Bitcoin (BTC): What Is It & How Does It Work?

Thanks to Bitcoin, anyone with an internet connection can store wealth and transfer it anywhere in the world within minutes. What some call magic internet money, others call a financial revolution. Despite its explosive growth, most people don’t understand how it works. Bitcoin is a digital currency that challenges the traditional pillars of finance by decentralizing authority to let people transact directly with each other. Here’s what to know about Bitcoin and its underlying blockchain technology. 

Bitcoin vs Money at a Glance:

What is Bitcoin? 

Bitcoin is the first-ever, digital-only currency that is not issued or backed by a central bank. Nor is access controlled by a middleman, like a bank or other financial institution. It completely sidesteps the traditional financial system by facilitating direct peer-to-peer transactions. It exists entirely online with no physical version of it in the real world. 

Think of it like email for money. Anyone with an internet connection can send Bitcoin directly to someone else. All you need is their public crypto wallet address. If you’ve ever sent an eTransfer, sending Bitcoin is similar but with fewer steps, more privacy, and no bank account required.

Who Created It & Why? 

Bitcoin was created by a person or group of people under the fictitious name of Satoshi Nakamoto. At the time of writing, their true identity remains a mystery. Satoshi launched Bitcoin in 2009, during the Global Financial Crisis. 

Bitcoin’s whitepaper criticizes traditional finance because it requires trust between parties but then continuously betrays that trust. The current system causes several problems such as high transaction costs, limits on the size of transactions, and transactions that can be reversed. 

Satoshi also pointed out that intermediaries, such as banks, expose us to risks like fraud because merchants are required to collect certain personal information from customers, which compromises privacy and efficiency. Satoshi also astutely explains that the current system inherently accepts a certain level of fraud as unavoidable and significantly restricts the potential for secure, direct transactions between people. 

Bitcoin was created as a monetary alternative to solve these issues. The goal was to expand financial inclusion, enhance security, and make transactions faster and less expensive. All while eliminating the scourge of inflation and policy failures. 

How Does Bitcoin Work?

Bitcoin introduced a disruptive new technology called a blockchain. Think of it like a giant, public, digital notebook that records every Bitcoin transaction ever made. Blockchain technology is revolutionary because the information is published on a distributed ledger spread across a network of computers called nodes, that anyone can access but no one controls. This is what creates trust without the need for a centralized authority. 

Every transaction is “written” in the notebook, which is stored across millions of nodes around the world. Everyone can see what’s in the notebook but no one can change or erase anything. This decentralization makes it incredibly difficult for anyone to cheat or manipulate the system.

The Blockchain

When you send Bitcoin to another person, it creates transaction data that details how much Bitcoin you sent and where it went. It’s then broadcast to the network and waits to be validated. 

Once the network of nodes has confirmed the transaction is legitimate, it’s grouped into a block with thousands of other transactions. When a block is filled with transactions, it gets added to the ledger like links in a chain, hence the name blockchain. 

Essentially, each block is a ‘page’ of transactions in our metaphorical digital notebook. Once a page is full, it’s time to start a new one. But before a new block can be added to the blockchain, it must be verified through a process called mining.

Digital Signatures & Cryptographic Keys

To send and receive Bitcoin, you must have a Bitcoin wallet. It provides you with a set of private and public keys. The private key is kind of like your debit card PIN, it gives you the sole power to make transactions and you never share it with anyone. The public key is more like your bank account number, it tells nodes where to deposit your money. 

Verifying Transactions 

When you send Bitcoin, you sign the transaction with your private key to prove you are the rightful owner. Miners use your public key to verify your signature, confirm you have enough Bitcoin to complete the transaction, and that it’s legitimately authorized by you. Once verified, the transaction is added to the blockchain, effectively updating the public ledger.

The Mining Process 

Mining is the engine that powers and secures Bitcoin’s blockchain network. Bitcoin mining refers to the process in which nodes solve complex mathematical problems to verify transactions and them to the blockchain. Miners compete with each other to solve these puzzles first. The ‘winner’ gets to add the block and is rewarded with some newly minted Bitcoin. This process secures the blockchain by incentivizing people to join the network and keep validating transactions.  

Blockchain’s Unique Security Advantage

Unlike traditional finance, Bitcoin’s blockchain network uses a trustless system that reduces the risk of fraud and manipulation. Here’s why that’s important: 

Trustless Transactions

The traditional financial system requires you to trust intermediaries, like banks and payment processors, to verify and process your transactions as well as safeguard your personal information. Bitcoin eliminates those middlemen so you can transact directly with your peers without sharing personally identifiable details. 

Blockchain technology delivers this “trustless” system. All transactions are validated, finalized, and secured by a distributed network. Everyone can see transactions between wallets on the public ledger, but no one can see your personal information.

Decentralized vs Centralized

Traditional financial systems concentrate control and data within a single organization or group. This makes their entire network vulnerable to a single attack. Hackers target centralized networks to steal data or money. Internal fraud is baked into this model precisely because of this inherent power concentration. Some of the most famous hacks and data breaches include JP Morgan (2014), Equifax (2017), and Capital One (2019), to name a few. 

Bitcoin, on the other hand, uses a decentralized model to distribute data across a massive global network of nodes. Because power is not concentrated, no single point of failure exists. Therefore, the blockchain is inherently difficult to hack. 

The Role of Network Consensus

To maintain the security and integrity of the blockchain, it uses a Proof of Work (PoS) consensus mechanism that requires the majority of nodes to agree that each transaction is valid before it can be added to the blockchain. This is crucial because it means an attacker would need to capture control of over half the network. 

This would require a practically unattainable amount of computational power and money. Estimates say it would cost hackers nearly $3 million per hour to attack Bitcoin. And if they were successful, users would no longer trust the network and likely dump their holdings, causing the price to plummet. This would likely render Bitcoin worthless, which would defeat the purpose of hacking the system. 

Bitcoin vs Traditional Money

Bitcoin’s total supply is capped at 21 million coins. This finite supply is a fundamental characteristic of Bitcoin that distinguishes it from traditional money which has no supply limit. This cap is hardcoded into the Bitcoin protocol to protect it from losing value over time, which is called inflation. Unlike traditional money, Bitcoin should become more valuable over time as demand increases and eventually outstrips supply. 

Traditional money is inherently inflationary, and central banks are tasked with keeping the inflation rate within a certain annual target. In Canada, the target inflation rate is 1-3% per year. That means your money is guaranteed to lose at least 1-3% of its value annually, and that’s best case scenario. 

Halving Events

Bitcoin halving events are specifically designed to control the supply, providing additional protection against inflation. Every four years, the reward for mining Bitcoin is reduced by half, which gradually reduces the rate at which new Bitcoin is created. That means each miner will receive 50% fewer rewards for adding blocks to the chain. 

How It's Valued

The value of traditional money is primarily determined by monetary policy, the strength of the economy, and the level of faith we have that it will continue to be accepted as legal tender. Neither traditional money nor Bitcoin is backed by any physical asset or commodity - Canada abandoned the gold standard in 1929. 

Since Bitcoin is not issued or controlled by governments or central banks, its value is driven entirely by supply and demand. Thanks to its fixed supply, Bitcoin currently behaves more like a commodity than a currency, albeit a speculative one.

The price of Bitcoin continues to be extremely sensitive to market sentiment, which simply refers to how people feel about it. As a new, speculative asset, the price is incredibly volatile and Bitcoin has experienced several stunning crashes over the years, sometimes losing up to 99% of its value. To date, it has survived every major crash and gone on to hit new all-time highs.

Pivotal Moments in Bitcoin’s History

Are You Ready For Bitcoin? 

Bitcoin is accessible to anyone with an internet connection and was created to give you total control of your wealth. Localcoin ATMs offer a safe and regulated platform to engage with the future of money. They work just like the regular ATMs you’re used to, and on-screen prompts guide you through the entire process. It only takes a few minutes to add some digital gold to your wallet. Find a Localcoin ATM near you and enjoy the easiest way to buy Bitcoin.