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What is Bitcoin and How Does It Work?

4.4 | by Joel Agbo

Key Takeaways

  • Bitcoin (BTC) is a form of electronic cash that can be transacted between peers on the Bitcoin network.

  • Bitcoin can be stored in wallets that recognize its distributed ledger system.

  • The Bitcoin whitepaper was released in 2008 by Satoshi Nakamoto and the first Bitcoin block was mined in 2009.

  • Bitcoin (BTC) can be traded on digital asset markets, held as a store of value, or used in accepted commercial setups as a means of payment.

  • Bitcoin is the most valuable cryptocurrency in terms of total market valuation.

What is bitcoin

An estimated number of 114 million people globally holding bitcoin is proof of the cryptocurrency's popularity. But this number is just the tip of the iceberg. For what started as an experimental payment solution, bitcoin has become a relevant topic in almost every discipline.

Bitcoin’s presence in politics, economies, and computing is evidence of growing interest. It is also the best-performing digital asset of the past ten years and is recognized as a legal currency in El Salvador and the Central African Republic.

Fun fact: Seven out of every ten people you meet have heard about bitcoin at least thrice.

So, what is Bitcoin?

What is Bitcoin and How Does it Work?

 A tradable digital asset, an economic and technological revolution, a virtual store of value; you could base your definition of Bitcoin on any one of these or a combination and still be accurate.

Bitcoin is an electronic cash technology powered by a decentralized authority network that records the history of transactions on a distributed and immutable ledger. This network is the Bitcoin core blockchain, running on blockchain technology. The Bitcoin blockchain stores records of transactions performed using the bitcoin cryptocurrency, and these records are impossible to modify once they are stored in the blockchain. 

The bitcoin currency (to be referred to as just 'bitcoin' in subsequent parts of this article) is a cryptographic token that operates on the Bitcoin blockchain.

Bitcoin can be transferred across every account on the Bitcoin network regardless of location and time. Transactions on the network don’t require third-party permissions; these transactions also can't be intersected by an external party or modified by anyone once they are executed, rendering bitcoin transactions permissionless, censorship-resistant, and immutable.

Thanks to this system, bitcoin is well-adapted for transactions between peers across borders and in a macro-financial setup. Over 200 thousand transactions are recorded on the bitcoin network daily, each costing less than $0.50 on average and cutting across every nation of the world. However, like all cryptocurrencies, bitcoin is subject to volatile swings in value due to demand and supply conditions.

History of Bitcoin

On 31st October 2022, crypto Twitter was set ablaze with tweets under the #bitcoinwhitepaper hashtag as the space celebrated the release of the Bitcoin whitepaper by Bitcoin's creator, which included details of his mission to develop a transparent financial solution built on a tamper-proof network.

The bitcoin whitepaper was released on 31st October 2008 and marked the onset of development and community building for the Bitcoin blockchain and the digital currency – bitcoin.

Who Founded Bitcoin?

Bitcoin's creator designed one of the most transparent financial systems, yet he remains one of the most mysterious figures in the crypto space. The name 'Satoshi Nakamoto' is to date, the only known identity of the Bitcoin creator. This identity is still unverified. Widespread investigation into the real identity of Satoshi has only met dead-ends and only yielded further speculation on the Bitcoin creator’s identity.

Popular rumors have credited Hal Finney as Bitcoin's creator. This speculation is based solely on Hal's involvement in the early days of the Bitcoin community and his famous "Running bitcoin" tweet. Hal Finney passed away from his long battle with Amyotrophic Lateral Sclerosis (ALS) but had rebuffed the bitcoin creator tag before passing away.

BSV's creator – Craig Wright has also claimed to be a part of the Bitcoin founding team, although this is unverified. 

The Beginnings of Bitcoin

Satoshi's whitepaper caught the interest of several individuals who became the pioneer members of the Bitcoin community. The Bitcoin community would quickly grow into a group of individuals participating in the Bitcoin network by running nodes and receiving bitcoin rewards in a process known as Bitcoin mining. The community also explored bitcoin's potential as a decentralized form of electronic cash through peer-to-peer transactions involving bitcoin.

Bitcoin's genesis block was mined on January 3 2009 and the first recorded bitcoin transfer was executed on January 12, 2009, which was a transfer transaction of10 BTC from Satoshi Nakamoto’s wallet to Hal Finney.

However, bitcoin didn't gain financial value until Bitcoiner, Lazslo Hanyecz, completed a transaction to swap 10,000 bitcoins for two pizzas on May 22, 2010. Hanyecz’s transaction marked the start of bitcoin’s recognition as a financial asset and influenced similar transactions.

Since these events, Bitcoin has grown into a complete system penetrating global sectors and making major news headlines. Let's go through some of them.

Bitcoin in the News

Here are the notable times Bitcoin has made major news headlines recently:

National Bans

In September 2021 the People’s Republic of China announced that it had placed a ban on crypto-related activities in the country and will proceed with a crack down on crypto firms operating in the country.

In similar news, the Federal Republic of Nigeria also announced a ban on cryptocurrency and related ventures in the African nation in February 2021.

National Regulations

On March 9 2021 the United States of America, under the presidency of Joe Biden released its first-ever, whole-of-government approach to addressing the risks and harnessing the potential benefits of bitcoin and other digital assets and their underlying technology.

These policies principally recognize the position of digital assets in the global economy and also the risks that accompany this space for both individuals and (national) institutions.

On the same date, Dubai also announced the creation of a regulatory and licensing authority for virtual assets and related activities under UAE law.  

National Adoption

On September 7, 2021, Central American nation El Salvador announced that it will accept bitcoin as legal tender and will also proceed to purchase and hold bitcoin in its national reserves. The country has also expanded its involvement in Bitcoin with advanced mining facilities and plans to build a high-class city powered by bitcoin.

Institutional Adoption

Twitter founder, Jack Dorsey, also announced extensive bitcoin service infrastructure on Square and also a $50 million bitcoin purchase in 2021.

In March 2021, PayPal announced that it has launched a service that will enable customers to buy, hold and sell cryptocurrency directly from their PayPal accounts; a move that it claimed will introduce cryptocurrency to its over 340 million users and 25 million merchants. PayPal claimed to be opening its new cryptocurrency service for bitcoin (BTC), Ether (ETH), Bitcoin Cash (BCH), and Litecoin (LTC).

Elon Musk’s Tesla also announced that it had acquired $1.5 billion worth of bitcoin, at about $30,000 each, in February 2021, although in July 2022, news broke that Tesla had sold about 75% of its bitcoin.

Technological Advancements

In November 2021 Bitcoin’s Taproot upgrade was completed at the block height of 709,632. The Taproot upgrade features improvements to the Bitcoin core code that makes for enhanced privacy, faster transaction speed, and cheaper transaction fee. The upgrade also enables the Bitcoin blockchain to run smart contracts.

Bitcoin (BTC) Tokenomics

Bitcoin overview

Bitcoin (BTC) is the currency of the Bitcoin blockchain. It embodies the technology and financial system instituted by Bitcoin’s creators and is managed by the Bitcoin community. Bitcoin’s supply is pegged to 21 million bitcoins. This supply is expected to gradually go into circulation only through bitcoin mining.

There was no pre-mining of bitcoin before launch and every circulating bitcoin was first earned through mining.  This tradition will continue until every bitcoin is mined, without any reservations and vesting for any party. Bitcoin developers are rewarded through donations while miners are rewarded through mining rewards.

To make bitcoin even more scarce and sustain mining activities, bitcoin halving was introduced by the Bitcoin creator. Learn more about bitcoin halving and its significance.

Where to Buy Bitcoin

Bitcoin is traded on EVERY centralized cryptocurrency exchange. Meanwhile, decentralized exchanges on other blockchains have also developed bitcoin wrapping techniques and created bitcoin trading pairs on their platforms. Decentralized exchanges like Uniswap on the Ethereum blockchain and PancakeSwap on Binance Smart Chain also offer bitcoin pairs.

Bitcoin Price Peaks and Drops

Since bitcoin’s emergence as a financially relevant entity, its value has been subject to fluctuations. Bitcoin is responsive to supply and demand changes and this shows in the price development. 

Bitcoin prices since 2013

Following the bitcoin for pizza deal, bitcoin attained a value relative to the US dollar. By the last quarter of 2010, bitcoin had already been traded for over 10 cents ($0.10) per bitcoin. Barely 6 months later, bitcoin broke the $1 mark and climbed to over $30 in 2011. However, its value dipped below $20 in the following year.

Bitcoin continued its rally in 2013 and climbed to a value of $100, a 1000% increase that saw it trade above $1,000 in the same year. This figure would drop to almost half in the last months of 2013.

The subsequent years were pretty stable for bitcoin as it continued to trade between $400-$700 for the majority of 2013 to 2016.

In 2017, bitcoin had a major breakout as it broke through the $1,000 barrier and climbed to $19,000. Events in the rest of the year saw bitcoin’s value drop below $4,000 in 2018.

Following the third bitcoin halving in 2020 and a wave of institutional adoption, bitcoin’s value rose exponentially to a new all-time high of $68,000 in 2021. Value retraced gradually from this level with weak recoveries at intervals.

Bitcoin Dominance and Influence on the Market

Data from CoinGecko shows that bitcoin controls over 37% of the total cryptocurrency market. This dominance establishes bitcoin is a pace-setting figure in the crypto space, where developments around it trigger reactions from other assets in the cryptocurrency market.

Bitcoin leads, others follow; routine cryptocurrency traders are conscious of this pattern. Historical events have shown that altcoins’ values rise a while after bitcoin’s value goes up as well. This is also seen when bitcoin’s price drops. Sometimes, this trend is instantaneous and other cryptocurrencies rapidly move with bitcoin.

Bitcoin is seen as “digital gold”, a reserve currency and a standard for every other cryptocurrency. In addition, bitcoin is the most paired asset on cryptocurrency trading platforms. Traders are engaged in constant swapping between digital assets and are focused on building up their reserves. A drop in bitcoin’s price prompts a sell-off of other assets as they are traded for bitcoin at a discount.

How to Invest in Bitcoin

Unlike other forms of investment, investing in bitcoin is an easy venture. Bitcoin can be easily traded on cryptocurrency markets, kept in personal wallets and held until the investor decides to sell them off. For investors who are new to cryptocurrency, buying bitcoin is as easy as creating an account on a trading platform. Most exchanges have on-ramp features that allow users to buy bitcoin directly, either through bank transfers or credit cards.

Bitcoin can also be acquired from peers through over-the-counter trades and ordinary p2p transfers. While institutional brokers aren’t required for any of these procedures, do research on any government regulations and do your due diligence before engaging in any transactions.

How to Store Your Bitcoin

So, now that you have some bitcoins, keeping them safe and accessible is an equally important task. Unfortunately, both don’t always go together. The best way to keep your bitcoin safe is to keep them in cold storage. However, to be able to use your bitcoin for routine transactions, they should be easily accessible (to you).

A good wallet and healthy security practices helps you achieve both accessibility and safety.

Bitcoin wallets are special applications that connect to the bitcoin network and the distributed ledger. They present users’ ledger accounts in a less complicated way. A variety of bitcoin wallets exist; each one has different perks and demerits as well. Before getting a bitcoin wallet, consider certain factors that apply to you and decide which wallet serves you best and if you need a wallet at all. In some cases, you might need multiple variants of bitcoin wallets.

Here are the major wallet options available to store your bitcoin:

Hardware (cold) wallets

Hardware wallets are the safest devices to store your bitcoin. They score high in terms of security because they are mostly offline and less prone to phishing and other risks due to frequent use. Hardware wallets share some resemblance with storage drives. 

They usually have a small user interface to allow users to perform core activities like asset transfer and regular checks. Hardware wallets can also be connected to other devices like a personal computer if needed, but they are never directly connected to the internet.

Ledger and Trezor wallets are the two most popular hardware wallet producers. The ledger nano series come with little variations in their specifications. The ledger Nano X allows you to hold over five thousand cryptocurrencies, including bitcoin, and it also has Bluetooth features that enhance connectivity; in contrast, Nano S doesn’t have Bluetooth features and can only hold about 1000 cryptocurrencies.

Online (hot) wallets

Hot wallets are wallets connected to the internet, and are popular because of their ease of use. These can be either exchange-based, or non-custodial software hot wallets. Most come with mobile applications, enabling their users to perform transactions from the convenience of their mobile devices. However, mobile wallets sacrifice security for accessibility, as their connection to the internet places them at greater risk of phishing and data sniffing.

Also, do note that if you opt for a non-custodial hot wallet, you will be responsible for your own private keys and the related seed phrase, which is a master key to let you recover access to your on-chain crypto assets.  

Never store your seed phrase online, and use crypto steel to record your seed phrase with multiple copies for backup.

Paper wallets

Paper wallets are almost completely deprecated. They are basically papers with a barcode and your private keys. Paper wallets were more popular in bitcoin’s early days and are hardly used currently. Nevertheless, they are still a valid option to keep your bitcoin.

Choosing a wallet

Hardware wallets are the safest asset storage medium, but compared to hot wallets, they are inconvenient. Hardware wallets work best for investors who own big amounts of bitcoin and plan to leave them untouched for a long time. If you are planning to hodl for the long run, moving your bitcoin to a hardware wallet and keeping the device and its details safe ensures optimal security of your bitcoin.

Hot wallets are best for routine transactions and they are as convenient as carrying your mobile devices. If you are constantly transacting with your bitcoin in less comfortable locations like your workplace, classroom, in transit, and on the go; mobile devices are best for this. Consider keeping a little fraction of your bitcoin in a hot wallet for easy access, while storing the bulk of your funds in a hardware wallet. 

Final thoughts

An average of $40 billion of bitcoin is traded across cryptocurrency exchanges daily, excluding transactions between peers and over-the-counter trades. The popularity of bitcoin on exchanges shows that investors are keen on cryptocurrency relative to older and alternative investments. It has also pioneered the cryptocurrency sector; this sector has gone ahead to claim a record valuation of over $3 trillion and inspired the creation of tons of new coins and tokens.

Along with these successes, at its heart, Bitcoin is meant to be a payment solution providing a decentralized alternative to traditional currencies, “a new electronic cash system that's fully peer-to-peer, with no trusted third party," according to Satoshi. We’ve seen the first step of this with the adoption of bitcoin as legal tender in El Salvador and it comes as little surprise that more nations are implementing regulations around bitcoin as it gains legitimacy and traction.

Cryptocurrencies are volatile assets, even established ones like bitcoin, so always do your own research before investing in them. 

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Joel Agbo
Joel Agbo

Joel is deeply interested in the technologies behind cryptocurrencies and blockchain networks. In his over 7 years of involvement in the space, he helps startups build a stronger internet presence through written content. He is the founder of CryptocurrencyScripts. Follow the author on Twitter @agboifesinachi

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