The Beginners Guide To bitcoin - cryptocurrency explained

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Most people first heard of Bitcoin during its historic 2017 price run, that caught not only the financial world off-guard, but left more questions than answers as to what this new technology really was. 

The price of a single coin jumped from $900 to over $20,000 faster than a Sonic the Hedgehog Speed Run. The year’s Bitcoin price charts look more like Green Hill Zone than mundane financial analysis.

And although Bitcoin’s value went crashing down right at the beginning of 2018, it has remained a lucrative investment asset for thousands of people since then. Most recently, it surged to $12,000 in June of this year, rewarding patient investors who know when to cash out.

But what is Bitcoin, exactly, and how does it work? Who determines the value of a single Bitcoin? Find out how cryptocurrencies like Bitcoin work and discover how you can catch more coins than an expertly played hedgehog in the Casino Night Zone.

Cryptocurrency Explained: Peer-to-Peer Digital Trust

Bitcoin is a cryptocurrency. While not technically the first cryptocurrency in existence, it’s by far the most popular. This is because it solves a problem that has existed for thousands of years: the problem of trust.

For most of human history, thievery and financial fraud were considered a necessary evil. From Julius Caesar defaulting on his loans to the enormously complex derivative bubble that caused the 2008 Financial Crisis, there seemed to be no way to prevent people from making bad deals.

Cryptocurrency addresses this issue by radically changing how value is stored and exchanged. Instead of tying value to paper notes, it’s bound to a cryptographic key that is near-impossible to break. In theory, this means two people can transact directly with one another without requiring a third-party to authorize the transaction.

Why Are Direct Transactions So Important?

Whenever two people perform a transaction, they aren’t actually exchanging money directly with one another. Dollars, euros, pounds, and Mongolian tögrög exist because of the United States, the European Union, the United Kingdom, and Mongolia support and issue them.

The value of paper money is tied to the value of an entire national economy, mediated by banks and other institutions. This huge, expensive, and inefficient system exists solely to act as the implicit “middle-man” between you and every one you buy things from.

When you buy apples from the grocery store, you and the store’s owner implicitly entrust the value of your money to the government of whatever territory you’re standing in. You trust banks to hold that money and give it back to you when you need it. You don’t trust one another.

Cryptocurrency does something different. It establishes value purely between users, without the need for a third-party authority to say how much it’s worth. It empowers people to transact directly with one another without the need for a government-backed currency to participate in the equation. You can buy, sell, and grab Bitcoins like crazed coin hedgehog in the Emerald Hill Zone.

Bitcoin does this through peer-to-peer networking. It uses cryptography (the same technology behind passwords, encryption, and cybersecurity) to facilitate transactions between people without requiring them to rely on a bank or other third-party authority.

There are many different ways to do this, and Bitcoin represents just one potential solution. The technology it uses is called blockchain.

Blockchain Technology Explained: How Bitcoin Works

Bitcoin is an example of a decentralized cryptocurrency. That means there’s no central authority governing how it works or what its value should be. It was designed in 2008 as a solution to facilitate e-commerce refunds, which typically rely on large banking institutions mediating disputes (and bringing their biases into the equation).

The principal idea behind Bitcoin is that the community itself is the institution that verifies transactions. Instead of reporting every Bitcoin transaction to a bank or government, every Bitcoin user automatically participates in the verification of every other user’s transactions at the software level.

 

Those transactions are coded into a digital record called a block. The “blockchain” is simply a digital ledger that contains a record of every transaction on the network. “Miners” are users who earn small amounts of Bitcoin by lending their computing power to solve the complex cryptographic equations needed to keep it running.

Economically speaking, Bitcoin is an unregulated asset. That means that there is no single person or institution out there in the world responsible for determining its price. Bitcoin’s value is directly tied to the law of supply and demand, alongside the rising cost of mining.

When you purchase a single Bitcoin, you actually purchase the right to put your digital signature on the blockchain ledger for every other Bitcoin user to see. Once the majority of Bitcoin users automatically validate your entry, you are the owner of that Bitcoin. When you sell it, the buyer completes the same process.

This process, along with the fact that there will only ever be a limited number of Bitcoins in existence, means it near-impossible to “counterfeit” a Bitcoin. As a financial asset, Bitcoin operates similarly to gold:

  • Limited Quantity: There is only so much gold on the planet. Likewise, there will only ever be 21 million Bitcoins. This limit is hardcoded into the cryptocurrency itself.
 
  • Eventual Plateau: Since supply is necessarily limited, both gold and Bitcoin’s values will eventually plateau once mining no longer produces new assets.
 
  • Divisibility: Like gold, Bitcoin is completely divisible. Unlike dollars and cents, there is nothing preventing a Bitcoin user from carrying 0.0001 BTC (about $0.72 USD as of December 2019) in their digital wallet.
 
  • Difficult to Counterfeit: While you can plausibly fool an uninformed person into buying counterfeit gold, there are numerous tools and techniques professionals use to verify and weigh gold. Similarly, it is practically impossible to replicate a Bitcoin convincingly.

How to Invest in Bitcoin

Bitcoin has made a great deal of money for a lot of people, but it also presents risks. There are no protections to investing in a decentralized, unregulated market.

Intelligent Bitcoin investors do their best to understand market trends and play those trends to their advantage. This requires paying close attention to the Bitcoin community and using the same tools and methods that an experienced stock market trader would use.

There are numerous exchanges and services that will convert U.S. dollars (and other currencies) into Bitcoin. CoinBase is one of the most popular—it lets new users start with as little as $25.

Starting slow and learning how the system works is critical for any potential investor. Take time to understand the fundamentals of virtual currency economics before diving in to make the experience as rewarding and lucrative as possible.

Successful Bitcoin investment is more of a marathon than a sprint, and even Sonic himself will have to slow down and consider his options before rushing forward.

For more fun financial wisdom, head back to our blog.