What is Bitcoin? (Easy to Understand in Simple English)

Physical Bitcoin

Although growing fast in popularity (and value!) the average person knows very little about Bitcoin. When I bought my first Bitcoin back in 2015 it felt very strange to exchange actual money for a series of binary numbers, but the price has soared and become my best ever investment – by a long way.

 

So… what is Bitcoin?

Bitcoin is a digital currency which continues to grow in popularity due to the various financial crises that have engulfed the world in recent times. While digital currencies, ranging from early trend-setters E-Gold to various online gaming tenders or loyalty points, have been available since the late 1990s when the internet started its rise to prominence, Bitcoin was the world’s first cryptocurrency. This simply refers to the way in which Bitcoin uses encryption techniques to process transactions and generate new units of the currency.

Since the release of Bitcoin back in 2009, various other cryptocurrencies have appeared, from Dogecoin (based on the Doge internet meme) to Dash, which serves as a similar alternative. Although, Bitcoin remains the most used and the most valuable currency on the market.

While more and more consumers and retailers continue to turn to electronic systems and online banking as a way of making and processing transactions, all of the money that passes through these systems are still tied to physical coins and notes. Standard currencies are centralised, meaning that they are controlled and produced by a central bank, such as the Bank of England or Federal Reserve, who can, in turn, produce more money as and when it is required.

Alternatively, they can also take back money when it is needed, too, as occurred following the 2013 Cypriot financial crisis, when those with uninsured deposits of more than €100,000 lost up to 48% of their funds as a way of recapitalising the Central Bank.

The risk of loss is one that has to be taken when handing your money over to a bank, but this risk is removed when purchasing Bitcoins, as the currency is decentralised, meaning that there is no higher power that is able to take it away and that you yourself are its sole owner. For this reason, it is understandable why so many, particularly those who have taken a hit to their savings, are turning to Bitcoins.

 

Who created Bitcoin?

Good question, but the simple answer is that nobody really knows. The original idea is linked to a mysterious software developer by the name of Satoshi Nakamoto. The creator once claimed that he was a 37-year-old Japanese male, but this is often disputed due to his perfect use of English and Bitcoin’s lack of Japanese documentation.

Most believe that the Satoshi Nakamoto name is merely a pseudonym used to mask either an individual, or more likely a group of people, who created the original software. Some have gone as far as to suggest that the name has been constructed in line with the currency and its creation – Satoshi translates to ‘clear thinking, quick witted or wise’, while Naka means ‘in, inside or middle’ and Moto means ‘origin’. Different people have interpreted the name in a variety of different ways.

This man denied claims he is Satoshi Nakamoto, creator of Bitcoin.
This man denied claims he is Satoshi Nakamoto, creator of Bitcoin.

Suspected individuals have included Michael Clear, a cryptography graduate at the University of Dublin, Martii Malmi, a Finnish developer who was responsible for the development of the system’s user interface and Jeb McCaleb, who developed a popular Bitcoin exchange based in Tokyo, Japan. Speculation surrounding Nakamoto’s true identity will likely persist for as long as the currency exists, but we are unlikely to ever find out who the man, or woman, behind Bitcoin actually is.

As there is no organisation responsible for the control and distribution of Bitcoins, you may be wondering why somebody would create something so complex if they are unable to profit from it. However, Bitcoin should not be thought of as a business, but a substance. Imagine Bitcoins as if they were gold or diamond – Nakamoto simply discovered the material and the type of pickaxe needed to mine it, and therefore profits from it in exactly the same way as everybody else. It is speculatively believed that he (or she) probably got a bit of a head-start, but Nakamoto hasn’t profited from the currency in any way other than selling Bitcoins.

 

What makes Bitcoin so special?

First and foremost, security. Credit cards and the internet don’t work too well together. When banks first started issuing payment cards, the internet was yet to be invented, and they are therefore not designed for use online. Computers are prone to picking up viruses, malware, spyware and various other infectious files, while online transactions require customers to enter their card number, expiry date and CSV number – everything a hacker needs to hijack your bank account and spend your hard-earned money.

Bitcoins, on the other hand, are sent and received using two keys which are tied to the account. The public key, which is visible to everybody, and the private key, which is connected to the user’s personal wallet. So long as you do not reveal your private key to others, your money is perfectly safe. Likewise, as Bitcoins are owned solely by the person who mines or purchases them, it is impossible for them to be taken away from you.

While Bitcoin is largely unregulated, there are some rules written in to the system to ensure its continuity. One such rule is the limit on the maximum amount of Bitcoins that can be mined, which stands at 21 million. When I first got involved, each block that the Miner mined would earn them 25 Bitcoins. This amount halved in 2016 and will be again every four years after that until the reward eventually reaches zero (which is not set to happen until 2140), when the 21 million limit will have been reached. This limit ultimately removes inflation, as more money cannot be added once it reaches the limit, which would harm the value of the Bitcoins already in existence.

Another perk is that you don’t have to deal with a bank when setting up your Bitcoin account. Setting up a bank account can often be both a confusing and tedious process. Once you have waded through the various different account types and each one’s particular characteristics, interest rates, limits and conditions, you will then have to set about applying, which involves submitting various forms of identification before waiting for the bank to perform various checks and approve your account. Don’t forget, you will also have to have some cash in hand to put into the account when you open it. Opening a Bitcoin account, on the other hand, is a simple, hassle-free process. Simply choose the type of account (or wallet, in Bitcoin terms) that you want and away you go. No need to fill out form after form, and no obligation to pay in any money whatsoever.

Likewise, the transaction fees incurred on payments are minimal. While large transactions will usually come with a very small fee, fees aren’t expected with smaller transactions. In fact, the person making the transaction can voluntarily decide whether to include a fee when they send Bitcoins, although these fees do work an an incentive for miners to continue mining. As Bitcoin is a universal currency, you won’t be subject to any currency conversion charges when paying somebody located somewhere else in the world, as you would with a bank or other online payment systems, such as PayPal, and it is often a much quicker process, with payments arriving in the payee’s wallet within minutes.

 

Where are my Bitcoins stored?

When making your first move into the world of Bitcoin, the first step is to set yourself set up with a digital Bitcoin wallet. A ‘wallet’ is fundamentally your account, where your private key will be stored and where you will go to send and receive a payment. There are five types of wallets for you to consider – Desktop, web, mobile, hardware and paper.

Image of a wallet containing physical Bitcoin.

Desktop wallets

Desktop wallets are installed directly to your computer and offer you complete control over your Bitcoins. Only the wallet owner will have access to the private key that keeps their Bitcoins safe, but desktop wallets require the user to download the blockchain which keeps track of all the transactions that have ever occurred – a file which has already surpassed the 40 gigabyte mark and continues to grow. Popular choices include ‘Bitcoin Armory’ and ‘Bitcoin Core’.

Web wallets

Web wallets are hosted online by a third-party company. While there are many wallet-hosting companies out there, they often vary in features and functionality. Although, they are usually far simpler and more streamlined that desktop wallets, which is viewed as more convenient for the majority of Bitcoin users’ purpose. Although, the downside is using these services is a reduction in security, as these services can be prone to hacking attempts and subsequent thefts. Popular choices include ‘Coinbase‘ and ‘Blockchain‘.

Mobile wallets

Mobile wallets allow you to control your Bitcoins using an application installed to your smartphone. As it is impractical to store a file that is upwards of 40gb on a device with a limited amount of storage, mobile wallets are usually ‘light’ wallets, which means that, while money can still be sent and received, many features are unavailable. Although, many Bitcoin users prefer mobile wallets due to the convenience of having access to your account when away from a computer system. Popular choices include ‘Mycelium’ and ‘Bitcoin Wallet’.

Hardware wallets

Hardware wallets are physical devices that allow users to store their private keys offline, inside the device’s hardware. This type is often preferred due to its increased safety, as it is impossible to lose your Bitcoins as a result of hacking attempts or viruses, as your account isn’t hosted on a computer system. I use a Ledger Nano S to store my Bitcoin, Ethereum, Ripple and other cryptocurrencies.

Paper wallets

In order to keep their Bitcoins safe, many users opt to transfer their private key into the physical world by writing it down or printing it off, before removing the data off of their computer system. This makes it impossible to gain access to the wallet without first gaining access to the piece of paper. Although, while you or others are still able to send Bitcoins to the paper wallet, you won’t be able to spend any of your Bitcoins without bringing it back online. While it is ideal for those looking to store their money securely for a long period of time, it isn’t the way to go for those spending their Bitcoins frequently.

 

Where can I buy Bitcoins?

For those that aren’t interested in mining Bitcoins, there are plenty of people looking to swap their Bitcoins for various other currencies. There are two places that you can turn to when looking to buy Bitcoins: exchanges or marketplaces.

Image of a physical bitcoin and various credit cards.

Exchanges are company run websites which deal in the buying and selling of Bitcoins. There are a number of these websites available, operating from a variety of different countries, each at varying scales. These exchange systems work by providing a platform which matches up buyers and sellers.

After depositing your funds, you then place an order stating how many Bitcoins you want for your deposited funds and vice versa. The system will then match up these buy and sell requests with somebody looking to complete a similar deal and perform the swap, effectively acting as the middleman between the buyer and seller. In line with laws and regulations, you will have to provide some personal details and proof of identity to use such exchanges.

Alternatively, there are also a number of marketplaces which allows sellers to list their prices and buyers to buy Bitcoins from whichever seller they choose. These systems will often allow buyers to view a array of information about the seller before purchasing, such as how many sales they have made and where they are based. I use LocalBitcoins.

Whether you’re looking to use Bitcoins as a way of making purchases easily and securely, or as a future investment in the hope that you can make a decent profit off of them in the future, it is an intriguing concept that you should certainly consider. Nobody knows for sure what the future holds for Bitcoin, but many experts believe its increasing popularity will see it grow and grow for years to come.

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Steve

Steve

Steve has been investing ever since his first share purchase (in Dunlop) way back in the 1980s. Since then, he has built a diversified portfolio of mainly low-to-medium risk investments but bucked that trend by investing in Bitcoin during 2015 at a price of just $230. This has gone on to become Steve's best investment by far, though his main focus remains on steady compounding.

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