Bitcoin – Investopedia – Sharper Insight. Smarter Investing.

What is Bitcoin

Bitcoin is a digital currency created in 2009. It follows the ideas set out in a white paper by the mysterious Satoshi Nakamoto, whose true identity has yet to be verified. Bitcoin offers the promise of lower transaction fees than traditional online payment mechanisms and is operated by a decentralized authority, unlike government-issued currencies.

There are no physical bitcoins, only balances kept on a public ledger in the cloud, that along with all Bitcoin transactions is verified by a massive amount of computing power. Bitcoins are not issued or backed by any banks or governments, nor are individual bitcoins valuable as a commodity. Despite its not being legal tender, Bitcoin charts high on popularity, and has triggered the launch of other virtual currencies collectively referred to as Altcoins.

Bitcoin is a type ofcryptocurrency: Balances are kept using public and private "keys," which are long strings of numbers and letters linked through the mathematical encryption algorithm that was used to create them. The public key (comparable to a bank account number) serves as the address which is published to the world and to which others may send bitcoins. The private key (comparable to an ATM PIN) is meant to be a guarded secret, and only used to authorize Bitcoin transmissions.

Style notes: According to the official Bitcoin Foundation, the word "Bitcoin" is capitalized in the context of referring to the entity or concept, whereas "bitcoin" is written in the lower case when referring to a quantity of the currency (e.g. "I traded 20 bitcoin") or the units themselves. The plural form can be either "bitcoin" or "bitcoins."

Bitcoin is one of the first digital currencies to use peer-to-peer technology to facilitate instant payments. The independent individuals and companies who own the governing computing power and participate in the Bitcoin network, also known as "miners," are motivated by rewards (the release of new bitcoin) and transaction fees paid in bitcoin. These miners can be thought of as the decentralized authority enforcing the credibility of the Bitcoin network. New bitcoin is being released to the miners at a fixed, but periodically declining rate, such that the total supply of bitcoins approaches 21 million. One bitcoin is divisible to eight decimal places (100 millionth of one bitcoin), and this smallest unit is referred to as a Satoshi. If necessary, and if the participating miners accept the change, Bitcoin could eventually be made divisible to even more decimal places.

Bitcoin miningisthe process through which bitcoins are released to come into circulation. Basically, it involves solving a computationally difficult puzzle to discover a new block, which is added to the blockchain, and receiving a reward in the form of few bitcoins. The block reward was 50 new bitcoins in 2009; it decreases every four years. As more and more bitcoins are created, the difficulty of the mining process that is, the amount of computing power involved increases. The mining difficulty began at 1.0 with Bitcoin's debut back in 2009; at the end of the year, it was only 1.18.As of April 2017, the mining difficulty is over 4.24 billion. Once, an ordinary desktop computer sufficed for the mining process; now, to combat the difficulty level, miners must use faster hardware like Application-Specific Integrated Circuits (ASIC), more advanced processing units like Graphic Processing Units (GPUs), etc.

In 2017 alone, the price of Bitcoin rose from a little under $1,000 at the beginning of the year to close to $19,000, ending the year more than 1,400% higher.

Bitcoin's price is also quite dependent on the size of its mining network, since the larger the network is, the more difficult and thus more costly it is to produce new bitcoins. As a result, the price of bitcoin has to increase as its cost of production also rises. The Bitcoin mining network's aggregate power has more than tripled over the past twelve months.

Aug. 18, 2008: The domain name bitcoin.org isregistered. Today, at least, this domain is "WhoisGuardProtected," meaning the identity of the person who registered it is not public information.

Oct. 31, 2008: Someone using the name Satoshi Nakamotomakes anannouncement on The Cryptography Mailing list at metzdowd.com: "I've been working on a new electronic cash system that's fully peer-to-peer, with no trusted third party. The paper is available athttp://www.bitcoin.org/bitcoin.pdf."This link leads to the now-famous white paper published on bitcoin.org entitled "Bitcoin: A Peer-to-Peer Electronic Cash System." This paper would become the Magna Carta for how Bitcoin operates today.

Jan. 3, 2009: The first Bitcoin block is mined, Block 0. This is also known as the "genesis block" and contains the text: "The Times 03/Jan/2009 Chancellor on brink of second bailout for banks," perhaps as proof that the block was mined on or after that date, and perhaps also as relevant political commentary.

Jan. 8, 2009: The first version of theBitcoinsoftware isannouncedon The Cryptography Mailing list.

Jan. 9, 2009:Block 1is mined, andBitcoin mining commences in earnest.

No one knows. Not conclusively, at any rate. SatoshiNakamotois the name associated with the person or group of people who released the originalBitcoinwhitepaperin 2008 and worked on the originalBitcoinsoftware that was released in 2009. TheBitcoinprotocol requires users to enter a birthday upon signup, and we knowthat an individual named SatoshiNakamotoregistered and put down April 5 as a birth date. And that's about it.

Though it is tempting to believe the media's spin that Satoshi Nakamoto is a lone, quixotic genius who created Bitcoin out of thin air, such innovations do not happen in a vacuum. All major scientific discoveries, no matter how original-seeming, were built on previously existing research. There are precursors toBitcoin:Adam BacksHashcash, invented in 1997, and subsequently WeiDaisb-money, NickSzabosbit-gold and Hal Finneys Reusable Proof of Work. The Bitcoin white paper itself cites Hashcashand b-money, as well as various other works spanning several research fields.

There are two primary motivations for keeping Bitcoin's inventor keeping his or her or their identity secret.One is privacy.AsBitcoinhas gained in popularity becoming something of a worldwide phenomenon SatoshiNakamoto would likely garner a lot of attention from the media and from governments.

The other reason is safety.Looking at 2009 alone, 32,489 blockswere mined; at the then-reward rate of 50BTC per block, the total payout in 2009 was 1,624,500BTC, which at todays prices is over $900 million. One may conclude that only Satoshi and perhaps a few other people were mining through 2009, and that they possess a majority of that $900 million worth ofBTC. Someone in possession of that muchBTCcould become a target of criminals, especially sincebitcoinsare less like stocks and more like cash, where the private keys needed to authorize spending could be printed out and literally kept under a mattress. While it's likely the inventor ofBitcoinwould take precautions to make any extortion-induced transfers traceable, remaining anonymous is a good way for Satoshi to limit exposure.

Numerous people have been suggested as possible SatoshiNakamotosby major media outlets.On Oct. 10, 2011, TheNew Yorkerpublished an article speculating thatNakamotomight be Irish cryptography student Michael Clear, or economic sociologistViliLehdonvirta. A day later,Fast Companysuggested thatNakamotocould be a group of three people Neal King, VladimirOksman and CharlesBry who together appear on a patent related to secure communications that was filed two months before bitcoin.org was registered. AVice articlepublished in May 2013 added more suspects to the list, including GavinAndresen, theBitcoinprojects lead developer; JedMcCaleb, co-founder of now-defunctBitcoinexchange Mt. Gox; and famed Japanese mathematicianShinichiMochizuki.

In December, 2013,Techcrunchpublished an interview with researcher Skye Grey who claimed textual analysis of published writings shows a link between Satoshi and bit-gold creator NickSzabo. And perhaps most famously, in March 2014,Newsweekran a cover article claiming that Satoshi is actually an individual named SatoshiNakamoto a 64-year-old Japanese-American engineer living in California. The list of suspects is long, and all the individuals deny being Satoshi.

It would seem even early collaborators on the project dont have verifiable proof of Satoshis identity. To reveal conclusively who SatoshiNakamoto is, a definitive link would need to be made between his/her activity withBitcoinand his/her identity.That could come in the form of linking the party behind the domain registration of bitcoin.org, email and forum accounts used by SatoshiNakamoto, or ownership of some portion of the earliest minedbitcoins. Even though thebitcoinsSatoshi likely possesses are traceable on theblockchain, it seems he/she has yet to cash them out in a way that reveals his/her identity. If Satoshi were to move his/herbitcoinsto an exchange today, this might attract attention, but it seems unlikely that a well-funded and successful exchange would betray a customer's privacy.

There are many Bitcoin supporters who believe that digital currency is the future.Those who endorse it are of the view that it facilitates a much faster, no-fee payment system for transactions across the globe. Although it is not itself any backed by any government or central bank,bitcoin can be exchanged for traditional currencies; in fact, its exchange rate against the dollar attracts potential investors and traders interested in currency plays. Indeed, one of the primary reasons for the growth of digital currencies like Bitcoin is that they can act as an alternative to national fiat money and traditional commodities like gold.

In March 2014, the IRS stated that all virtual currencies, including bitcoins, would be taxed as property rather than currency. Gains or losses from bitcoins held as capital will be realized as capital gains or losses, while bitcoins held as inventory will incur ordinary gains or losses.

Like any other asset, the principle of buy low and sell high applies to bitcoins.The most popular way of amassing the currency is through buying on a Bitcoin exchange, but there are many other ways to earn and own bitcoins. Here are a few options which Bitcoin enthusiasts can explore.

Bitcoins can be accepted as a means of payment for products sold or services provided. If you have a brick and mortar store, just display a sign saying Bitcoin Accepted Here and many of your customers may well take you up on it; the transactions can be handled with the requisite hardware terminal or wallet address through QR codes and touch screen apps. An online business can easily accept bitcoins by just adding this payment option to the others it offers, like credit cards, PayPal, etc. Online payments will require a Bitcoin merchant tool (an external processor like Coinbase or BitPay).

Those who are self-employed can get paid for a job in bitcoins. There are several websites/job boards which are dedicated to the digital currency:

Another interesting way (literally) to earn bitcoins is by lending them out, and being repaid in the currency. Lending can take three forms direct lending to someone you know; through a website which facilitates peer-to-peer transactions, pairing borrowers and lenders; or depositing bitcoins in a virtual bank that offers a certain interest rate for Bitcoin accounts. Some such sites are Bitbond, BitLendingClub and BTCjam. Obviously, you should do due diligence on any third-party site.

Its possible to play at casinos that cater to Bitcoin aficionados, with options like online lotteries, jackpots, spread betting and other games. Of course, the pros and cons and risks that apply to any sort of gambling and betting endeavors are in force here too.

The concept of a virtual currency is still novel and, compared to traditional investments, Bitcoin doesn't have much of a longterm track record or history of credibility to back it. With their increasing use, bitcoins are becoming less experimental every day, of course; still, after eight years, they (like all digital currencies) remain in a development phase, still evolving. "It is pretty much the highest-risk, highest-return investment that you can possibly make, says Barry Silbert, CEO of Digital Currency Group, which builds and invests in Bitcoin and blockchain companies.

Not for the risk-adverse, in other words. If you are considering investing in bitcoin, understand these unique investment risks:

Regulatory Risk: Bitcoins are a rival to government currency and may be used for black market transactions, money laundering, illegal activities or tax evasion. As a result, governments may seek to regulate, restrict or ban the use and sale of bitcoins, and some already have. Others are coming up with various rules. For example, in 2015, the New York State Department of Financial Services finalized regulations that would require companies dealing with the buy, sell, transfer or storage of bitcoins to record the identity of customers, have a compliance officer and maintain capital reserves. The transactions worth $10,000 or more will have to be recorded and reported.

Although more agencies will follow suit, issuing rules and guidelines, the lack of uniform regulations about bitcoins (and other virtual currency) raises questions over their longevity, liquidity and universality.

Security Risk: Bitcoin exchanges are entirely digital and, as with any virtual system, are at risk from hackers, malware and operational glitches. If a thief gains access to a Bitcoin owner's computer hard drive and steals his private encryption key, he could transfer the stolen Bitcoins to another account. (Users can prevent this only if bitcoins are stored on a computer which is not connected to the internet, or else by choosing to use a paper wallet printing out the Bitcoin private keys and addresses, and not keeping them on a computer at all.) Hackers can also target Bitcoin exchanges, gaining access to thousands of accounts and digital wallets where bitcoins are stored. One especially notorious hacking incident took place in 2014, when Mt. Gox, a Bitcoin exchange in Japan, was forced to close down after millions of dollars worth of bitcoins were stolen.

This is particularly problematic once you remember that all Bitcoin transactions are permanent and irreversible. It's like dealing with cash: Any transaction carried out with bitcoins can only be reversed if the person who has received them refunds them. There is no third party or a payment processor, as in the case of a debit or credit card hence, no source of protection or appeal if there is a problem.

Fraud Risk: While Bitcoin uses private key encryption to verify owners and register transactions, fraudsters and scammers may attempt to sell false bitcoins. For instance, in July 2013, the SEC brought legal action against an operator of a Bitcoin-related Ponzi scheme.

Market Risk: Like with any investment, Bitcoin values can fluctuate. Indeed, the value of the currency has seen wild swings in price over its short existence. Subject to high volume buying and selling on exchanges, it has a high sensitivity to news." According to the CFPB, the price of bitcoins fell by 61% in a single day in 2013, while the one-day price drop in 2014 has been as big as 80%.

If fewer people begin to accept Bitcoin as a currency, these digital units may lose value and could become worthless. There is already plenty of competition, and though Bitcoin has a huge lead over the other 100-odd digital currencies that have sprung up, thanks to its brand recognition andventure capital money, a technological break-through in the form of a better virtual coin is always a threat.

Tax Risk: As bitcoin is ineligible to be included in any tax-advantaged retirement accounts, there are no good, legal options to shield investments from taxation.

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