What is bitcoin and how does it work?
Bitcoin is a virtual digital currency, it is secured by a cryptographic protocol and it is not controlled by any central authority. Created in 2009 by an individual under the pseudonym Satoshi Nakamoto, it was initially conceived as a method of payment that would not be subject to government oversight, with no transaction fees or transfer delays, unlike traditional fiat currency.
In 2010, one bitcoin was priced at about 0.003 cents. By October 2017, its price had surpassed $4,200. During this period, hundreds of crypto-currencies have emerged, each with unique characteristics and applications. Few of them have significant value. Bitcoin does have some rivals, however, such as ether, bitcoin cash and to a lesser extent litecoin, ripple and dash.
Currency or commodity?
Bitcoin was originally conceived as a payment method, and in some cases functions as such. But it is currently far too volatile and not widely enough used to become a real alternative to fiat currencies: merchants would have to adjust their prices every day to keep up with price changes.
This means that Bitcoin is mainly used as an investment, more like gold and other precious metals than traditional currencies. Like commodities, its value is not influenced by the performance of any particular economy, and it is not affected by monetary policies.
Please note that while bitcoin is not affected by many of the factors that influence traditional currencies, there are a number of factors that it does face.
How does bitcoin work?
Bitcoin needs two underlying mechanisms to work: the blockchain and mining.
The blockchain is a distributed database that contains all the bitcoin transactions that have been made so far. These transactions are grouped into “blocks” which are cryptographically secured during the mining phase and linked together.
Mining is the process by which blocks are secured, after which new units of crypto-currency are released. These units are called “rewards”. For bitcoin, the reward currently stands at 12.5 bitcoins, but it decreases by half every four years or so.
The responsibility of miners is verifying transactions and securing them cryptographically by solving complex algorithms. Their difficulty can be adjusted to keep block processing time roughly constant. Miners have significant control over Bitcoin because of their crucial role in the network, especially since mining is now a very profitable business.
Once these units are in circulation, they can be freely traded on an exchange and stored in a virtual wallet. When you trade Bitcoins with IG, you never own the security, so you don’t need to own a wallet or a securities account.
How is bitcoin used?
As a means of payment
A number of companies already accept bitcoin as a payment method, although they are still very much in the minority. These include, for example:
Obviously, these big names have the infrastructure to handle crypto-currencies. But given the uncertainty of its regulation and the volatility of the market, it’s not surprising that bitcoin integration hasn’t become more mainstream.
As a technology foundation
Many companies are looking past the currency itself and into the decentralized database at the heart of bitcoin.
The technology behind the blockchain has already enabled a series of new business models in the areas of international payments, web development and data protection. In addition, several funds are looking to invest in projects that harness the potential of blockchain, sparking interest in crypto-currencies in international financial centers.
Is bitcoin regulated?
No, bitcoin is not currently regulated by either governments or central banks. One of the main concerns about the future of bitcoin is the inability to know how the regulatory landscape will change over the next few years, and how it will impact the value of the investment.
U.S. regulators have taken the lead in regulating bitcoin and its exchanges, although many disagreements still remain.
Is bitcoin risky?
Trading involves risk regardless of the security you choose, but bitcoin is even riskier because :
it is volatile: sudden, sharp price movements can lose hundreds or even thousands of dollars very quickly.
it’s niche: although bitcoin’s popularity has skyrocketed recently, most businesses and consumers are still a long way from seriously adopting it
transfers are not foolproof: there is no ideal way to protect against human error, technical glitches or fraud, and there is no system in place to pay back your losses.
Its future remains uncertain: over the next few years, governments and central banks will continue to scrutinize crypto-currencies. New regulations could reduce the advantages that distinguish them from fiat currencies.