What is Bitcoin and How Does it Work

Bitcoin (BTC) is the world’s first cryptocurrency and decentralized payment system. It was created in 2008 by a pseudonymous programmer named Satoshi Nakamoto.

It's the world's first cryptocurrency built on top of blockchain technology to secure and verify transactions. The bitcoin (BTC) price has increased over 13 000 000 000% since 2010 when 1 bitcoin was worth $0.0008 to its current price of over $104,000 at the time of writing. This marked the beginning of a new era of digital currencies with transformative and disruptive potential.

1. What is bitcoin?

Bitcoin is a form of digital currency that operates as a decentralized system. It is not tied to central banks or governments but is open-source and global. All operations related to Bitcoin are carried out by a network of users who maintain the digital ledger called a blockchain.

A bitcoin can be divided into smaller units called “satoshis” (up to 8 decimal places). As a cryptocurrency, it is mostly used as a digital medium of exchange but is also considered a store of value like silver or gold. As a market asset, bitcoin is represented by the ticker symbol BTC whereas the blockchain on which it operates is written with a capital 'B’ as Bitcoin. The bitcoin (BTC) currency operates on top of this decentralized network, facilitating peer-to-peer transactions without any intermediaries.

2. The origin of bitcoin

The world first heard about bitcoin in a paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System" published in 2008 by an anonymous developer or team of developers under the name Satoshi Nakamoto.

Bitcoin (BTC) was proposed as an alternative to traditional currencies as a way to counter inflation and strict cross-border payment regulations. Even in the 21st century, there are millions of unbanked and underbanked people worldwide while international transfers remain slow and expensive. Intermediaries, like banks and payment processors, add cost and time to the process.

The original Bitcoin whitepaper proposed a method to solve these issues in the form of a digital currency that operates on a peer-to-peer network, allowing for fast, borderless transactions without intermediaries. Satoshi combined several existing technologies in a novel way to achieve this:

• Cryptography: Wallet software assigns Bitcoin users a public key and a private key. A public key is used to create a public wallet address, allowing you to receive payments and check digital signatures. A private key works like a password. It helps create digital signatures to show that you own your money when making transactions.
• Peer-to-peer networking: Nodes (computers using the software) check transactions to make sure the software's rules are being followed. Bitcoin miners are special computers that check new transactions. They fight to get the chance to add a group of these pending transactions to the blockchain.
• A finite supply: The software rules state that there can never be more than 21 million Bitcoin available. This limit helps Bitcoin maintain its worth driven by scarcity.

3. How does bitcoin work?

There are three main components that work together to form Bitcoin and they are not controlled by any one person or group:

• The Bitcoin network
• bitcoin (BTC) is the main payment used on the Bitcoin network.
• The Bitcoin blockchain

Bitcoin operates on a peer-to-peer network, allowing users to exchange bitcoin without middlemen to execute and validate transactions. Users can connect their computer to the Bitcoin network and download the public record that has all the past activity.

This public record uses a technology called "blockchain," which is also known as a "distributed ledger." Blockchain technology is what makes it possible to verify, store, and organize cryptocurrency transactions securely and openly. Immutability and openness are crucial for a payment system that uses a zero-trust approach.

When new transactions are approved and added to the ledger, the network updates everyone's copy of the ledger to show the latest changes. Think of it as an open Google document that updates instantly when anyone with access edits its content.

The Bitcoin blockchain is a series of blocks linked together in order. Each block holds information about bitcoin transactions. It's important to note that validating transfers and mining bitcoin are two different tasks. Mining can happen without adding new blocks to the blockchain.

4. What is proof-of-work?

The Bitcoin blockchain relies on a global network of computers to maintain the integrity of the system. This network is made up of globally distributed computers (called nodes) that help validate transactions. Anyone can run a node and participate in the network, which contributes to secure the system.

The Bitcoin network runs on the Proof-of-Work (PoW) consensus model to validate BTC transactions. Mining involves using a lot of computer power to store and check events on the blockchain. This makes it harder for one malicious actor to take over the network and compromise its safety.

A network of "miners" verifies every Bitcoin transaction. These are users who run hash verification processes to validate Bitcoin transactions and provide the required security for the public ledger of the Bitcoin network. They earn rewards in the form of bitcoin for their efforts, which encourages them to keep proposing new valid blocks. This method for achieving agreement among users without relying on centralized control is known as a consensus mechanism.

5. How are bitcoins created?

There are incentives for miners on the Bitcoin blockchain to encourage them to continue competing against each other to propose new blocks and secure the network. Winners receive a block reward in the form of newly minted bitcoin along with any fees attached to the transactions included in the respective block.

The Bitcoin network is designed to be self-regulating, adjusting the mining difficulty automatically every 2,016 blocks (about every two weeks) and maintaining a 10-minute average block discovery time. When blocks are mined too quickly, the algorithm increases the mining difficulty and lowers it if they are mined too slowly. This creates a steady and predictable flow of new bitcoin entering circulation.

Every 210,000 blocks the mining rewards get reduced in half (known as a halving) and as of April 2024, the block reward is 3.125 BTC per block. Once the number of Bitcoin in circulation reaches the total supply of 21 million, there will be no more bitcoin released.

6. How to mine bitcoin?

Mining is the process of validating transactions on the Bitcoin network and adding new blocks to the blockchain. Miners need to solve complex mathematical problems using specialized computer software and hardware. Initially, it was possible to mine bitcoin (BTC) using a desktop computer, but the computational hardware requirements have increased since then and it’s no longer possible. Some websites offer a service where a group of miners can join a mining pool, combining their resources for greater efficiency.

The mining of bitcoin (BTC) is energy-intensive and requires specialized hardware—often Application-Specific Integrated Circuits (ASICs)—to solve the problems. This process is competitive to encourage participation: the first miner to solve the problem receives the bitcoin reward and adds the next block to the blockchain.

7. How to buy and sell bitcoin?

People can buy and sell bitcoin using centralized cryptocurrency platforms like Freedx or decentralized ones where they swap their assets with other users. Cryptocurrency exchanges usually support multiple fiat and cryptocurrencies like FOREX brokers, allowing users to buy crypto with credit and debit cards, bank accounts and fiat.

You can exchange different coins, meme coins and tokens and engage in cryptocurrency trading on a centralized cryptocurrency exchange. However, you need to pass a KYC (Know Your Customer) procedure and provide some personal information before you can buy and sell bitcoin.

The growing adoption of cryptocurrencies has seen more traditional payment providers offer exchange services. But you should always check the fees associated with fiat-to-crypto conversion as well as the terms for your country of residence.

You can also buy bitcoin on peer-to-peer platforms, but the process is risky and there are no guarantees.

8. What is a bitcoin wallet?

Bitcoin (BTC) exists purely in digital form. You need a specialized bitcoin wallet to store this cryptocurrency. Digital wallets come in many forms and types and you need to pick the one that best suits your needs and requirements.

There are software (hot) and hardware (cold) wallets you can use to store and safekeep your bitcoin. The main difference between the two is the price, security and convenience.

Read our article A complete guide to crypto wallets to learn more about the best crypto wallets and the ways to secure your digital assets when using them.

9. Pros and cons of bitcoin

Initially designed as a peer-to-peer payment system, bitcoin has grown to include other use cases. With this in mind, there are certain drawbacks to it due to the model of the blockchain it runs on.

Advantages of Bitcoin

Security: Bitcoin uses strong cryptographic algorithms to secure transactions and prevent fraud and hacking. This makes it a secure and reliable solution for storing and transmitting value.

Decentralization: Bitcoin is not managed or controlled by a central body or government. This increases consumers' freedom and privacy when using bitcoin and makes it more resistant to governmental exploitation.
Disadvantages of Bitcoin

Volatility: The price of BTC can be extremely volatile and fluctuate frequently, making it a dangerous investment option for individuals trying to hold onto their coins in the long run.

Lack of regulation: While bitcoin's decentralization is generally viewed as a benefit, a lack of regulation can render the entire ecosystem more vulnerable to fraudulent operations and scams.

Lack of widespread acceptance: Despite its growing popularity, Bitcoin is still not commonly recognized as a payment method by merchants and businesses. As a result, it is impractical for everyday use and serves best as a store of value/investment.

10. What is the future of bitcoin?

Bitcoin has evolved massively since its inception in 2008. Satoshi sparked a financial revolution by blending cryptography, proof-of-work, and a hard-capped supply. Over time, Bitcoin has shifted from a pure medium of exchange to a recognized store of value. Innovations like the Lightning Network have enhanced its scalability and transactional efficiency.

Gold, like bitcoin, holds value primarily because people believe it does. Its real purpose is tracking and preserving wealth over time. As Web3 matures, Bitcoin’s role in securing decentralized transactions will only expand. Freedom, security, and efficiency will define the future of money.

While the original bitcoin cryptocurrency and its network have limitations, especially when it comes to scalability, the future of Bitcoin as a store of value appears to be quite secure.

Now that you have learned about bitcoin, you can continue your crypto journey on Freedx and discover other types of cryptocurrencies and information about blockchain technology.

Platform usage is subject to successful onboarding and KYC. Freedx services may be limited / not available in certain countries.