What is Bitcoin? Here’s How BTC Works

A shady form of payment, a speculative bubble or the future of finance? Here’s how to make sense of the news around bitcoin.
Mar 10, 2014

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Bitcoin, the first and most valuable cryptocurrency, has grown from a fringe experiment into one of the hottest tickets in global finance. As of November 2021, the combined worth of all bitcoins was more than $1 trillion, exceeding the market capitalizations of some of the world's most valuable companies — such as Tesla, Berkshire Hathaway, and Facebook parent Meta.

Bitcoin, also known as BTC, is unlike any other asset to have attained such heights. Rather than representing a share of a company, a bitcoin is a unit of digital currency whose value can fluctuate widely. And it is underpinned not by the economic fundamentals of a company or a national bank, but by an encrypted ledger of digital transactions jointly maintained by thousands of computers.

You don't have to be an expert to understand how bitcoin works. While the underlying "blockchain" technology can get quite complex, it's not hard to grasp the basics. Here are some things you should know.

BTC definition: What is bitcoin?

Bitcoin, launched in 2009, is decentralized digital cash that eliminates the need for intermediaries like banks and governments, using instead a peer-to-peer computer network to confirm purchases directly between users.

Fiat currency (like the U.S. dollars in your bank account) is backed and regulated by the government that issues it. Bitcoin, on the other hand, is powered through a combination of networking technology and software-driven cryptography, the science of passing secret information that can only be read by the sender and receiver. This creates a currency backed by code rather than items of physical value, like gold or silver, or by trust in central financial authorities.

The price of one bitcoin has grown substantially. In April 2011, the price was $1. By the fall of 2021, it was setting all-time highs above $65,000.

» How much is bitcoin worth? Check the current price to buy bitcoin:

Data is pulled from Google Finance and may be delayed up to 20 minutes. Information is solely for informational purposes and not for trading purposes or advice.

How does bitcoin work?

Each bitcoin (trading symbol “BTC,” though “XBT” is also used) is a computer file stored in a digital wallet on a computer or smartphone. To understand how the cryptocurrency works, it helps to understand these terms and a little context:

  • Blockchain: Bitcoin is powered by open-source code known as blockchain, which creates a shared public ledger of transactions organized into "blocks" that are "chained" together to prevent tampering. This technology creates a permanent record of each transaction, and it is at the heart of more than 10,000 cryptocurrencies that have followed in bitcoin’s wake.

  • Private and public keys: A bitcoin wallet contains a public key and a private key, which work together to allow the owner to initiate and digitally sign transactions, providing proof of authorization.

  • Bitcoin miners: Miners — or members of the peer-to-peer platform — then independently confirm the transaction using high-speed computers, typically within 10 to 20 minutes.

» Ready to invest in bitcoin? Here's our picks for best bitcoin and cryptocurrency exchanges.

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What is bitcoin mining?

Bitcoin miners — also known as "nodes" — are the owners of high-speed computers which independently confirm each transaction, and add a completed "block" of transactions to the ever-growing "chain," which has a complete, public and permanent record of every bitcoin transaction.

Miners are paid in bitcoin as reward for their efforts, which incentivizes the decentralized network to independently verify each transaction. This independent network of miners also decreases the chance for fraud or false information to be recorded, as the majority of miners need to confirm the authenticity of each block of data before it's added to the blockchain, in a process known as "proof of work."

How does bitcoin make money?

Bitcoin value follows the law of supply and demand — and because demand waxes and wanes, there’s a lot of volatility in the cryptocurrency’s price.

Besides mining bitcoin, which requires technical expertise and an investment in high-performance computers, most people purchase bitcoin as a form of currency speculation — betting that the market value of one bitcoin will be higher in the future than it is today. But that's difficult to predict.

Storing your bitcoins: Hot wallets vs. cold wallets

Bitcoins can be stored in two kinds of digital wallets:

  • Hot wallet: Digital currency is stored in the cloud on a trusted exchange or provider, and accessed through a computer browser, desktop or smartphone app.

  • Cold wallet: An encrypted portable device much like a thumb drive that allows you to download and carry your bitcoins.

Basically, a hot wallet is connected to the internet; a cold wallet is not. But you need a hot wallet to download bitcoins into a portable cold wallet.

Buying bitcoin: pros and cons

With a speculative asset class like bitcoin, it’s better to start with why you should be wary:

Bitcoin cons

  • Price volatility. While bitcoin's value has risen dramatically over the years,  buyers' fortunes have varied widely depending on the timing of their investment. Those who bought in 2017 when bitcoin’s price was racing toward $20,000, for example, had to wait until December 2020 to recover their losses. And even though 2021 has been a strong year for bitcoin, it still lost half of its value between April and July before recovering and hitting new highs in November.

  • Hacking concerns. While backers say the blockchain technology behind bitcoin is even more secure than traditional electronic money transfers, bitcoin hot wallets have been an attractive target for hackers. There have been a number of high-profile hacks, such as the news in May 2019 that more than $40 million in bitcoin was stolen from several high-net-worth accounts on cryptocurrency exchange Binance (the company covered the losses).

  • Limited (but growing) use. In May 2019, telecommunications giant AT&T joined companies such as Overstock.com, Microsoft and Dish Network in accepting bitcoin payments. But these companies are the exception, not the rule.

  • Not protected by SIPC. The Securities Investor Protection Corporation insures investors up to $500,000 if a brokerage fails or funds are stolen, but that insurance doesn’t cover cryptocurrency.

Bitcoin pros

  • Private, secure transactions anytime — with fewer potential fees. Once you own bitcoin, you can transfer them anytime, anywhere, reducing the time and potential expense of any transaction. Transactions don’t contain personal information like a name or credit card number, which eliminates the risk of consumer information being stolen for fraudulent purchases or identity theft. (Keep in mind, though, that to purchase bitcoins on an exchange, generally you'll first need to link your bank account.)

  • The potential for big growth. Some investors who buy and hold the currency are betting that once bitcoin matures, greater trust and more widespread use will follow, and therefore bitcoin’s value will grow.

  • Decentralization. After the financial crisis and the Great Recession, some investors are eager to embrace an alternative, decentralized currency — one that is essentially outside the control of regular banks, governing authorities or other third parties.

Should you buy bitcoin?

Bitcoin is an incredibly speculative and volatile buy. It’s worth remembering that stock trading can give you a similar thrill — and picking stocks of established companies is generally less risky than investing in bitcoin. (A common rule of thumb is to devote only a small slice of your overall portfolio to individual stocks or speculative assets like bitcoin.)

Where can I buy bitcoin?

There are several ways to get bitcoin, but these are some of the most common:

  • Bitcoin ATMs. There are more than 26,000 bitcoin ATMs in the U.S. (Search Coin ATM Radar to find one near you.)

  • Investment brokerages. Robinhood was the first mainstream investment broker to offer bitcoin and other cryptocurrencies. (Robinhood Crypto is available in most, but not all, U.S. states.) TradestationeToro and Sofi Active Investing also offer cryptocurrency trading in most U.S. states.

  • Cryptocurrency exchanges. There are a number of exchanges in the U.S. and abroad. Coinbase is the largest cryptocurrency exchange in the U.S., with access to around 100 cryptocurrencies.

Of the online brokerages and cryptocurrency exchanges that NerdWallet reviews, the following currently offer bitcoin.

Available for:

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Binance.US

Access to buy and sell nearly 60 cryptocurrencies.

Coinbase

Access to buy and sell nearly 100 cryptocurrencies.

eToro

Trading platform with access to 17 cryptocurrencies.

Gemini

Ability to buy and sell more than 50 cryptocurrencies.

Robinhood

Seven cryptocurrencies including bitcoin, bitcoin cash and ethereum.

SoFi Active Investing

Offers more than 20 cryptocurrencies for trading including bitcoin, ethereum and litecoin.

TradeStation

Offers trading for five cryptocurrencies, including bitcoin, bitcoin cash and ethereum.

Webull

Offers 10 cryptocurrencies for trading, including bitcoin, bitcoin cash, ethereum and litecoin.

Kraken

Offers more than 90 cryptocurrencies.

Disclosure: The author held no positions in the aforementioned investments at the original time of publication.

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