Bitcoin and other cryptocurrencies have gained worldwide fame and attracted the attention of even those who were initially far from the cryptocurrency market. Now the BTC rate is reported in the news reports along with the quotes of the usual securities on the stock exchange. The success stories about buying bitcoin and successfully reselling it with a yield of hundreds of percent add fuel to the fire.
The thirst for a quick buck pushes beginners to buy cryptocurrency. However, before investing money, you need to know at least the basics of the digital money market. In this article, we will try to explain in simple terms what bitcoin is, how it works, and what investor income is based on.
What is bitcoin
Bitcoin, abbreviated BTC, is a user payment system that resembles ordinary digital wallets or a bank account. The “currency” for transactions is bitcoin. BTC, along with other cryptocurrencies, is not associated with any state economy and is not regulated by any Central Bank, Treasury, or Ministry of Finance. In other words, the issuance of BTC is not controlled by government agencies, unlike standard money.
Even though cryptocurrencies have gained wide popularity quite recently, bitcoin appeared back in 2008. Satoshi Nakamoto and Hal Finney invented it. A year later, the system was up and running. Initially, the meaning of bitcoin was the protest against fiat money, the centralization of the economic system as a whole, and the binding of financial resources to a single state.
Fiat currency is traditional money issued and controlled by the state, such as rubles and dollars.
As a result, the concept of independent money found its supporters. The turnover of BTC and its scope has increased mainly for paying for services and goods on the Internet. At the same time, the bitcoins rose in price, which attracted the attention of investors.
How bitcoin works
To understand the essence of BTC, you need to study the very principle of the blockchain system and its transactions and the idea of digital wallets. We’ll try to explain the essential points briefly.
A cryptocurrency wallet is set up like a standard bank account. We all keep our money on it. However, a BTC wallet is created using special programs and websites and is not registered with a bank. After registration, the wallet owner is given a public key and a private key. The first is the account number where the bitcoins come to (and are debited from), and the second is the password for managing the wallet’s contents.
It is possible to exchange bitcoins between wallets as with regular payment transactions. All transactions are transferred to a single pool, which other users in the blockchain network process. The operation must be confirmed, for which separate payment is charged.
In addition to buying BTC, it is allowed to extract it. This process is called mining, and the people doing it are called miners. For mining, powerful computer equipment is used. The computing power of users is used to maintain the overall network. For this, they get a reward in bitcoins. Thus, the miners are involved in creating new blocks for the blockchain and the processing of payments.
Blockchain is literally what it sounds like “a chain of blocks”. Each block stores information about all transactions for the entire network operation. Independent servers support the function of the blocks. If one of the servers fails, the network will remain operational.
Ultimately, the value of bitcoin depends on the number of miners, users, turnover on the exchange, and market sentiment. User trust also plays an important role. For this reason, by the way, some analysts consider BTC a new financial bubble. Developed countries have not yet determined the status of cryptocurrencies, and new laws in this area create additional volatility.
Important! From a technical point of view, the Bitcoin system is one of the most reliable. The more users participate in mining and are present in the network, the more difficult it is to hack from outside. At the same time, this factor does not apply to the exchange where BTC is traded.
Pros and cons of bitcoins
It’s logical to wonder, what is good about bitcoin as a digital currency? Why do we need digital money at all? The investment attractiveness of the first cryptocurrency consists of several points.
Benefits of Bitcoin
The network participants themselves issue the Bitcoin currency. They also process payments. As a result, the cryptocurrency does not have a single governing body. At the same time, each user has the opportunity to take part in the additional emission of BTC. The only limitation is the high demands of computing equipment.
Another advantage is the network safety and security level. In the creation of new blocks, the proof-of-work method is used. The method itself is demanding on the equipment of the miner. Security is maintained by the number of machines on the network. Given their decentralized nature, attacking the network is borderline impossible.
Bitcoin is not tied to a specific economy or country. Accordingly, it does not have restrictions on transfers and additional payments imposed by the system of a particular state. The international transactions are made instantly, and the fee is minimal. There is no need to pay for the work and services of any brokers.
Note! Low fees are often singled out as a distinct advantage. The fee amount is set independently by user. The higher the commission, the faster the transaction will be made.
Disadvantages of Bitcoin
Like any other financial instrument, Bitcoin has its drawbacks. For example, high volatility. Bitcoin quotes change almost daily. They are influenced by laws, new restrictions and bans on digital money in different countries, the rise and fall of the stock market, public statements, and other factors. BTC is sensitive to changes in the real world, so it is extremely difficult to predict its movement.
BTC Volatility for 2021
High volatility creates high market risk. It is easier to incur losses from investments in “crypto” than in the stock market. Moreover, it is necessary to store the private key securely and thoroughly select the exchange or website for registering the wallet. Cryptocurrency wallets are not insured in any way, and no one guarantees that the trading platform will compensate for losses if it is hacked.
The development of digital money has spurred Internet fraud. Fake websites and wallets are created that steal all funds and disappear. Due to the lack of state official services, the Bitcoin payment system is supported by the private business only.
The difference between BTC and other cryptocurrencies and regular money
Why does Bitcoin have its value against the background of fiat money or other cryptocurrencies? When did the dollar and the euro lose part of their investment? Why haven’t other digital currencies received the same attention? Let’s take a detailed look at this.
Fiat money differences
Ordinary wallets allow you to conduct transactions only with standard currencies, be it the dollar, rubles, euros, etc. It is possible to withdraw them to bank accounts and pay for purchases.
Often, to use standard wallets and bank accounts, you need to verify your identity. For example, provide passport data, phone numbers, and other information. Often, copies of documents need to be uploaded to the network of a bank or other intermediary.
Sometimes this procedure is needed to increase the transfer limit.
The centralized system handles all transactions. In case of system failure or fraud, the client has the opportunity to contact the support service, office, or other representatives of the service company.
Differences between BTC and fiat money
Let’s highlight some of the main differences between bitcoins and standard money. The cost of BTC is formed exclusively on the market by the network participants themselves. The bitcoin currency is not backed by gold, securities, raw materials, and key rates of Central banks.
Cryptocurrency wallets are anonymous. You do not need to upload documents and provide personal data for registration. Moreover, there are no limits on the number of bitcoins and transactions on the accounts themselves. Also, they often allow to also store regular money.
Payment transactions are processed using the computing power of miners and other network participants. At the same time, a refund is not possible if there is an erroneous transaction. There is no support service. The users themselves bear all responsibility for their actions.
Differences between BTC and other cryptocurrencies
Bitcoin is the first cryptocurrency in the world that has found success among users. All other digital money emerged after it, often even on a BTC basis. They are considered derivatives and are far behind in value. For example, the next most popular Ethereum, Bitcoin Cash and Litecoin, are several times cheaper.
The main difference lies in the structure of the network system, operation algorithms, information encryption methods, payment processing speed, and block sizes. As a rule, this is secondary information for an investor who generates income on the resale of cryptocurrencies.
Risks of investing in Bitcoin
Stories about the purchase of cryptocurrency and incredible gainings periodically flash in the media. However, no one talks about those who suffered losses or lost all the money invested. Let’s talk about the risks that crypto investors face.
As we have already noted, Bitcoin is characterized by volatility. Its value can move up and down by 10-15% every day. Such volatility is an excellent opportunity to make money on speculation, but by no means is it possible to predict a reversal trend or correction consistently.
Another critical aspect is laws and regulations. States have not yet come to a consensus on the status of Bitcoin and other cryptocurrencies. It means that it can be banned. Restrictions tend to harm its cost. If the new restrictions concern you, you will have to sell assets or transfer them to foreign platforms. Also, in the case of bitcoin banning, questions about the legitimacy of the gaining arise.
In many countries you must independently declare all income for which tax has not been paid at the Tax Inspectorate. In addition, transfers of large amounts will cause suspicion on the part of the bank, and it could block the transaction. Moreover, the tax office has the right to demand an explanation of the money’s origin. If tax evasion is discovered, it is fraught with a criminal case.
Without legal status, there is no regulation. When trading classic stock instruments, the procedure is transparent. Each stage is controlled by law, and all exchange participants have a license from the main regulator, the National Bank. Crypto exchanges are not subject to anyone as their status is not fully defined. Hence a large number of scammers.
Important! The anonymity of payments and the lack of identity verification allow for illegal financial activities. For example, money laundering or the purchase of prohibited goods. It is one of the reasons for the uncertain status of BTC.
How do you make money buying bitcoins?
The ways of earning on the crypto exchange are the same as in the stock market. These are long-term investments, speculation, arbitrage, and also mining. The latter is an exclusive privilege of cryptocurrency.
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Can I sell bitcoin on a regular exchange?
No, cryptocurrencies are only traded on crypto exchanges. Bitcoins do not have an approved status, so they are not allowed to trade.
Is it legal to mine and store bitcoin?
The law does not prohibit mining cryptocurrency. It is forbidden to use it to receive and pay for goods and services.