A Beginner's Guide to Bitcoin
If you’re reading this then you’ve probably been hearing all the buzz surrounding Bitcoin recently. This article is my attempt to create a comprehensive, one stop shop for any questions or concerns you may have. To make this article succinct, I will avoid spending too much time on the details, but I do plan on eventually addressing each aspect of the technology in future articles. Feel free to comment below with any additional questions.
What is Bitcoin?
Simply put, Bitcoin is a decentralized digital currency that was built using blockchain technology. I’ll explain the blockchain later in the article, but for now let’s focus on the term “decentralized”. Bitcoin’s decentralized nature means that no country, no government, nor any corporation owns Bitcoin. Let me say that again; No one owns Bitcoin. No one owns Bitcoin the way no one owns the internet. It’s simply an open-source protocol that users can contribute to, make changes to when necessary, and build applications for.
If the idea of a digital currency sounds odd to you, consider how much of our lives has been digitized. We listen to music online; we shop online; we take college courses and pay bills online. A digital currency is the inevitable byproduct of the technological revolution we’re all a part of.
Where did Bitcoin come from?
In 2008, we saw the collapse of the global financial system. Commercial banks were issuing reckless mortgage loans to unqualified buyers, and investment banks were packaging them up and selling them to investors. It was only a matter of time before the house of cards came crashing down and people lost their homes and jobs while the banks were bailed out by Congress.
The proposal for Bitcoin was published shortly after this in 2008 by its anonymous founder, Satoshi Nakamoto. That’s right; no one actually knows who Satoshi Nakamoto is. There is some speculation that it was actually a group of people, but it’s hard to say with certainty. Regardless, after working on the technology for two years, Satoshi disappeared, leaving the project in the hands of a group of developers who have been working on it ever since.
Why does Bitcoin matter?
The lesson we learned in 2008 is that we can no longer trust banks or any other financial institution. They gambled with their customer’s money and when they lost, the government bailed them out to the tune of $700 billion worth of taxpayer money. Bitcoin addresses this issue of trust by cutting out the middleman.
Bitcoin is borderless; it is not confined to any one country or corporation. It can be sent anywhere in the world instantaneously with minimal fees and no intermediaries. If you wanted to do that now, you’d have to go to your local bank to send a wire transfer or use a service like Venmo, Paypal, or Western Union, which can take days. The philosophy behind Bitcoin is to provide a network that doesn’t require trust in order for people to be truly in control of their finances.
How does Bitcoin work?
This is perhaps the most difficult part to explain in a way that would be simple to understand, but I’ll do my best using a series of analogies.
Earlier I mentioned that Bitcoin is built using blockchain technology. Here’s an analogy to explain how it works: Imagine you’ve just started your own small business, and you need to keep track of all your receipts so you can pay taxes at the end of the year (gross). At the end of your first week, you put all your receipts from that week in a shoe box. Next week you do the same thing, but this time you put this week’s shoe box on top of last week’s shoe box. You continue doing the same thing every week and by the end of the year, you have a stack of 52 shoe boxes with the shoe box from the first week at the bottom of the stack. This is kind of how the blockchain works.
Bitcoin transactions that have occurred are collected in a block every ten minutes and added to a long chain of blocks that go all the way back to the beginning. This is what makes Bitcoin secure. Every transaction that has ever occurred on the network is permanently recorded on a public ledger and is nearly impossible to reverse. Here’s a recent transaction of mine:
That long string of numbers is the “confirmation code” for my transaction
The people that keep this system running are known as “miners”, a term you may have heard before. The best analogy I could come up with for this term has to do with that of a popular nightclub. The people lined up outside are the transactions; the bouncer at the door is the miner; and the nightclub is a block. Imagine that every ten minutes a bouncer calls a group of people forward, checks their IDs to make sure they’re of age, and he charges them a cover to get in. Likewise, a miner collects a group of transactions, checks them to make sure they’re valid, and then charges a small fee to include these transactions in the next block that will be added to the blockchain.
At any given moment, there are thousands of independent miners all over the world that are constantly powering the network, and they’re being paid a fee to do so. This is what makes Bitcoin decentralized. In other words, the network does not rely on any one individual. For instance, let’s say that there are 1000 miners in China. If China decided to ban Bitcoin and the miners in that country were forced to shut down their operation, there are still thousands of other miners across the globe that are handling transactions.
Compare this to a centralized database where one hacker can bring down an entire system. For example, when Equifax was breached earlier this year, the highly sensitive personal and financial information of over 143 million people was compromised. This highlights a major benefit of a decentralized network.
Should I invest in Bitcoin?
Answering this question may be more difficult than the previous. While I definitely believe in this revolutionary technology long-term, nothing is guaranteed, and I am not certified nor qualified to give financial advice. In fact, this article should only be considered for educational purposes.
The potential returns from investing is generally what draws people to Bitcoin. For example, if you had purchased 1 Bitcoin at the beginning of 2017, you would have paid around $964 (USD). If you had sold it at Bitcoin’s recent all time high of $7,895 (USD), you would have made a return on your investment of around 719%. These type of returns are nearly unheard of when it comes to any other type of investment.
So what’s the catch? Bitcoin has had three major corrections (significant price drops) this year alone. There was a 38% drop from June to July, a 40% drop mid-September due to regulations from China, and a recent 30% drop due to some internal disagreements about a potential change to the protocol.
I can tell you from personal experience that these price swings are not easy to stomach. The last Bitcoin I purchased was $4200. Shortly after, the price rose to $5,000 then dropped to $2900 in a matter of days. I went from a period of elation from having made a potential return of 20% to despair as that return quickly turned to a potential loss of 30% of my investment. Despite these corrections, Bitcoin generally begins its upwards trend in a matter of days. At the time of writing, Bitcoin has recovered from the last correction and is approaching $8,000.
With all this in mind, after considering the risks involved, if you decide you still want to invest, the general rule of investing is never invest more than you’re willing to lose. One common misconception is that you have to buy an entire Bitcoin. The truth is you can buy fractions of a Bitcoin (half of one or a tenth). Just like 1 US dollar is made of 100 cents, 1 Bitcoin is made up of 100,000,000 “satoshis.”
If tomorrow news came out that Congress had decided to ban the use of Bitcoin in the United States and the price went down to $0, would you be OK with having lost your investment? Would you still be able to pay your rent and buy groceries? While this scenario is extremely unlikely (Bitcoin currently has the green light in the US), this is a useful exercise to help people figure out an amount they’re comfortable investing. In the end, the choice is yours.
My hope in writing this article was to give those who have just learned about Bitcoin or those who have simply been wondering what all the fuss was about a place to start. Getting a firm grasp on some of the terms and concepts I’ve introduced here is a bit like painting a wall — it may take a few coats. Rereading the article and giving your brain some time to digest it all may be the best way to internalize everything we’ve gone over together.
Bitcoin is an ultra-dynamic technology; there are exciting, new developments and updates coming out almost everyday that make it hard to keep up with. If you’re feeling a little confused or intimidated after reading this, don’t. I’ve been studying the many facets of the digital currency in-depth for the last six months and there are still many parts I have yet to grasp. I’m comforted by a quote from Andreas Antonopoulos, considered the chief evangelist of Bitcoin:
“I wrote a book that answers the question ‘What is Bitcoin?’ It’s 300 pages long, was [outdated] the moment it was printed and has to be corrected and updated every three months just to keep up with changes.”
Ultimately, having an in-depth understanding of the intricacies of the technology is not necessary for participating. In other words, getting involved with Bitcoin doesn’t require you to be an expert. In fact, because the learning curve is so steep, one of the best ways to get started is simply by diving in. However, it is important to note that Bitcoin is still in its early stages. Having been introduced only eight years ago, it still needs some time and lot of work to be done in order to reach mainstream adoption.
When I bought my first Bitcoin in 2013, I was way in over my head. I also had no idea that in only a matter of years the digital currency would take the finance industry and the world by storm. While it’s hard to make predictions about where the price will be in the future, one thing I can say with certainty is that Bitcoin, and digital currencies in general, are not going anywhere. While they may never replace fiat currencies, they are serious contenders and a welcomed alternative. The question is: will you be a part of the movement?
If you made it this far, I just wanted to personally say thanks for reading! You can find part 2 here: A Beginner’s Guide to Buying Bitcoin. This guide will focus on how to buy and store your digital currency.
If you had any additional questions or just wanted to say hi, you can reach me on twitter @ChrisAllenDunn or BitcoinDunny.
Also, Coinbase, which is one of the largest Bitcoin exchanges, has a pretty cool referral program. If after reading you decide you want to move forward, use this link to sign up and we both get $10 worth of Bitcoin when you purchase.
Lastly, if you found this article useful, feel free to leave at a tip of any amount at this address: 1GCha36QmVyAACoDT8j27AzfweC3krTD4i