How Bitcoin Works
What is Bitcoin
Bitcoin is a digital store of value and a disinflationary digital currency designed to facilitate financial transactions without a centralized intermediary and government control.
You can read the original Bitcoin whitepaper by clicking on this link.
We will explain how Bitcoin works, in simple terms. First of all, Bitcoin is a digital asset and therefore does not have physical monetary value like a gold or fiat currency. Rather, Bitcoin is just a record on the Bitcoin blockchain that confirms Bitcoin ownership. Bitcoin blockchain is a distributed ledger of timestamped Bitcoin transactions that are bundled into blocks. The Bitcoin blockchain is immutable and Bitcoin transactions are irreversible. Bitcoin network consists of thousands of Bitcoin miners and Bitcoin nodes.
Role of Bitcoin Miners
The security of the Bitcoin network is ensured by Bitcoin miners. Bitcoin miners use powerful computers to solve complex cryptographic problems to validate Bitcoin transactions and receive a Bitcoin reward. This computing process is called “proof-of-work”. The first miner that finds the solution to the cryptographic problem and creates a new Bitcoin block, receives a Bitcoin block award. This is how new bitcoins are created. Each Bitcoin block is mined every 10 minutes on average, which is roughly 144 blocks per day.
Besides block rewards, Bitcoin miners earn Bitcoin transaction fees that are currently much smaller than the block reward amount. Specifically, they receive transaction fees for verifying and processing Bitcoin transactions included in the block they have mined and added to the Bitcoin blockchain. We expect that Bitcoin transaction fees will increase substantially once the last Bitcoin is mined and no more block rewards are available. Miners tend to prioritize Bitcoin transactions with the highest transaction fees. It’s important to remember that miners are driven by financial incentives. This will help you to better understand Bitcoin security model and to learn how Bitcoin works.
A new Bitcoin block is created on average every ten minutes, with the block size limited to 1 MB. Therefore, Bitcoin block can accommodate only a limited number of Bitcoin transactions and it takes approximately ten minutes for Bitcoin nodes to verify them. As a result, Bitcoin has a scalability problem because of the limited number of Bitcoin transactions that can be processed in a given time. Bitcoin community has been trying to resolve this issue, considering various technical improvements of the Bitcoin protocol.
Fortunately, some of these attempts were successful. For example, Bitcoin technical improvement SegWit increased Bitcoin block size by removing signature data from Bitcoin transactions. The Lightning Network proposal aims to make Bitcoin scalable by introducing instant payments that occur off-chain. Lightning transactions offer considerably lower fees and faster settlement times than do Bitcoin on-chain transactions. You can read more about the Lightning Network in “The Lightning Network” research paper prepared by SMITH+CROWN.
Bitcoin Economic Model
The most important advantage of Bitcoin is its unique disinflationary economic model that makes it an excellent investment alternative to gold and traditional fiat currency. Total Bitcoin supply is fixed at 21 million. As of August 2020, around 18.45 million bitcoin have already been mined, which is roughly 88% of the total supply. The current disinflationary Bitcoin economic model will transform into a deflationary model once the last Bitcoin is mined. This is how Bitcoin economic model works in contrast with the traditional fiat system. No more Bitcoin will be mined beyond 2140 and the total Bitcoin supply will be only decreasing for such reasons as lost Bitcoin and mistaken Bitcoin transaction.
The current block reward amount is equal to 6.25 BTC per Bitcoin block and decreases by half every 210,000 blocks, or approximately every four years. We estimate that around 900 bitcoins will be mined on daily basis until the next Bitcoin halving event in 2024. Bitcoin block reward will be reduced to 3.125 BTC per block at this time and Bitcoin inflation rate will drop below 1% first time ever. Notably, Bitcoin inflation rate will become equal to 0% when the last bitcoin is mined, presumably in 2140. Once the last bitcoin is mined, the Bitcoin economic model will become purely deflationary.
Why Investors Buy Bitcoin
Bitcoin as a New Asset Class
Smart investors are always seeking non-correlated alternatives to traditional asset classes, especially during the economic recession. We believe that Bitcoin is an attractive investment opportunity, given its robust disinflationary model, excellent historical performance, and low correlation with traditional asset classes. Bitcoin can serve as an investment alternative to gold given similar features like scarcity. But unlike gold, Bitcoin is providing unique advantages such as fast settlement and instant cross-border transfers. Moreover, Bitcoin holders can generate substantial income by depositing their Bitcoin to a Bitcoin interest account. At the same time, institutional investors are facing a steep learning curve to understand how Bitcoin works and how Bitcoin market is regulated.
Bitcoin as a Reserve Currency
We can speculate that Bitcoin at some point can serve as an alternative to reserve currencies, especially in the developing countries. If this is the case, its value will increase substantially. Besides that, Bitcoin’s censorship-resistant nature may provide an attractive alternative to the offshore banking system. Overall, allocation to Bitcoin makes economic sense as it enhances risk-adjusted returns for traditional investment portfolios. Bitcoin market is growing exponentially, and it is really important to understand how Bitcoin works to make informed investment decisions. We provide easy exposure to this new asset class and you can instantly buy Bitcoin here.
Bitcoin Historical Performance
Bitcoin is the best performing asset class for the past decade. Investment in Bitcoin has been providing an annual average return of over 300% for the past several years. Besides its outstanding investment performance, Bitcoin is the most liquid digital asset currently available on the market. In addition, it is the largest cryptocurrency by market capitalization. Bitcoin is becoming an essential part of the global financial infrastructure because of its unique economic model and investment characteristics. We expect that more investment managers will gain expertise about how Bitcoin works and will start allocating capital to this asset class. This may trigger its further global adoption and price appreciation.
How to Buy Bitcoin Online
Digital assets such as Bitcoin are going mainstream. The number of cryptocurrency holders worldwide continues to grow on average twice every year. A recent survey by research group YouGov shows that 48% of American millennials understand how Bitcoin works and interested in using cryptocurrency. Bitcoin is a digital currency and hence you can easily purchase it online. The most common way to buy Bitcoin online is purchasing it on cryptocurrency exchanges. The largest crypto exchange globally is Binance, and the largest crypto exchange in the United States is Coinbase. Both of these cryptocurrency exchanges have more than 13 million users, though Binance has a slightly larger market share.
Payment and Trading Apps
Besides crypto exchanges, many fintech payment services allow their customers to seamlessly purchase Bitcoin online. Most of them started offering exposure to Bitcoin back in 2017-2018. Cash App by Square allows their users to buy Bitcoin starting 2018. Trading apps Robinhood and eToro started offering Bitcoin to their customers also in 2018. Leading European fintech bank Revolut began offering Bitcoin back in 2017. The largest global online payment systems PayPal and Venmo are rolling out a new product in 2020 to allow their users to easily buy Bitcoin online.
Other Fintech Companies
You can instantly purchase Bitcoin online with debit or credit card using payment services such as Simplex or MoonPay. Unlike the majority of crypto exchanges and other online services, they have implemented a simplified KYC process for their customers. As a result, you can receive your Bitcoin in minutes after initiating a purchase. However, both Simplex and MoonPay sell Bitcoin not directly but through their trusted partners. We explain our users how Bitcoin works in simple terms and partner with MoonPay to help our clients to purchase Bitcoin online with a debit or credit card instantly.
How to Securely Store Bitcoin
Currently, Bitcoin investors usually store their Bitcoin holdings in cold or hot wallets. Cold wallets are usually hardware flash drives such as Ledger or Trezor wallets, which are not accessible from the Internet. Hot wallets, such as Electrum, are software wallets that are connected to Internet. Those investors who use the “Buy and Hold” passive investment approach need to have a secure Bitcoin wallet to ensure the security of their Bitcoin holdings. However, while holding Bitcoin in a crypto wallet provides certain level of security, it does not help investors to generate a passive income on their Bitcoin holdings.
Alternatively, you can deposit your Bitcoin to a Bitcoin interest account and receive up to 6% annually. We partner with BlockFi that offers high-yield Bitcoin savings accounts to customers from all over the world. BlockFi holds its Bitcoin assets with the custodian company Gemini. Gemini is a New York trust company regulated by the New York State Department of Financial Services. It is registered as a Qualified Custodian under New York Banking Law and has excellent reputation in the digital assets space. Gemini stores digital assets using the most secure and compliant custody solution on the market.
Therefore, investors who understand financial instruments and how Bitcoin works, can not only instantly buy Bitcoin with a debit or credit card on our website but also earn up to 6% annually with a reliable Bitcoin interest account.
Currently, the Commodity Futures Trading Commission (CFTC) regulates digital assets that are considered commodities. Bitcoin is considered as commodity under the Commodity Exchange Act and regulated by the CFTC. The U.S. Securities and Exchange Commission (SEC) regulates digital assets that are considered securities. Bitcoin is not considered as security by the SEC, however it has issued several important regulations, no-action letters, and enforcement actions concerning digital assets in general.
Financial Crimes Enforcement Network (FinCEN) analyzes digital asset transactions to combat money laundering, terrorist financing, and other financial crimes. The Internal Revenue Service (IRS) is responsible for the collection of taxes based on income received from the digital asset investments and transactions. Both FinCEN and IRS regulate Bitcoin within their competence. Finally, the Office of the Comptroller of the Currency (OCC), an independent bureau within the U.S. Department of the Treasury, supervises all national banks that provide Bitcoin custody services to customers.
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