Bitcoin and How it Works

Although it may seem complicated, understanding Bitcoin and how it works isn’t really that difficult. Personally, I think the difficulty people have with the idea of it is simply that they have not taken the time to understand it. For argument sake let’s take the idea of government fiat currencies. Now when it really comes down to it, in thinking about these I would suspect that the majority of people do not really understand how these work either. If you don’t believe me just take a tally of your family and friends and ask them simple questions that everyone should know about the money we use daily such as how is the money supply increased, what is fractional reserve banking, how does an ATM ensure the money is from my account, how does the bank ensure my cheques are processed in the order that I write them, how is a wire transfer from my bank account to another work, and why are traditional currencies inflationary? As you can see these are no easy questions to answer either. The difference it seems really boils down to the fact that in the case of real world money it is the institutions that control it and the common folk have no need to understand it beyond how to insert a debit card into the machine, write the amount and name on a cheque, and fill out paperwork at a bank teller window. To me personally this is a little crazy. I mean would you sit down at a table with a bunch of professionals and play poker without having any idea of how the game is actually played simply trusting trusting in the fact that all those other players have your best interest at heart. I mean chances are they would not outright lie about the rules, but I would bet that there would be some things that they would hold back to ensure that they have the upper hand in the long game. Antidotes aside, understanding what Bitcoin is and how it works does take a little time and mental capabilities, but I think when you really boil it down it’s really no more difficult than understanding what goes on in the back corridor of the fiat and banking worlds of the common money we use everyday. Of course, the thing with Bitcoin as at present individuals are required to do most things individually understanding is imperative to access and usability as walking up to a teller window and begging for assistance and advice really ain’t possible in the crypto sphere. So with further ado, let’s dive in and see what a little time spent to understand can do.

As you can see then, Bitcoin is digital decentralized currency built for the masses. As with all forms of money, Bitcoins value resides in it’s ability to carry out transactions in a form of currency that is trusted to maintain it’s value. It is rather bizarre if you think about it, but government backed fiat legal tender actually at present is an inflationary store of value, meaning quite simply that as the amount of currency in circulation is increased, the buying power of that currency is decreased. In this way Bitcoin is one up on it’s paper competitors, as the supply of Bitcoin is set to a maximum of 21 million. This means that in addition to the properties that make commonly accepted currencies value hold, Bitcoin can add a fixed supply meaning that in actuality according to the principles of basic economics, as supply is not increasing the value should actually go up.

Bitcoin Technical Overview

For some understanding on how Bitcoin works in simple terms is good enough, but it’s always good to appease as many of the masses as possible. To that end then, the following video, albeit slightly dated, does an excellent job of furthering the quest to understand the how Bitcoin works in simple yet technical terms that non tech minded people usually have difficulties wrapping their minds around.

How Does a Bitcoin Transaction Work?

A Bitcoin transaction is the act of sending Bitcoin from one address to another. In thinking in terms of physical cash, one could say that a transaction takes place any time money changes hand preferably in return for goods and services. I’m not entirely sure that handing your child 10 dollars to go to the corner store would fall under the definition of transaction, but realistically speaking albeit in a cold heartless way, it does. Transitioning that concept into the digital world then, a transaction would be every time the movement of money changes the central ledger attached to it. So although it is obvious that making a visa or debit card that comes out of your account alters the digital ledger and is considered a transaction, it might not be so common to think of a wire transfer from one account owned by yourself to another account under your name as such even though it actually is.

From a practical point of view, sending a Bitcoin transaction is pretty straight forward. Essentially what is involved is copying in an address, pushing the transaction to the blockchain, and waiting the required amount of time for the miners to approve the transaction for it to be reflected in the Bitcoin ledger. Despite the fact that this seems like a lot of steps, once everything is set up it’s really as simple as copy and paste or scan of a QR code to send.

Of course with something as complicated as Bitcoin, from the inside it really is not that simple. When it comes to Bitcoin technology as compared to centralized transaction ledgers that pre-existed it there are few things that set Bitcoin apart.

So, at the risk of being called out for providing information that is a little too dumbed down, here is a slightly albeit still simple more detailed infographic explaining the process of a Bitcoin transactions and how they work in slightly more detail.

And just in case anyone out there prefers to listen as opposed to read, here is a great explanation on the more technical yet simplified process of how Bitcoin transactions work by the one and only Naomi Brockwell. (On a side note, although the video below has been set to start at the point that concerns us in this piece, the entire video is well worth a watch for very different but equally valid merits).

And now that we have the basics of Bitcoin how does it work down, let’s take a step back and walk through the process of how to initially get set up with Bitcoin should you not already be familiar.

Getting Started with Bitcoin

The first thing you will need to do in order to get started with Bitcoin is to get some Bitcoin. There are actually many ways to do this, but by far the easiest is to buy Bitcoin on an exchange.

How Does a Bitcoin Exchange Work? In simplified terms, “A cryptocurrency exchange or a digital currency exchange (DCE) is a business that allows customers to trade cryptocurrencies or digital currencies for other assets, such as conventional fiat money or other digital currencies” (Everipedia). Now being Bitcoin is the big daddy of all cryptocurrencies, just about every exchange will have Bitcoin or BTC pairings. That said, not all exchanges will allow for the ability to purchase Bitcoin with fiat currency either directly or through gateway means such as credit, debit cards, and bank account transfers. If you are unfamiliar with this please check out the following articles which should help you become familiar on how to go about purchasing Bitcoin on some of the best known and most trusted exchanges.

Essentially then, a Bitcoin exchange is likely the most common way to get your hands on some Bitcoin or trade some Bitcoin for fiat or other cryptocurrencies. As far as Bitcoin exchange working basics, funds are transferred onto the exchange, a buy or sell order is placed at a desired price, the order is either triggered right away (if buying at market price) or goes into the order book and waits to be met by someone on the opposite side of the trade. It is completely dependent upon the one placing the order what specifics the order will have and at what price. As defining the detailed parameters of how Bitcoin words technical analysis and trading wise is a gigantic topic in and of itself and far beyond the scope of what is necessary in this specific post, hopefully the above explanation will suffice for the time being.

Other Ways to Get Bitcoins. Of course there are other ways to get Bitcoins beyond the centralized exchanges, and although be it slightly more intimidating for first time users, buying Bitcoin from a friend or colleague, using a Bitcoin ATM, or paying for Bitcoin with PayPal are also very valid options for those that want to take a slightly less beaten path.

And for those that really want to go above and beyond, there is always Bitcoin mining. This can be done either by investing in mining hardware or joining mining operations through collective mining pools. For those that are curious about how long to mine Bitcoin to make it worthwhile, the overall process, and the hardware needed to get set-up, Bitcoin Mining Hardware gives a great general overview well worth checking out for foray into the subject.

Getting Your Bitcoin Off Exchange. Once you have purchased Bitcoin or any other cryptocurrency for that matter on exchange, it is highly recommended that you transfer your funds to a private wallet address. The main reason behind this is that when your Bitcoin or other cryptocurrencies are stored in an exchange wallet you do not control the private keys. Although the exchange may be reputable, exchange hacks and exit scams do happen which will in most cases leave you without your funds. Unlike banks that do insure your funds in their possession, most crypto exchanges do not. Essentially then, it’s always best in crypto to learn how to manage your assets yourself to minimize the chances of something going wrong even for the most reputable of exchanges, no matter how slim. Furthermore, if purchasing Bitcoin from another person or a Bitcoin ATM you will need a place to store it. To get you on your way with understanding information regarding a Bitcoin wallet and how it works to secure your crypto under your own private keys, as well as the basics of sending your crypto from various Bitcoin wallets, the following articles will help you on your way to both choose a wallet and guide you through the more specific personalized details of sending transactions as they pertain to the user like you.

How Does Investing in Bitcoin Work?

“When people invest in Bitcoin, it usually means that they are buying Bitcoin for the long term. In other words, they believe that the price will ultimately rise, regardless of the ups and down that occur along the way. Usually, people invest in Bitcoin because they believe in the technology, ideology, or team behind the currency. Bitcoin investors tend to HODL the currency for the long run (HODL is a popular term in the Bitcoin community that was actually born out of a typo of the word “hold”—in an old 2013 post in the BitcoinTalk forum)” (source).

How to Invest In Bitcoin?

Essentially then, investing in Bitcoin is simply to buy Bitcoin and keep it for a set amount of time. Before you begin however, it is best to have a strategy that you can stick too to maximize the potential of how does investing in Bitcoin work specifically for you. This will ensure you do not panic when the price fluctuates rapidly and end up buying overpriced Bitcoin or selling prematurely at a loss. It is actually quite common to for investors to make mistakes typically made by traders. Bitcoin investing and Bitcoin trading are not the same thing, but more on that later. When it comes to investing it is important to remember that you are in it for the long haul and short term price action will be but a blip on the screen if you truly believe that Bitcoin will be a solid investment.

For those wishing to only invest, the best strategy seems to be DCA, or Dollar Cost Averaging. Simply stated, this involves putting a set amount of money into the market on a set time frame schedule. So maybe on the last day of every month, no matter what the price of Bitcoin should be, you purchase a certain fiat amount of Bitcoin and leave it for a pre-designated amount of time. This takes emotion out of the mix and means all you have to do is simply stick to the plan. For example, buy 100 dollars of Bitcoin on the 1st of every month and hodl it for 10 years.

That is not to say that you cannot also trade or play the markets, but do this with a different account if you want to be an investor. You don’t have to be an investor or a trader, you can be both of course, but you should keep your investing account and trading account separate and manage them differently according to your predefined goals.

How Bitcoin Trading Works

Unlike Bitcoin investors that tend to buy Bitcoin and hold it for the long term profit potential, those trading Bitcoin buy and sell over the shorter periods with the prime objective of turning a profit. There are many trading strategies that can be adopted depending upon individual preferences, time availability, profit motive, and emotional stability. Some of the most common strategies for trading are scalping, range trading, day trading, swing trading, position trading, arbitrage, and let us not forget buying high and selling low. And no, that wasn’t a typo – but unfortunately that is a trap a lot of people have fallen into. Whatever you decide to do is up to you, but please come up with a game plan that fits your time schedule and emotional character. And as I mentioned previously, even if you want to be a trader, it’s likely a good idea to hodl some Bitcoin beyond that account knowing full well that no matter how much you lose trading, knock on wood, that those funds will never be allocated to ‘make the money you lost in that bad trade back’. For that I reckon is a surefire way to leave this crypto space completely rekt. For a more comprehensive review of Bitcoin trading strategies, recommended exchanges, and traders to follow in an effort to better understand and hone your skills, please check out my previous post How to Trade Bitcoin: A Not So Brief Nor Overtly Technical Overview.

And that then brings this not so brief introduction on Bitcoin and how it works to a close. Of course the rabbit hole of Bitcoin and cryptocurrencies pretty much goes as deep as you are willing an wanting to pursue, but it is my hope that this piece was able to somewhat bridge the gap between the overtly technical and minimalistic dumbed down explanations often polarizing the space. As always, let me know what you think in the comments below, and thanks so much for taking the time to drop on by and giving this article a read. Until that time whence we shall have the pleasure again, take care and happy trails on all your journeys in both crypto and beyond.

Your trybalist in informative arms, Jimmy D

Cover Image Source: dreamtime.com stock images

**Please note: Although I have to the best of my ability done my due diligence in researching this piece, I am not a financial advisor and assume no responsibility for any losses incurred on the readers part for any investments or products supported obtained from this post. Please understand that it is the readers responsibility to look after and maintain their own finances and perform all due diligence on their own part for their personal and financial well being and safety and not rely on myself or others in this space to keep them safe. In addition, although I have done my best to only include what appear to be legitimate sources and projects, due to the sheer volume and scope of projects in this post, unfortunately I have not personally had either the time or the resources available to verify the validity of all the projects mentioned, so please do be sure the do your due diligence before embarking on using or sending money to any of the above projects or companies.

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