What is Bitcoin & How Does It Work?

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Updated: 30 August 2020

On October 31st 2008, Satoshi Nakamoto published the white paper for Bitcoin. Bitcoin is considered the first digital currency and the largest one by market capitalization as of 2018, with market cap of $150 billion. Bitcoin came out as the very first decentralized digital currency, one that does not require a third party for regulation such as a bank or a financial intermediary. Instead, Bitcoin was developed as a peer-to-peer network, where each transaction is verified and recorded on a network node on the distributed ledger called blockchain.

Bitcoin – Brief History and Essence

In the summer of 2008, the creator of Bitcoin, Satoshi Nakamoto, registered the public domain bitcoin.org and posted the open source code on SourceForge in January 2009. The white paper of Bitcoin explained what it was and how it can serve society. The very first block on the blockchain of Bitcoin is known as the genesis (the first) block ever and it contained the following message:

“The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”

The message is considered by many as the explanation as to why Nakamoto created bitcoin in the first place. It is no coincidence that bitcoin came to life amidst the Global Financial Crisis of 2008. According to some sources and opinions, Nakamoto created bitcoin to allow the regular person, who was tired of traditional banking and its “fractures” to be able to transact on their own, without the need of a bank or another intermediary.

After the first block was mined, there were the first individuals to received bitcoin and who further developed the cryptocurrency. Those include Hal Finney, the creator of the Proof-of-Work mechanism, Wei Dal, Nick Szabo and Gavin Andresen. Satoshi Nakamoto mined the first 1 million bitcoins. Sometimes these first coins are referred to as the Satoshi Coins, in the name of their creator. Soon after Satoshi mined those, he transferred the project to Gavin Andresen, who, according to sources, wanted to decentralize bitcoin as much as possible.

Little is known about Satoshi Nakamoto and his identity. He left the bitcoin project soon after he handed it to Andresen. From then on, there have been multiple speculations as to Nakamoto’s identity and his motivation to create Bitcoin.

What is Bitcoin

Satoshi Nakamoto

Except for posting in few tech forums on bitcoin, Nakamoto has not revealed his true identity. Many have been considered to be the true Satoshi Nakamoto. Some of the most famous allegations fall to Nick Szabo, Dorian Nakamoto, Hal Finney, Craig Steven Wright and even SpaceX founder, Elon Musk.

According to Wikipedia and latest news, Satoshi Nakamoto is a male Japanese, which was doubted as a news, considering Nakamoto’s fluent English and even posting patterns. One of the most famous Swiss coders, Stefan Thomas, analyzed all posts by Satoshi and the graph that came out showed that given the time he wrote and was active suggested that Satoshi was very unlikely to be residing in Japan.

Others claim that just because of the perfection of the entire code in bitcoin, the creator cannot be a single person. On the contrary, bitcoin may be created by a group of highly skilled mathematicians and coders.

In 2014, a man named Dorian Nakamoto was thought to be the real bitcoin creator. However, while Dorian’s birth name was Satoshi, he denied to have had anything to do with bitcoin and its creation.

Up until now, the only piece of information that has come from the real Nakamoto is that he resided in Japan and is of Japanese origin.

Bitcoin Wallets

Bitcoin is stored in digital wallets. Bitcoin wallets can be hardware wallets, web-based, mobile or desktop wallets. Each wallet comes with a public address, which is a unique alphanumeric code that is generated automatically when the wallet is created. A single user can create several Bitcoin public addresses. These public addresses can also be used to send and receive Bitcoin. They can be shared without issues.

Bitcoin wallets also come with a private key and seed phrase. The private key is used to generate a unique signature for every sent Bitcoin transaction. It is from the private key that the public key is generated using a hash function and other additional information. Reverse key generation (i.e. reverse engineering a public key to derive the private key that generated it) has been made so complex that it would take virtually forever for a computer to do this, thus conferring protection to the user in this regard. The private key should be kept a secret, else any Bitcoins associated with the wallet risk being stolen by an unauthorized person that has access to the private key. The seed phrase is a 12-word mnemonic phrase that is used to recover Bitcoin wallet particulars.

Structure of Bitcoin

Bitcoin’s transactions are all recorded on blockchain. Blockchain is a decentralized, distributed public digital ledger that records transactions so that the information cannot be changed retroactively without changing all blocks. Each “block” is verified and each transaction is verified across millions of computers, so that the “community” agrees on the transaction. This method of transacting is what eliminates the need for the verification by a third party. The whole database on the blockchain is managed through the peer-to-peer network and a distributed timestamping server. Once the data is verified and secured, the participants in the transaction feel much less insecure as to whether there is breach of privacy, inaccuracy or self-interest among members of the community. When each unit of any data is transferred only one time, double-spending, which is typical for digital assets, is eliminated. This is one of the major reasons why blockchain and bitcoin have been so successful thus far.

Each bitcoin has a specific bitcoin address on the blockchain. This is done through private keys, which allow each bitcoin to have a unique address along the chain. The issue with private keys and the address of bitcoin is that if the key is lost, there is no way to reassign ownership since all coins with the lost address are lost as well and cannot be retrieved. So, to prevent this, many users have backup so as not to lose valuable coins.


Bitcoins are mined. As quoted from The Economist, miners keep the blockchain consistent, complete, and unalterable by repeatedly grouping newly broadcast transactions into a block, which is then broadcast to the network and verified by recipient nodes. The mining of a bitcoin is just the keeping of the whole record contained so far on the blockchain, while adding the new transactions and making a whole, consistent and verifiable new block on the chain.

After being mined, each new block on the chain must be accepted and verified by the rest of the community. This is done through the help of the concept of Proof-of-Work (PoW). This process represents a complex mathematical computation that finds a number called nonce. The PoW concept is extremely important to bitcoin mining, just because since every block must be verified and accepted, it becomes very difficult for a hacker to break the chain. So, from a security perspective, the mining of bitcoin and the creation of new blocks is one of the greatest advantages that the technology has. All blocks go back to the original one, or the so-called genesis block, the one created by Satoshi himself.

Bitcoin Blockchain

When a block is successfully mined and integrated in the chain, the miner who mined it gets rewarded in the form of bitcoins.

One very interesting concept is the limited supply of bitcoin. Satoshi Nakamoto set the limited of bitcoins that can be mined to 21 million. After all these bitcoins are mined, they will all be in circulation. It is estimated that 2140, all 21 million bitcoins will be mined.

There have been many questions as to why 21 million bitcoins should be mined and not 28 million, for instance. There are several explanations. First, the cap is actually not a round number (21), but rather 20999999.9769. Some calculate the number of blocks that can be mined in a single year and then go on to calculate the precise supply set by Satoshi. Other people believe that Satoshi came up with this number just to make the cryptocurrency all the more special by setting a limited supply to it. While the currency is capped, the taxation imposed by the government will not change. What will change is how money is spent should be agreed by all parties: residents, institutions and so on. According to some opinions published in Quora, Satoshi created a deflationary monetary policy that is aimed at helping the regular people have more voice about how wealth is distributed and how taxes are spent. [1]


All transactions and funds that are done through bitcoin are anonymous and stored in bitcoin addresses. While that has been cited as one of the most debatable features of Bitcoin whether it is more advantageous or harmful to society, transacting with Bitcoin is transparent and secure, as every transaction is verified and recorded on the blockchain.

Block size

The major issue with bitcoin in the past few years was its high transaction fees and time taken to create a new block. Since bitcoin is often used as a payment method, the community realized the importance of having a faster, more cost-efficient currency to represent than what they previously had. For example, when Satoshi created the block with size limit of 32 megabytes per block. However, in August 2017, a major breakthrough at block 481,824 occurred when Segregated Witness changed the limit size of each block and introduced a new transaction format called “the witness”. The new format helped the block size increased and new proportions and metrics were introduced.

[1] https://www.quora.com/Why-is-Bitcoins-cap-set-at-circa-21-million-coins-and-not-more-or-less-Is-this-amount-chosen-in-an-arbitrary-way-or-is-there-an-argument-behind-it


Payment method

While in 2009 it was virtually impossible to buy Bitcoin, let alone to transact with it, now, in 2018, bitcoin is already accepted as a payment method in many countries around the world such as Japan, Sweden, Estonia etc. According to International Business Times report in 2015, there were 100,000 merchants in the world accepting bitcoin as official payment method. While acceptance by merchants has fallen slightly in 2017 due to scalability and cost issues, many industries are now turning to bitcoin as a payment method. For example, one of the oldest law firms in New York is now accepting Bitcoin in exchange for legal services. In addition, the real estate market is more than open to accepting Bitcoin, especially after the first home was sold for Bitcoin in 2017 in the United Kingdom. Another benefit of Bitcoin as a payment method is the low fee that it charges to merchants when compared to credit cards. Merchants who accept bitcoin usually pay anywhere between 0% – 2%, while those working with credit cards – 2% – 3%.

Store of Value

Some countries have viewed Bitcoin as an investment rather than a currency. Resident in countries in South Africa and South America (Argentina) have often bought bitcoin to shield their savings from rising inflation, political turmoil and unrest. Consequently, the price of bitcoin in such countries is exorbitantly high, which is explained by the “store of value” concept. Bitcoin has also been compared to gold when it comes to its store-of-value.

Financial Institutions

Banks and financial institutions have all had mixed feelings when it comes to Bitcoin. In the summer of 2017, the CEO of JP Morgan, Jamie Dimon, called Bitcoin a “fraud”. Warren Buffet, one of the greatest investors of all times and chairman of Berkshire Hathaway, recently said that bitcoin is not producing anything and is not backed by anything, so it really has no value. Other major banks, such as Goldman Sachs, has been working on developing a cryptocurrency trading desk and has been rumored to support altcoins. One thing, however, is probably agreed upon by almost all major financial institutions: Bitcoin can pose serious threats to traditional currencies and how people transact in the future. And while most banks and financial institutions have supported blockchain as a top technology that is worth investing in, most of them have feared the power of bitcoin. Thus, there has been a lot of space to be filled by more non-traditional “financial institutions”. Robinhood, for example, one of the most successful trading apps in the USA, has already launched a cryptocurrency trading platform and plans to expand its range of altcoins in the upcoming months. So, bitcoin has changed the level-playing field for banks, financial institutions and startups.

Bitcoin’s Price Movements

Bitcoin’s Price Movements

Bitcoin was trading at around $6 in 2012. Then, in 2014, the price of bitcoin was just under $1,000. And from then on, the hockey-stick price movement noted a tremendous growth when in December, 2017, the price hit $20,000. After the end of last year, the value of bitcoin has been trading with ups and down, but it fluctuates around the $9,000. The massive growth of Bitcoin has been even compared to the Tulip Fever in the Netherlands in the 17th century.

There seem to be two opposite sides of the debate as to whether Bitcoin will skyrocket or go to zero. Prominent investors such as Warren Buffet and tycoons such as Bill Gates have all expressed their negative outlook on bitcoin’s future. Others, however, such as John McAfee and the Winklevoss twins all agree that Bitcoin is just starting out. With rumors on Bitcoin’s ETF coming out soon, and with the constant improvements in blockchain, there can be a very bright future for Bitcoin. However, the opposite scenario may also hold true, if Bitcoin turn out to be of no value, since it’s not producing anything and is not backed up by anything of value, in the words of Buffet.

How is Bitcoin acquired?

Bitcoin can be earned in three ways:

  • It can be digitally created with computers using a process known as mining.
  • It can be purchased from exchanges and entities who own it.
  • It can be earned by exchanging goods and services and accepting Bitcoin as payment.

Many e-commerce merchants are adding Bitcoin as a payment method. This also constitutes another way of earning Bitcoin. However, the volatility of Bitcoin makes it an unsuitable method for large scale e-commerce use.

Trading Bitcoin

A crypto broker comparison shows that one of the secondary uses to which Bitcoin has been adapted to is the trading of this cryptocurrency as a profit-making venture.

Bitcoin has over the years, gained a lot of traction on a worldwide scale and the demand for it grew considerably, causing it to increase in price from 2014 to December 2017. It is no longer rare to see Bitcoin prices changing at an average of $500 to $1000 daily.
Bitcoin can be traded on exchanges as well as on FX platforms as CFD assets.
To trade Bitcoin on exchanges, you need to open an account on an exchange which features the listing of Bitcoin and another altcoin as a pair e.g. TRX/BTC. You will also need to fund your trading account with Bitcoin and use it to trade the price differentials with another altcoins.

To trade Bitcoin as a CFD asset such as the BTC/USD, you simply need to open an account with any of the best crypto brokers that offer this or any other Bitcoin pairs, and use any of the crypto trading strategies that are derived from technical analysis to trade them profitably. Since there is no need to own the cryptocurrencies, there is no need to worry about getting a Bitcoin wallet or securing such a wallet.

The difference in both styles of trading is that exchange-based trading requires the trader to actually own the Bitcoins, while crypto CFD trading does not. However, prices are generally similar and each method of trading Bitcoins has its advantages and disadvantages.

Bitcoin CFD Trade Example: An example of a BTC/USD trade involving the BTC/USD CFD pair is show below. The setup is a chart pattern known as the bearish flag. It is a bearish continuation pattern, which means that prices are expected to keep falling once out of the pattern.

The trade setup is to sell Bitcoin against the US Dollar, in order to profit from the expected drop in prices. The Stop Loss and Take Profit parameters are setup and the trader can take the trade using good crypto trading strategies.

Bitcoin Exchange Trade Example: Exchanges are barred from holding fiat currency accounts in many countries. As a result, users have to fund their exchange accounts using base cryptocurrencies such as Bitcoin. Once the account is funded by transferring Bitcoin from the user’s wallet to the exchange’s wallet, the trader’s account is credited in BTC. The trader must then trade the BTC with another crypto by selecting the appropriate pairing.

How Bitcoin works in the exchange trade process is that the user must view the list of BTC pairs and select the BTC pair to trade. The trade parameters are entered as shown above, and the trade executed.

Shortcomings in Bitcoin

  • Transaction costs: Miners are rewarded for mining Bitcoins and per transaction. These transaction costs are usually higher than transacting with cash or with a credit or a debit card. Furthermore, miners tend to confirm transactions where the user outbids other users in terms of fees paid. The cost implications of swapping fiat currency payment methods with Bitcoin make this an unattractive proposition.
  • Transaction Confirmation Times:The surge in demand for Bitcoin has created capacity problems for exchanges and miners. This has led to an increase in the time it takes to get transactions confirmed. It takes 6 confirmations for a transaction to be settled. Nowadays, it is not unusual for Bitcoin transactions to take as much as 30 minutes to an hour for the complete set of confirmations to be performed at the cheapest possible rate. This will never stack up against a card transaction that takes just seconds to complete.
  • Security:Perhaps the greatest challenge of all is the issue of security. Bitcoin wallets are by default, unencrypted. This renders them particularly vulnerable to hacks.
  • Production Costs:The mining rigs require tremendous amounts of electricity and generate a lot of heat, which requires that the setup includes cooling systems. The result is that the mining of Bitcoin comes at a tremendous energy cost, estimated at 32 terrawatt-hours of energy as at December 2017 by the Bitcoin Energy Consumption Index.


Aside from the trading frenzy which has gripped cryptocurrencies, the adoption of Bitcoin in many countries has continued to be a subject of debate. Some countries have banned its use in payment platforms, while others like Japan have embraced it and it is now running concurrently with the national fiat currency as a joint means of exchange. Furthermore, some progress is being made in the US, where several Bitcoin-based derivative products are being designed for launch. In December 2017, the CBOE and CME launched their own versions of Bitcoin futures, while other exchanges prepare to launch new Bitcoin-based products.

As has been shown above, Bitcoin can be traded in both directions: sell to profit from declining prices, and buy to profit from rising prices. Despite the present slump in the Bitcoin market, there will still be opportunities to trade. You will need access to good crypto trading strategies to trade successfully. Bitcoin trading is inherently risky; you should only trade Bitcoin if you know how to do so and you are well capitalized to handle the volatile price movements. Some brokers offer mini-contracts for trading.

2018 and 2019 have also seen increased moves to regulate the Bitcoin market. Some countries have gladly welcomed Bitcoin exchanges to do business within their borders, where others have shut the door. Institutional traders continue to sit on the sidelines, and if they eventually get into the market, Bitcoin may yet see some astounding price moves in the years to come.