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Bitcoin 101

Chapter 01

What is Bitcoin?

Last updated: 26th January 2020

To cut through some of the confusion surrounding bitcoin, we need to separate it into two components. On the one hand, you have bitcoin-the-token, a snippet of code that represents ownership of a digital concept – sort of like a virtual IOU. On the other hand, you have bitcoin-the-protocol, a distributed network that maintains a ledger of balances of bitcoin-the-token. Both are referred to as “bitcoin.”

The system enables payments to be sent between users without passing through a central authority, such as a bank or payment gateway. It is created and held electronically. Bitcoins aren’t printed, like dollars or euros – they’re produced by computers all around the world, using free software.

It was the first example of what we today call cryptocurrencies, a growing asset class that shares some characteristics of traditional currencies, with verification based on cryptography.

Who created it?

A pseudonymous software developer going by the name of Satoshi Nakamoto proposed bitcoin in 2008, as an electronic payment system based on mathematical proof. The idea was to produce a means of exchange, independent of any central authority, that could be transferred electronically in a secure, verifiable and immutable way.

To this day, no-one knows who Satoshi Nakamoto really is.

In what ways is it different from traditional currencies?

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Bitcoin can be used to pay for things electronically, if both parties are willing. In that sense, it’s like conventional dollars, euros, or yen, which are also traded digitally.

But it differs from fiat digital currencies in several important ways:

1 – Decentralization

Bitcoin’s most important characteristic is that it is decentralized. No single institution controls the bitcoin network. It is maintained by a group of volunteer coders, and run by an open network of dedicated computers spread around the world. This attracts individuals and groups that are uncomfortable with the control that banks or government institutions have over their money.

Bitcoin solves the “double spending problem” of electronic currencies (in which digital assets can easily be copied and re-used) through an ingenious combination of cryptography and economic incentives. In electronic fiat currencies, this function is fulfilled by banks, which gives them control over the traditional system. With bitcoin, the integrity of the transactions is maintained by a distributed and open network, owned by no-one.

2 – Limited supply

Fiat currencies (dollars, euros, yen, etc.) have an unlimited supply – central banks can issue as many as they want, and can attempt to manipulate a currency’s value relative to others. Holders of the currency (and especially citizens with little alternative) bear the cost.

With bitcoin, on the other hand, the supply is tightly controlled by the underlying algorithm. A small number of new bitcoins trickle out every hour, and will continue to do so at a diminishing rate until a maximum of 21 million has been reached. This makes bitcoin more attractive as an asset – in theory, if demand grows and the supply remains the same, the value will increase.

3 – Pseudonymity

While senders of traditional electronic payments are usually identified (for verification purposes, and to comply with anti-money laundering and other legislation), users of bitcoin in theory operate in semi-anonymity. Since there is no central “validator,” users do not need to identify themselves when sending bitcoin to another user. When a transaction request is submitted, the protocol checks all previous transactions to confirm that the sender has the necessary bitcoin as well as the authority to send them. The system does not need to know his or her identity.

In practice, each user is identified by the address of his or her wallet. Transactions can, with some effort, be tracked this way. Also, law enforcement has developed methods to identify users if necessary.

Furthermore, most exchanges are required by law to perform identity checks on their customers before they are allowed to buy or sell bitcoin, facilitating another way that bitcoin usage can be tracked. Since the network is transparent, the progress of a particular transaction is visible to all.

This makes bitcoin not an ideal currency for criminals, terrorists or money-launderers.

4 – Immutability

Bitcoin transactions cannot be reversed, unlike electronic fiat transactions.

This is because there is no central “adjudicator” that can say “ok, return the money.” If a transaction is recorded on the network, and if more than an hour has passed, it is impossible to modify.

While this may disquiet some, it does mean that any transaction on the bitcoin network cannot be tampered with.

5 – Divisibility

The smallest unit of a bitcoin is called a satoshi. It is one hundred millionth of a bitcoin (0.00000001) – at today’s prices, about one hundredth of a cent. This could conceivably enable microtransactions that traditional electronic money cannot.

Read more to find out how bitcoin transactions are processed and how bitcoins are mined, what it can be used for, as well as how you can buy, sell and store your bitcoin. We also explain a few alternatives to bitcoin, as well as how its underlying technology – the blockchain – works.

Authored by Noelle Acheson. Network image via Shutterstock.

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

Chapter 02

How Can I Buy Bitcoin?

Last updated: 26th January 2020

So you’ve learned the basics about bitcoin, you’re excited about the potential and now you want to buy some*. But how?

(*Please, never invest more than you can afford to lose – cryptocurrencies are volatile and the price could go down as well as up.)

Bitcoin can be bought on exchanges, or directly from other people via marketplaces.

You can pay for them in a variety of ways, ranging from hard cash to credit and debit cards to wire transfers, or even with other cryptocurrencies, depending on who you are buying them from and where you live.

1 – set up a wallet

The first step is to set up a wallet to store your bitcoin – you will need one, whatever your preferred method of purchase. This could be an online wallet (either part of an exchange platform, or via an independent provider), a desktop wallet, a mobile wallet or an offline one (such as a hardware device or a paper wallet).

Even within these categories of wallets there is a wide variety of services to choose from, so do some research before deciding on which version best suits your needs.

You can find more information on some of the wallets out there, as well as tips on how to use them, here and here.

The most important part of any wallet is keeping your keys (a string of characters) and/or passwords safe. If you lose them, you lose access to the bitcoin stored there.

BUYING ONLINE

2 – open an account at an exchange

Cryptocurrency exchanges will buy and sell bitcoin on your behalf. There are hundreds currently operating, with varying degrees of liquidity and security, and new ones continue to emerge while others end up closing down. As with wallets, it is advisable to do some research before choosing – you may be lucky enough to have several reputable exchanges to choose from, or your access may be limited to one or two, depending on your geographical area.

The largest bitcoin exchange in the world at the moment in terms of US$ volume is Bitfinex, although it is mainly aimed at spot traders. Other high-volume exchanges are Coinbase, Bitstamp and Poloniex, but for small amounts, most reputable exchanges should work well. (Note: at time of writing, the surge of interest in bitcoin trading is placing strain on most retail buy and sell operations, so a degree of patience and caution is recommended.)

With the clampdown on know-your-client (KYC) and anti-money-laundering (AML) regulation, many exchanges now require verified identification for account setup. This will usually include a photo of your official ID, and sometimes also a proof of address.

Most exchanges accept payment via bank transfer or credit card, and some are willing to work with Paypal transfers. And most exchanges charge fees (which generally include the fees for using the bitcoin network).

Each exchange has a different procedure for both setup and transaction, and should give you sufficient detail to be able to execute the purchase. If not, consider changing the service provider.

Once the exchange has received payment, it will purchase the corresponding amount of bitcoin on your behalf, and deposit them in an automatically generated wallet on the exchange. This can take minutes, or sometimes hours due to network bottlenecks. If you wish (recommended), you can then move the funds to your off-exchange wallet.

BUYING WITH CASH

2 – choose a purchase method

Platforms such as LocalBitcoins will help you to find individuals near you who are willing to exchange bitcoin for cash. Also, LibertyX lists retail outlets across the United States at which you can exchange cash for bitcoin. And WallofCoins, Paxful and BitQuick will direct you to a bank branch near you that will allow you to make a cash deposit and receive bitcoin a few hours later.

ATMs are machines that will send bitcoin to your wallet in exchange for cash. They operate in a similar way to bank ATMs – you feed in the bills, hold your wallet’s QR code up to a screen, and the corresponding amount of bitcoin are beamed to your account. Coinatmradar can help you to find a bitcoin ATM near you.

(Note: specific businesses mentioned here are not the only options available, and should not be taken as a recommendation.)

Authored by Noelle Acheson. Bitcoin image via Shutterstock.

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

Chapter 03

How to Store Your Bitcoin

Last updated: 20th January 2020

Before owning any bitcoin, you need somewhere to store them. That place is called a “wallet.” Rather than actually holding your bitcoin, it holds the private key that allows you to access your bitcoin address (which is also your public key). If the wallet software is well designed, it will look as if your bitcoins are actually there, which makes using bitcoin more convenient and intuitive.

Actually, a wallet usually holds several private keys, and many bitcoin investors have several wallets.

Wallets can either live on your computer and/or mobile device, on a physical storage gadget, or even on a piece of paper. Here we’ll briefly look at the different types.

Electronic wallets

Electronic wallets can be downloaded software, or hosted in the cloud. The former is simply a formatted file that lives on your computer or device, that facilitates transactions. Hosted (cloud-based) wallets tend to have a more user-friendly interface, but you will be trusting a third party with your private keys.

Software wallet

Installing a wallet directly on your computer gives you the security that you control your keys. Most have relatively easy configuration, and are free. The disadvantage is that they do require more maintenance in the form of backups. If your computer gets stolen or corrupted and your private keys are not also stored elsewhere, you lose your bitcoin.

They also require greater security precautions. If your computer is hacked and the thief gets a hold of your wallet or your private keys, he also gets hold of your bitcoin.

The original software wallet is the Bitcoin Core protocol, the program that runs the bitcoin network. You can download this here (it doesn’t mean that you have to become a fully operational node), but you’d also have to download the ledger of all transactions since the dawn of bitcoin time (2009). As you can guess, this takes up a lot of memory – at time of writing, over 145GB.

Most wallets in use today are “light” wallets, or SPV (Simplified Payment Verification) wallets, which do not download the entire ledger but sync to the real thing. Electrum is a well-known SPV desktop bitcoin wallet that also offers “cold storage” (a totally offline option for additional security). Exodus can track multiple assets with a sophisticated user interface. Some (such as Jaxx) can hold a wide range of digital assets, and some (such as Copay) offer the possibility of shared accounts.

Online wallet

Online (or cloud-based) wallets offer increased convenience – you can generally access your bitcoin from any device if you have the right passwords. All are easy to set up, come with desktop and mobile apps which make it easy to spend and receive bitcoin, and most are free.

The disadvantage is the lower security. With your private keys stored in the cloud, you have to trust the host’s security measures, and that it won’t disappear with your money, or close down and deny you access.

Some leading online wallets are attached to exchanges (such as Coinbase and Blockchain). Some offer additional security features such as offline storage (Coinbase and Xapo).

Mobile wallets

Mobile wallets are available as apps for your smartphone, especially useful if you want to pay for something in bitcoin in a shop, or if you want to buy, sell or send while on the move. All of the online wallets and most of the desktop ones mentioned above have mobile versions, while others – such as Abra, Airbitz and Bread – were created with mobile in mind.

Hardware wallets

Hardware wallets are small devices that occasionally connect to the web to enact bitcoin transactions. They are extremely secure, as they are generally offline and therefore not hackable. They can be stolen or lost, however, along with the bitcoins that belong to the stored private keys. Some large investors keep their hardware wallets in secure locations such as bank vaults. Trezor, Keepkey and Ledger and Case are notable examples.

Paper wallets

Perhaps the simplest of all the wallets, these are pieces of paper on which the private and public keys of a bitcoin address are printed. Ideal for the long-term storage of bitcoin (away from fire and water, obviously), or for the giving of bitcoin as a gift, these wallets are more secure in that they’re not connected to a network. They are, however, easier to lose.

With services such as WalletGenerator, you can easily create a new address and print the wallet on your printer. Fold, seal and you’re set. Send some bitcoin to that address, and then store it safely or give it away. (See our tutorial on paper wallets here.)

Are bitcoin wallets safe?

That depends on the version and format you have chosen, and how you use them.

The safest option is a hardware wallet which you keep offline, in a secure place. That way there is no risk that your account can be hacked, your keys stolen and your bitcoin whisked away. But, if you lose the wallet, your bitcoin are gone, unless you have created a clone and/or kept reliable backups of the keys.

The least secure option is an online wallet, since the keys are held by a third party. It also happens to be the easiest to set up and use, presenting you with an all-too-familiar choice: convenience vs safety.

Many serious bitcoin investors use a hybrid approach: they hold a core, long-term amount of bitcoin offline, while having a “spending balance” for liquidity in a mobile account. Your choice will depend on your bitcoin strategy, and your willingness to get “technical.”

Whatever option you go for, please be careful. Back up everything, and only tell your nearest and dearest where your backups are stored.

For more information on how to buy bitcoin, see here. And for some examples of what you can spend it on, see here.

(Note: specific businesses mentioned here are not the only options available, and should not be taken as a recommendation.)

Authored by Noelle Acheson. Wallet image via Shutterstock.

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

Chapter 04

How to Sell Bitcoin

Last Updated: 20th January 2020

These days virtually all the methods available to buy bitcoin also offer the option to sell.

The exception is bitcoin ATMs – some do allow you to exchange bitcoin for cash, but not all. Coinatmradar will guide you to bitcoin ATMs in your area.

All exchanges allow you to sell as well as buy. What type of exchange you choose to sell your bitcoin will depend on what type of holder you are: small investor, institutional holder or trader?

Some platforms such as GDAX and Gemini are aimed more at large orders from institutional investors and traders.

Retail clients can sell bitcoin at exchanges such as Coinbase, Kraken, Bitstamp, Poloniex, etc. Each exchange has a different interface, and some offer related services such as secure storage. Some require verified identification for all trades, while others are more relaxed if small amounts are involved.

(Of course, don’t forget to declare any profit you make on the sale to your relevant tax authority!)

You can, if you wish, exchange your bitcoin for other cryptoassets rather than for cash. Some exchanges such as ShapeShift focus on this service, allowing you to swap between bitcoin and ether, litecoin, XRP, dash and several others.

Another alternative is the direct sale. You can register as a seller on platforms such as LocalBitcoins, BitQuick, Bittylicious and BitBargain, and interested parties will contact you if they like your price. Transactions are usually done via deposits or wires to your bank account, after which you are expected to transfer the agreed amount of bitcoin to the specified address.

Or, you can sell directly to friends and family once they have a bitcoin wallet set up. Just send the bitcoin, collect the cash or mobile payment, and have a celebratory drink together. (Note: it is generally not a good idea to meet up with strangers to exchange bitcoin for cash in person. Be safe.)

(Note: specific businesses mentioned here are not the only options available, and should not be taken as a recommendation.)

Authored by Noelle Acheson. Graph image via Shutterstock.

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

Chapter 05

How do Bitcoin Transactions Work?

Last updated: 29th January 2020

If I want to send some of my bitcoin to you, I publish my intention and the nodes scan the entire bitcoin network to validate that I 1) have the bitcoin that I want to send, and 2) haven’t already sent it to someone else. Once that information is confirmed, my transaction gets included in a “block” which gets attached to the previous block – hence the term “blockchain.” Transactions can’t be undone or tampered with, because it would mean re-doing all the blocks that came after.

Getting a bit more complicated:

My bitcoin wallet doesn’t actually hold my bitcoin. What it does is hold my bitcoin address, which keeps a record of all of my transactions, and therefore of my balance. This address – a long string of 34 letters and numbers – is also known as my “public key.” I don’t mind that the whole world can see this sequence. Each address/public key has a corresponding “private key” of 64 letters and numbers. This is private, and it’s crucial that I keep it secret and safe. The two keys are related, but there’s no way that you can figure out my private key from my public key.

That’s important, because any transaction I issue from my bitcoin address needs to be “signed” with my private key. To do that, I put both my private key and the transaction details (how many bitcoins I want to send, and to whom) into the bitcoin software on my computer or smartphone.

With this information, the program spits out a digital signature, which gets sent out to the network for validation.

This transaction can be validated – that is, it can be confirmed that I own the bitcoin that I am transferring to you, and that I haven’t already sent it to someone else – by plugging the signature and my public key (which everyone knows) into the bitcoin program. This is one of the genius parts of bitcoin: if the signature was made with the private key that corresponds to that public key, the program will validate the transaction, without knowing what the private key is. Very clever.

The network then confirms that I haven’t previously spent the bitcoin by running through my address history, which it can do because it knows my address (= my public key), and because all transactions are public on the bitcoin ledger.

Even more complicated:

Once my transaction has been validated, it gets included into a “block,” along with a bunch of other transactions.

A brief detour to discuss what a “hash” is, because it’s important for the next paragraph: a hash is produced by a “hash function,” which is a complex math equation that reduces any amount of text or data to 64-character string. It’s not random – every time you put in that particular data set through the hash function, you’ll get the same 64-character string. But if you change so much as a comma, you’ll get a completely different 64-character string. This whole article could be reduced to a hash, and unless I change, remove or add anything to the text, the same hash can be produced again and again. This is a very effective way to tell if something has been changed, and is how the blockchain can confirm that a transaction has not been tampered with.

Back to our blocks: each block includes, as part of its data, a hash of the previous block. That’s what makes it part of a chain, hence the term “blockchain.” So, if one small part of the previous block was tampered with, the current block’s hash would have to change (remember that one tiny change in the input of the hash function changes the output). So if you want to change something in the previous block, you also have to change something (= the hash) in the current block, because the one that is currently included is no longer correct. That’s very hard to do, especially since by the time you’ve reached half way, there’s probably another block on top of the current one. You’d then also have to change that one. And so on.

This is what makes Bitcoin virtually tamper-proof. I say virtually because it’s not impossible, just very very, very, very, very difficult and therefore unlikely.

And if you want to indulge in some mindless fascination, you can sit at your desk and watch bitcoin transactions float by. Blockchain.info is good for this, but if you want a hypnotically fun version, try BitBonkers.

(For more detail on how blocks are processed and on how bitcoin mining works, see this article.)

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

How to Buy Bitcoin

When it comes to some exotic investments like bitcoins, investors not only need to consider the worthiness of the investment, but how to even buy the digital currency in the first place.

This article was updated on December 1, 2020, and originally published on June 6, 2020.

Bitcoin is a digital cryptocurrency with no intermediaries or banks necessary to conduct transactions. It was designed as open-source software in 2009 by an individual or group known only as Satoshi Nakamoto with the intention to minimize transaction costs and deregulate currency. The cost of a bitcoin has skyrocketed this year. When the calendar rolled over to 2020, the price of one bitcoin was just a shade under $1,000. As I write, the price of bitcoin has skyrocketed to almost $7,500!

This huge increase in price has led some investors to not only some to wonder if they should invest in bitcoin, but even how to invest in bitcoin in the first place. After all, it’s not like they can purchase a bitcoin at their brokerage or bank. Heck, one can’t even buy a bitcoin at Amazon.com, and Amazon sells everything! With this question in mind, let’s look at some different ways investors can buy bitcoins or otherwise gain exposure to this unique asset class.

(If you’re still a little confused about what exactly a bitcoin is, here is an excellent primer on the unregulated virtual currency by fellow Fool Matthew Frankel).

There are several ways for investors to buy bitcoin. Image source: Getty Images.

What’s in your (bitcoin) wallet?

The most popular way to buy bitcoins is through bitcoin wallets, digital wallets for the exclusive use of bitcoins. There are many different types of bitcoin-based wallets and you need to be very careful to choose something that will best meet your needs. Some bitcoin wallets are device-specific, while others are web-based.

Coinbase is one of the most popular digital wallets used to purchase bitcoins. As with almost any of these wallets, customers must sign up for an account online and then link a bank account. If they just want to buy, a valid credit card number will do. Coinbase accepts Mastercard and Visa. Before any bitcoin transaction, Coinbase shows users the current value of the digital currency in U.S. dollars. When making a withdrawal from a Coinbase account, account holders can choose to have the funds go to either a linked bank or PayPal account.

Since third-party cryptocurrency wallets have been famously known to be hacked resulting in a permanent loss of funds, investors must be careful to properly secure their bitcoin wallets. Remember, bitcoins are not stored in FDIC-insured accounts and most third parties do not offer insurance in case of theft or fraud. How bad is this problem? Last August, Reuters reported that a full third of bitcoin exchanges had been breached.

Security is vitally important in keeping bitcoin accounts safe. Back-ups are critical in cases of computer crashes or stolen wallets. Wallets must be encrypted so anyone withdrawing bitcoins from your account must know a password. Whatever you do, don’t forget your password! Many wallets offer two-factor authentication, where a unique code is texted or emailed to you before withdrawals can be made. Bitcoin passwords are also critical as, unlike bank accounts, there is no customer service line to reset your password. Bitcoin.org recommends either memorizing the password or writing it down and storing it in a safe place.

Alternative ways to purchase bitcoins

There are other ways to purchase bitcoins; some more exotic than others. Bitcoin Depot, in conjunction with the bitcoin wallet Airbitz, allows users to buy bitcoins with cash at dozens of special ATM locations spread across six states: Alabama, Florida, Georgia, Massachusetts, Tennessee, and Texas. After setting up an account, all customers need to do is deposit cash in the ATM and scan a QR code with a special scanner attached to the ATM and, within minutes, the purchased bitcoins will be available in the Airbitz account.

The bitcoin-based ETF

The most convenient way to gain exposure to bitcoins is through the Bitcoin Investment Trust (OTC:GBTC) . This fund was created so that buying bitcoins could be as easy as buying any stock or ETF share. All people have to do is buy shares through their regular broker using the ticker symbol. Each share represents about one-tenth of a bitcoin. But, as fellow Fool Jordan Wathen has pointed out, this convenience comes at a steep cost. According to his calculations, a share often costs more than the value of the underlying bitcoin.

As with any security, one should do their due diligence before buying bitcoins. Not only on its worthiness as an investment, but on the right exchange platform that best meets your security and convenience needs.

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