Bitcoin, and more broadly cryptocurrencies, are seeing increasing news coverage. This has left many wondering: “What is bitcoin and how does it work?” For those trying to better understand bitcoin and cryptocurrencies, here’s our understanding on a handful of frequently asked questions:
What is bitcoin?
Bitcoin is a digital “currency” that can be used to purchase goods and services (only at select locations, for now), or held as a store of speculative value. There are many differences between bitcoin and traditional currency, but the principal difference is that bitcoin is not issued by a government or regulated by a government entity.
Where did bitcoin come from?
This is where it gets a bit mysterious. Bitcoin was created by “Satoshi Nakamoto”, an unknown individual or group of individuals. Under this pseudonym a white paper was circulated in 2008 that first described the concept for a transparent, visible peer-to-peer payment system authenticated by a vast network that does not require the presence of a third party middleman – such as banks or other financial institutions. By combining cryptography and unique software protocols, Satoshi Nakamoto originated a payment system that allowed participants to transact directly with one another.
How is it possible to make currency transactions without banks?
Bitcoin transactions have been made possible with the encryption technology underpinning cryptocurrencies known as “blockchain.” Blockchain is a global Internet-wide distributed network that is at its core a decentralized accounting ledger recording every bitcoin transaction. The blockchain ledger is shared by way of an extensive network and the information therein is validated by network “miners” every ten minutes by solving mathematical puzzles using very fast computers and high amounts of electricity. This network validated ledger is crucial as it ascribes proof of ownership to digital assets like bitcoin. If the ledger proves ownership, participants can have trust when making transactions.
Tying together the concept of bitcoin and blockchain, think of it this way – the bitcoin “coins” themselves are simply seats within the aforementioned blockchain ledger. Anyone can buy into or sell out of this ledger at any time – with no prior consent, and with little-to-no fees. Therefore, when buying a bitcoin you are essentially acquiring one of a number of fixed slots within this ledger. You leave the ledger by selling your bitcoin to someone else who wishes to buy in.
If I want to buy bitcoin, how would I make a purchase? Do I need to buy a whole coin?
There are many exchanges out there that allow participants to deposit US dollars (or other widely accepted global currencies) directly from traditional bank accounts in exchange for bitcoin. Some cryptocurrency exchanges also have mobile apps allowing participants to buy bitcoin anytime, anywhere.
Additionally, participants need not buy a whole bitcoin to participate. The smallest unit of bitcoin, a “satoshi”, is the size of one hundred millionth of a single bitcoin (0.00000001 BTC).
What are the risks to purchasing and holding bitcoin? The current price seems high!
It depends on the type of risk one is referring to. Let’s start with general cybersecurity threats. Cryptocurrency exchanges, including those which trade bitcoin, have been hacked before, and will likely be hacked again. Perhaps the most notable example was in 2014 when “Mt. Gox”, the largest bitcoin exchange at the time, failed as a direct result of hackers and vast bitcoin theft. Security surrounding cryptocurrency exchanges have notably improved since Mt. Gox’s failure. Individuals can use bitcoin digital wallets and vaults that are encrypted with a secure network key which dramatically reduces the possibility of being hacked.
Another key risk worth touching on is the possibility of loss of capital for those speculating on its price. Bitcoin has experienced a monumental run as of late. There are a variety of opinions and market variables as to why this has occurred. Will this price rally continue, or crash? Nobody knows for sure. However one way to think about it is, by design, bitcoin was given a finite supply – determined at inception to be 21,000,000 bitcoins – and we are now seeing growing awareness leading to rising demand. This basic supply / demand dynamic may help describe, at least at some level, recent price moves in bitcoin. That being said, just because more cryptocurrency enthusiasts are now entering the market seemingly pushing up prices does not mean everyone should take a position. With a greater understanding of bitcoin – both its potential opportunities and risks – paired with careful holistic wealth advice, more educated decision making can be made on potential bitcoin / cryptocurrency participation.
We hope that this FAQ provides a helpful introduction to bitcoin / cryptocurrencies, and perhaps even sparks your desire to want to learn more. The investment team at Albion Financial Group is well versed in bitcoin / cryptocurrencies and blockchain technology. Please reach out to us at 801-487-3700 or info@albionfinancial.com if we can answer your bitcoin, investment, or financial planning questions.
Disclaimer: Information provided is for educational purposes only. This is not a recommendation to buy or sell any security or cryptocurrency. There are significant risks associated with cryptocurrency that are unique and must not be taken lightly. It is critical that you perform your own due diligence prior to engaging in any buy or sell transaction. The value of bitcoin, or any cryptocurrency can, and may, ultimately go to zero.