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What is Bitcoin?
Bitcoin is a digital currency which operates free of any central control or the oversight of banks or governments. Instead it relies on peer-to-peer software and cryptography.
A public ledger records all bitcoin transactions and copies are held on servers around the world. Anyone with a spare computer can set up one of these servers, known as a node. Consensus on who owns which coins is reached cryptographically across these nodes rather than relying on a central source of trust like a bank.
Every transaction is publicly broadcast to the network and shared from node to node. Every ten minutes or so these transactions are collected together by miners into a group called a block and added permanently to the blockchain. This is the definitive account book of bitcoin.
In much the same way you would keep traditional coins in a physical wallet, virtual currencies are held in digital wallets and can be accessed from client software or a range of online and hardware tools.
Bitcoins can currently be subdivided by seven decimal places: a thousandth of a bitcoin is known as a milli and a hundred millionth of a bitcoin is known as a satoshi.
In truth there is no such thing as a bitcoin or a wallet, just agreement among the network about ownership of a coin. A private key is used to prove ownership of funds to the network when making a transaction. A person could simply memorise their private key and need nothing else to retrieve or spend their virtual cash, a concept which is known as a “brain wallet”.
Bitcoin is a network that runs on a protocol known as the blockchain. While it does not mention the word blockchain, a 2008 paper by a person or people calling themselves Satoshi Nakamoto first described the use of a chain of blocks to verify transactions and engender trust in a network.
The blockchain has since evolved into a separate concept, and thousands of blockchains have been created using similar cryptographic techniques. This history can make the nomenclature confusing. Blockchain sometimes refers to the original Bitcoin blockchain. At other times, it refers to blockchain technology in general, or to any other specific blockchain, such as the one that powers Ethereum.
Any given blockchain consists of a single chain of discrete blocks of information, arranged chronologically. In principle, this information could include emails, contracts, land titles, marriage certificates, or bond trades. In theory, any type of contract between two parties can be established on a blockchain as long as both parties agree on the contract. This takes away any need for a third party to be involved in any contract and opens up a world of possibilities including peer-to-peer financial products, such as loans or decentralized savings and checking accounts, wherein banks or any intermediary are irrelevant.
Blockchain’s versatility has caught the eye of governments and private corporations indeed, some analysts believe that blockchain technology will ultimately be the most impactful aspect of the cryptocurrency craze.
In Bitcoin’s case, the information on the blockchain is mostly transactions. Bitcoin is really just a list. Person A sent X bitcoin to person B, who sent Y bitcoin to person C, etc. By tallying these transactions up, everyone knows where individual users stand. It’s important to note that these transactions do not necessarily need to take place between humans.
Bitcoin’s blockchain network creates vast possibilities for the Internet of things. In the future, we could see systems in which self-driving taxis or Uber vehicles have their own blockchain wallets. The passenger would send cryptocurrency directly to the car, which would not move until the funds were received. The vehicle would be able to assess when it needs fuel and use its wallet to facilitate a refill.
Another name for a blockchain is a “distributed ledger,” which emphasizes the key difference between this technology and a well-kept Word document. Bitcoin’s blockchain is distributed, meaning that it is public. Anyone can download it in its entirety or go to any number of sites that parse it. This means that the record is publicly available, but it also means that there are complicated measures in place for updating the blockchain ledger. There is no central authority to keep tabs on all Bitcoin transactions, so the participants themselves do so by creating and verifying “blocks” of transaction data. See the section on mining below for more information.
You can see the status of blocks, and their associated transactions, on sites. Such sites list the address identifier for the transacting parties, dates, the date on which the transaction took place, and the time of the transaction.3
The long strings of numbers and letters are addresses, and if you were in law enforcement or just very well informed, you could probably figure out who controlled them. It is a misconception that Bitcoin’s network is totally anonymous, although taking certain precautions can make it very hard to link individuals to transactions.
How Does Bitcoin Work?
Bitcoin is built on a distributed digital record called a blockchain. As the name implies, blockchain is a linked body of data, made up of units called blocks that contain information about each and every transaction, including date and time, total value, buyer and seller, and a unique identifying code for each exchange. Entries are strung together in chronological order, creating a digital chain of blocks.
How to Use Bitcoin?
In the U.S. people generally use Bitcoin as an alternative investment, helping diversify a portfolio apart from stocks and bonds. You can also use Bitcoin to make purchases, but the number of vendors that accept the cryptocurrency is still limited.
Big companies that accept Bitcoin include Microsoft, PayPal and Whole Foods, to name only a few. You may also find that some small local retailers or certain websites take Bitcoin, but you’ll have to do some digging.
You can also use a service that allows you to connect a debit card to your crypto account, meaning you can use Bitcoin the same way you’d use a credit card. This also generally involves a financial provider instantly converting your Bitcoin into dollars. “Crypto.com and CoinZoom are two services that have regulation in the U.S.,” Montgomery says.
In other countries—particularly those with less stable currencies—people sometimes use cryptocurrency instead of their own currency.
“Bitcoin provides an opportunity for people to store value without relying on a currency that is backed by a government,” Montgomery says. “It gives people an option to hedge for a worst-case scenario. You’re already seeing people in countries like Venezuela, Argentina, Zimbabwe—in countries heavily in debt, Bitcoin is getting tremendous traction.”
That said, when you use Bitcoin as a currency, not an investment, in the U.S., you do have to be aware of certain tax implications.
Bitcoin is different than what you know and use every day. Before you start using Bitcoin, there are a few things that you need to know in order to use it securely and avoid common pitfalls.
Choose Your Wallet
Free bitcoin wallets are available for all major operating systems and devices to serve a variety of your needs. For example, you can install an app on your mobile device for everyday use or you can have a wallet only for online payments on your computer. In any case, choosing a wallet is easy and can be done in minutes.
You can get Bitcoin by accepting it as a payment for goods and services. There are also several ways you can buy Bitcoin.
There are a growing number of services and merchants accepting Bitcoin all over the world. Use Bitcoin to pay them and rate your experience to help them gain more visibility.
How to Accept Bitcoin
Bitcoin does not require merchants to change their habits. However, Bitcoin is different than what you know and use every day. Before you start using Bitcoin, there are a few things that you need to know in order to use it securely and avoid common pitfalls.
You can process payments and invoices by yourself or you can use merchant services and deposit money in your local currency or bitcoins. Most point of sales businesses use a tablet or a mobile phone to let customers pay with their mobile phones.
3.Accounting and Taxes
Merchants often deposit and display prices in their local currency. In other cases, Bitcoin works similarly to a foreign currency. To get appropriate guidance regarding tax compliance for your own jurisdiction, you should contact a qualified accountant.
There is a growing number of users searching for ways to spend their bitcoins. You can submit your business in online directories to help them easily find you. You can also display the Bitcoin logo on your website or your brick and mortar business.
What is Bitcoin Mining And How Does It Work?
Bitcoin mining is the process of creating new bitcoin by solving puzzles. It consists of computing systems equipped with specialized chips competing to solve mathematical puzzles. The first bitcoin miner (as these systems are called) to solve the puzzle is rewarded with bitcoin. The mining process also confirms transactions on the cryptocurrency’s network and makes them trustworthy.
For a short time after Bitcoin was launched, it was mined on desktop computers with regular central processing units (CPUs). But the process was extremely slow. Now the cryptocurrency is generated using large mining pools spread across many geographies. Bitcoin miners aggregate mining systems that consume massive amounts of electricity to mine the cryptocurrency.
In order to successfully add a block, Bitcoin miners compete to solve extremely complex math problems that require the use of expensive computers and enormous amounts of electricity. The computer hardware required is known as application-specific integrated circuits, or ASICs, and can cost up to $10,000. ASICs consume huge amounts of electricity, which has drawn criticism from environmental groups and limits the profitability of miners.
If a miner is able to successfully add a block to the blockchain, they will receive 6.25 bitcoins as a reward. The reward amount is cut in half roughly every four years, or every 210,000 blocks. As of January 2022, bitcoin traded at around $43,000, making 6.25 bitcoins worth nearly $270,000.
But the price of bitcoin has been highly volatile, which makes it difficult or impossible for miners to know what their payment might be worth whenever they receive it.
How Do You Start Bitcoin Mining?
Here are the basics you’ll need to start mining Bitcoin:
- Wallet: This is where any Bitcoin you earn as a result of your mining efforts will be stored. A wallet is an encrypted online account that allows you to store, transfer and accept Bitcoin or other cryptocurrencies. Companies such as Coinbase, Trezor and Exodus all offer wallet options for cryptocurrency.
- Mining software: There are a number of different providers of mining software, many of which are free to download and can run on Windows and Mac computers. Once the software is connected to the necessary hardware, you’ll be able to mine Bitcoin.
- Computer equipment: The most cost-prohibitive aspect of Bitcoin mining involves the hardware. You’ll need a powerful computer that uses an enormous amount of electricity in order to successfully mine Bitcoin. It’s not uncommon for the hardware costs to run around $10,000 or more.
Risks Of Bitcoin Mining
- Price volatility. Bitcoin’s price has varied widely since it was introduced in 2009. In just the past year, Bitcoin has traded for less than $30,000 and nearly $69,000. This kind of volatility makes it difficult for miners to know if their reward will outweigh the high costs of mining.
- Regulation. Very few governments have embraced cryptocurrencies such as Bitcoin, and many are more likely to view them skeptically because the currencies operate outside government control. There is always the risk that governments could outlaw the mining of Bitcoin or cryptocurrencies altogether as China did in 2021, citing financial risks and increased speculative trading.
Taxes On Bitcoin Mining
It’s important to remember the impact that taxes can have on Bitcoin mining. The IRS has been looking to crack down on owners and traders of cryptocurrencies as the asset prices have ballooned in recent years. Here are the key tax considerations to keep in mind for Bitcoin mining.
- Are you a business? If Bitcoin mining is your business, you may be able to deduct expenses you incur for tax purposes. Revenue would be the value of the bitcoin you earn. But if mining is a hobby for you, it’s not likely you’ll be able to deduct expenses.
- Mined bitcoin is income. If you’re successfully able to mine bitcoin or other cryptocurrencies, the fair market value of the currencies at the time of receipt will be taxed at ordinary income rates.
- Capital gains. If you sell bitcoins at a price above where you received them, that qualifies as a capital gain, which would be taxed the same way it would for traditional assets such as stocks or bonds.
Pros Of Bitcoin
Although Bitcoin was created in 2009, it’s still considered a relatively new kind of currency, which comes with a lot of misinformation. Learning about the benefits of Bitcoin can help you decide if it’s a good investment opportunity for you.
1. Accessibility and Liquidity
One of the biggest advantages of cryptocurrency is it often sees no borders, and Bitcoin is no exception. A major benefit of Bitcoin is that it’s a very accessible and versatile currency. Since it only takes a few minutes to transfer bitcoins to another user, it can be used to purchase goods and services from the ever-growing list of places accepting it. This makes spending money in another country and exchanging for other currencies easier, with a bonus of having little to no fees applied. Bitcoins can also be easily sold at any moment.
2. User Anonymity and Transparency
Although not completely anonymous, Bitcoin users are identified by numerical codes and can have multiple public keys. This ensures there’s no public tracking, and transactions can’t be traced back to the user. Despite the transactions being permanently viewable, which gives you transparency, they’re still kept safe from fraud due to the blockchain technology. On top of that, only you, as the wallet owner, would be able to know how many bitcoins you have.
For added security and anonymity, even if the address for your wallet became public, you could generate a new wallet address to keep your information safe. Compared to a traditional currency system in which personal information could be leaked from a bank, no other personal information is required to conduct Bitcoin transactions, which increases user privacy.
3. Independence From Central Authority
Bitcoin is a decentralized currency, meaning it’s not regulated by a single government or central bank. This means that authorities will likely not freeze and demand your coins. There’s also no viable way that a taxation would be implemented for Bitcoin. Theoretically, this gives users autonomy and control over their money, because the price isn’t linked to government policies. And generally, cryptocurrency users view this as one of the main advantages of Bitcoin.
4. High Return Potential
Bitcoin prices can be highly volatile, changing drastically on a monthly and even daily basis. For instance, in March 2017, Bitcoin was priced at $975.70, and in just a matter of months it spiked to $20,089 in December. A couple of years later, the price of Bitcoin reached an all-time high of $64,000 in April 2021.
This goes to show that although there’s high volatility in prices, cryptocurrency users might view this as one of the benefits of Bitcoin because it can result in a high return potential. And with a growing number of users believing Bitcoin is a promising global currency, many investors and businesses have decided to adopt it. This helps with increasing the higher return potential, especially for those who bought it at a lower price.
Cons Of Bitcoin
Despite its rapid growth and an increasing number of users, there are some disadvantages of Bitcoin to consider, especially if you’re wondering, “Is it worth investing in Bitcoin?”. Like in many financial decisions, the more you know, the more informed a decision you can make on whether Bitcoin is worth investing in.
When Bitcoin was created by Satoshi Nakamoto, a limit was set of 21 million bitcoins that could ever exist, which is why some regard Bitcoin as being absolutely scarce. This scarcity is what makes Bitcoin so valuable, but also what makes its prices vary because the price is now the only variable that can change to ensure demand.
There are also other factors that influence Bitcoin’s volatility such as headline-making news that is perceived as bad by investors, the uncertainty about its future value and uses, as well as security breaches.
6. No Government Regulations
Sure, a decentralized currency can be viewed as one of the benefits of cryptocurrency, but it can also be considered a disadvantage of Bitcoin, since it means investing in Bitcoin is not regulated. Unlike a currency that’s regulated by a central bank, Bitcoin transactions don’t come with legal protection and typically are not reversible, which makes them susceptible to scams.
Another issue with Bitcoin being decentralized is that there’s no guarantee of a minimum valuation. So if a big group of investors decides to stop using bitcoins and sell them, the value of it could decrease greatly and affect users with a large amount of the cryptocurrency.
Since Bitcoin transactions are anonymous and unregulated, another disadvantage is the lack of security. Transactions done through Bitcoin are irreversible and final, so nothing can be done if the wrong amount is sent or if it’s sent to the wrong recipient.
In addition, there’s a risk of loss. Many Bitcoin users choose to keep their bitcoins in a cryptocurrency wallet, which puts them at risk of losing their investments if they lose access to their private key. In case a hard drive crashes or a virus corrupts the records or even your wallet, your funds could become inaccessible or gone completely in a matter of minutes.
8. Limited Use
Even though there’s a growing number of companies that accept Bitcoin, such as Microsoft and some Subway franchises, it’s still not widely accepted. This puts a limit on where you can spend your money, unlike using a credit or debit card.
Should I Invest In Bitcoin?
Bitcoin is extremely volatile. If you are willing to take the risk, first make sure you understand what you are investing in and have a crypto investment strategy.
Also make sure you aren’t investing simply because you have a fear of missing out. There are a number of questions you should ask yourself before getting involved:
- Do I understand what I am investing in and how bitcoin and the crypto market work?
- Am I happy with the level of risk?
- How much more expensive is it now compared to a few months ago? If so, why am I wanting to buy a thing because its price is higher? Where else in my life do I do that?
- Is there any evidence to suggest prices could rise even higher?
- If I buy it now with a view to sell it for even more later, who do I think will buy it from me for that higher price and why?
- If an asset is so great, why was I not interested when it was much cheaper?
- Have I convinced myself that I am in some way “in the know?”
If you don’t have answers to these questions, it’s probably not a good idea to invest. If you do buy bitcoin, make sure you aren’t putting money you need on the line