?

Bitcoin is the first ever cryptocurrency, supported by the first ever blockchain. It is digital money that you can send directly to another person, without the need for a traditional financial institution, like a bank.

All transactions take place on a blockchain, a digital ledger that keeps a timestamped record every time a Bitcoin is created or moved. That record is ‘immutable’, it cannot be changed, and each transaction is linked to a ‘wallet’ address, rather than your name or any personal details. In theory, this means Bitcoin transactions are anonymous, although in reality it has proved possible to trace these transactions.

Who or what created Bitcoin?

Nobody knows for certain. Bitcoin was created in 2008 by person(s) unknown named Satoshi Nakamoto, shortly after they published an academic journal article entitled ‘Bitcoin: A Peer-to-Peer Electronic Cash System’. This article not only put forward the idea of cryptocurrency, but also detailed exactly how a blockchain would work. It is Nakamoto’s paper that introduced blockchain technology to the world.

There has been an enduring mystery about who this person is, or whether it is in fact (as many believe) a pseudonym for a group of people. Despite many attempts to uncover the truth, and a few individuals coming out in public professing to be Satoshi Nakamoto, the identity of the person(s) behind Bitcoin still remains a mystery.

Why was Bitcoin created?

There are many potential reasons for this, but the event that certainly did most to influence the creation of Bitcoin was the 2008 financial crash. On the first block of the Bitcoin blockchain (the ‘Genesis block’), Satoshi Nakamoto cited an article from The Times titled ‘Chancellor on brink of second bailout for banks’.

It appears that Satoshi Nakamoto’s creation of the first Bitcoin block was a direct response to their own unhappiness with the global financial system in the wake of the crash. Through the creation of a whole new form of decentralised currency, the immense power of ‘too big to fail’ banks could be challenged.

How does Bitcoin work?

Bitcoin works by using a blockchain to store a record of all transactions. To send or receive money over a blockchain, you need a wallet.

From a user’s perspective, wallets function a little like email accounts, but they are much more secure. Each wallet has a public address used to send and receive bitcoin (like your email address), and a ‘private key’ used to access your funds (like your password).

A bitcoin wallet public address (also known as a ‘public key’ or ‘wallet address’) is comprised of a string of 26-35 letters and numbers, starting with numbers 1 or 3. Here’s an example of a bitcoin wallet address:

1S0xjzn7AcGd7wl7AyLqmLYL2oFl

Users of the blockchain can transfer funds to your wallet by entering your public address, and if you transfer bitcoin to somewhere else it will be recorded on the blockchain as having been sent from your wallet address.

Private keys are comparable to your password. They are what enable you to access the bitcoin you have received, and send bitcoins to other wallets. But private keys are much, much more secure than email passwords. Private keys take the form of a 64 character long string of letters (A-F) and numbers (0-9). Here’s an example of one:

072DDD3DE3017A3D82CDEA29E585004AD25
F132CE36BA7D0D48B73736822353C

So, if you wanted to make a payment to someone, you would first need to have your wallet’s private key to gain access to your bitcoin wallet and the funds held within it. You can then choose to send funds from your wallet to the other’s person by entering her wallet’s public address.

The transaction will then be publicly recorded on the blockchain as a transfer of one bitcoin from your wallet to the recipient’s address.

What is Bitcoin used for?

You can use Bitcoin as money to buy goods and services, or you can use it as a store of value. Bitcoin can now be used for almost anything that you’d usually purchase with ‘regular’ currency, and many online merchants accept Bitcoin as a means of payment.

Examples being: many Australians today pay their household bills using Bitcoin, you can gamble with bitcoin in many online casinos and betting sites, buy furniture from Overstock, and send remittance payments using your bitcoins. Bitcoin is particularly suited to the latter because it can be transferred anywhere in the world instantly with no conversion fees.

Other people prefer to hold onto their Bitcoin as a form of ‘digital gold’, that offers a way to hold your money outside of the existing financial system. Another way to go is to buy Bitcoin ETFs that allow you to passively invest in Bitcoin.

Who accepts Bitcoin?

If you want to spend your Bitcoins, this is the most important question. Transactions with bitcoin can only be completed with shops/individuals that accept it as a payment option and have a wallet address to receive bitcoins. If this is the case, spending your Bitcoin usually involves the simple process of scanning a QR code generated by the shop’s wallet and inputting the amount of Bitcoin you wish to send.

Otherwise, companies have created products to encourage the adoption of Bitcoin into existing payment schemes around the world, rather than just waiting for every shop to accept Bitcoin directly. Bitcoin prepaid cards and Bitcoin debit cards allow you to pay with your Bitcoins anywhere that accepts ‘regular’ card payments.

Both varieties of Bitcoin cards (prepaid and debit) are loaded with Bitcoins, but allow you to pay in shops that only accept card payments. This means that it’s possible to incorporate Bitcoin into your day-to-day life easily, and you can even start paying for monthly expenses, such as a mobile phone contract, with your Bitcoin debit card.

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