We hear a lot in the news about Bitcoin. But what exactly is it, how does it work, and what impact will it have in the wider world? Here is everything you need to know
Bitcoin was invented in 2009 and is the world’s oldest and best-known cryptocurrency. Like its various crypto counterparts, it is also extremely volatile. While many Australian investors are attracted by its wealth creation potential, it is rarely a smooth or even successful path to wealth building.
Cryptocurrencies are also a popular haunt for scammers, with a number of Australians losing tens of thousands of dollars to crypto scams.
What is a Bitcoin?
People once traded physical assets such as gold and silver for goods and services. But these were difficult to carry and vulnerable to theft and loss, so the banks offered to hold them for us, issuing notes to prove the wealth we had in the bank.
Eventually, the link between these notes and the goods they represented was broken. Instead, governments said the notes themselves had value.
We trust the banks to respect the value of our currency so we can accept cash as payment and trust others to accept it from us.
A cryptocurrency is essentially a digital version of cash that exists outside the established framework of national governments and central and private banks. It allows two people to exchange it or buy and sell with it without the likes of Westpac or NAB needing to facilitate the payment.
In other words, each party to the transaction trusts that the asset being exchanged has intrinsic value.
How do Bitcoin payments work?
Making a Bitcoin payment is as easy as sending an email. You transfer Bitcoins from your digital wallet (obtained when you buy the currency from a crypto exchange) to someone else’s using an app or website and the person’s unique Bitcoin address.
Payments are processed and verified by a network of ordinary people with computers running special software.
These volunteers are called Bitcoin miners. They use advanced hardware to crack increasingly complex mathematical verification problems generated by Bitcoin’s source code – its computing DNA.
The hardware is expensive, extremely powerful and consumes enormous amounts of energy. More on this later.
Once a payment is confirmed, the miner adds a record of the transaction to a shared ledger. The record includes the sender’s and receiver’s Bitcoin addresses and the amount transferred.
Entries in the ledger cannot be changed or deleted. And since everyone’s copy of the ledger must match, it makes it extremely difficult for someone to claim they have more Bitcoin than they actually own, as everyone else’s copy of the ledger would contradict them.
Miners do not confirm one transaction at a time. Transactions are grouped into “blocks” that have limited space. When a block is ‘full’, a new, empty block is created.
Each new block links back to the previous block containing information about older transactions. The blocks form a chain that links back all the way to the very first Bitcoin transaction.
This public ‘blockchain’ ledger provides an indelible, definitive and transparent account of which wallets hold Bitcoin and how much each holds at any given time – with receipts to prove it.
What is Bitcoin Mining?
A Bitcoin miner who adds a block to the chain is issued a new Bitcoin worth thousands of dollars. It sounds like free money, but the investment required to build and run a machine capable of processing a block is significant and adds up over time.
Around 900 Bitcoins are “minted” every day. At today’s prices, their total value is more than $18 million. The total supply of Bitcoins is limited to 21 million. Once the limit is reached, it will no longer be possible to emboss.
Also, the reward for mining a Bitcoin is halved every four years. On the current trajectory, it is predicted that the last Bitcoin will be mined by 2140 unless current protocols change.
How to use Bitcoin?
You can buy it, sell it and use it to buy goods and services wherever it is accepted. You don’t have to spend all your Bitcoins – each one can be split (see below).
Bitcoin payments aren’t exactly mainstream, but big names like Microsoft, Express VPN and Wikipedia take Bitcoin payments.
Many simply invest in Bitcoin in the hope that it will increase in value. Bitcoin reached nearly $69,000 in November 2021, but has since fallen by a dramatic 70% in value. At the time of writing, one Bitcoin was valued at around 20,000 USD. The cryptocurrency continues to fluctuate in value today, with some industry figures claiming that the value of Bitcoin could remain well below its peak for the next two years.
This kind of market volatility has raised regulators’ eyebrows. The federal government points out through the Moneysmart website that in most cases crypto is not considered a financial product and your crypto platform may not be regulated by the corporate regulator, the Australian Securities and Investments Commission (ASIC).
As Moneysmart says: “When a cryptocurrency fails, investors will most likely lose all the money they put in.”
Who Can Buy Bitcoin?
Anyone can buy Bitcoin from crypto exchanges such as Binance and Coinbase. According to Roy Morgan research, more than one million Australians aged 18 and over, or 5% of the population, invest in cryptocurrency.
But unless you have an extra $US20,000 in your account to buy a single token, you’re going to be buying a fraction, or share, of a Bitcoin.
Smaller denominations of Bitcoin are called Satoshis after the pseudonym used by its anonymous inventor(s). One Satoshi is worth 0.00000001 Bitcoin.
As mentioned earlier, Bitcoin and the cryptocurrency market are unregulated. This means that there are no rules in place to protect you from losing everything, and no watchdog to ensure that everyone involved is playing fairly.
What do I need to mine Bitcoin?
According to Bitcoin expert and journalist Connor Sephton, miners need three things to succeed: access to cheap electricity, hardware known as application-specific integrated circuits (ASICs), and mining software that connects them to the Bitcoin network.
The most capable ASICs can cost thousands of pounds to buy and run, making them prohibitively expensive for the average person.
Is Bitcoin the only cryptocurrency?
There are countless other cryptocurrencies, collectively referred to as altcoins.
They include well-established altcoins such as Ethereum and Litecoin, as well as new altcoins such as Elrond and Clover. Each currency has different values and rules, but they all follow the basic regulations of cryptocurrency.
What are the benefits of Bitcoin?
Without intermediaries, no one can take a cut of each transaction. Bitcoin is a global currency that is also easier to move across borders, and as a relatively anonymous currency, it makes transactions truly private.
It’s also revered by many proponents of “DeFi” — or decentralized finance — because it doesn’t rely on human gatekeepers or middlemen.
What are the disadvantages of Bitcoin?
It is unregulated, volatile and cannot be used as much as traditional currencies.
The amount of energy used globally to make Bitcoin work is also huge. It has the same carbon footprint as the entire country of Argentina, according to researchers from Oxford University in the UK.
This has raised questions about the long-term sustainability of the phenomenon, particularly as global economies strive to reduce their greenhouse gas emissions in line with international environmental agreements and associated ‘green’ targets.
This article is not an endorsement of any particular cryptocurrency, broker or exchange, nor does it constitute a recommendation of cryptocurrency as an investment class.
