How Bitcoin Works

Bitcoin is a form of virtual currency designed to create a true global economy. It’s the wave of the future, although the basic workings of this payment system are still a mystery to most. This article is meant to remedy that situation, providing a basic understanding of how Bitcoin works and the positives and negatives most often associated with it.

How Does Bitcoin Work?

For most users, Bitcoin works like a digital wallet that allows units of currency known as bitcoins to be sent and received. Customers can turn their cash into bitcoins at an online exchange, although turning bitcoins back into cash (known as “selling”) requires you to find someone willing to trade real-life currency for bitcoins.

In order to send bitcoins to someone else, you’ll need their unique address. Once you have this information, you simply access your wallet application, enter the amount you want to transfer, and press the send button.

Every transaction ever processed on Bitcoin is recorded in a public ledger known as a “block chain.” These transactions can be viewed by anyone on the peer-to-peer computer network.

Complex number-crunching tasks known as “Bitcoin mining” are required to process transactions securely and ensure that someone isn’t trying to send the same unit of currency to multiple people. These functions are performed by other users, and they are rewarded with additional bitcoins for their efforts. This is the only way that new coins are created from scratch within the system, and it’s designed to become more difficult as the network expands.

That’s all there is to it. Now let’s review:

  1. Enter the address of the person you want to send bitcoins to, as well as the amount.
  2. Press send.
  3. The transaction is added to the block chain, and bitcoin miners confirm that the transaction is legitimate.
  4. In exchange for their services, the miner may receive a small number of bitcoins. Meanwhile, the transaction is processed and the virtual currency is sent to its intended recipient.

Advantages of Bitcoin

If you’re still sitting the fence on whether or not to use Bitcoin, here are a few reasons why you might want to give it a try:

You’re in Control – With other payment methods, it’s possible for merchants to add hidden charges without the customer being aware. This can’t happen with Bitcoin, and payments can also be made anonymously without divulging a lot of personal information. There’s also the added bonus of top-flight security, as Bitcoin uses encryptions and backups to make your transactions as safe as possible.

Absolute Freedom – Banks are closed on holidays, and transferring money from one country to another can often be an exercise in frustration. Neither of these problems is an issue when you use Bitcoin, as customers can send and receive virtual currency every second of every day with no restrictions.

The Power of Transparency – Want to know more about the Bitcoin money supply? All information is right there in the block chain for everyone to see, and their cryptographically secure system makes certain that nobody can manipulate the protocol.

Safer for Merchants – Online merchants can use Bitcoin without worrying about being privy to the sensitive data of their customers. This cuts down on the risk of fraud, and it also allows businesses to bypass credit cards and their various geographical restrictions. The overall cost is less, and it instantly gives you access to every part of the world where Internet access is available.

Cheaper than the Competition – Credit card companies and payment processors such as PayPal make a fortune by charging a small percentage on all the transactions they help facilitate. Most Bitcoin payments are processed for free, although the customer does have the option of paying a small amount to receive priority service. Even in the last case, however, the amount is still cheaper than what you’ll find at other services. That means more money in your bank account, which is always a good thing.

Disadvantages of Bitcoin

For those cautious individuals who prefer to avoid the latest trends and flash-in-the-pan fads, the following reasons might persuade you to avoid Bitcoin:

Limited Acceptance – The majority of the planet still doesn’t know about Bitcoin, which means that only a limited percent of businesses accept it as a valid form of currency. Brick-and-mortar establishments are especially unwelcoming, and you shouldn’t expect the latter to change in the near future (although the number has grown at a respectable rate).

A Work in Progress – Bitcoin is blazing a bold new trail in international finance, but uncharted waters can often be choppy and full of danger. There’s no way to accurately predict what’s going to happen to the system in the coming years, so keep this in mind before converting your life’s savings into virtual coinage.

Volatility – At the moment, the number of businesses accepting Bitcoin and the overall number of bitcoins in circulation are relatively low when compared to most forms of paper currency. This means that minor events can have a major impact on the value of bitcoins, much like the effect of throwing a stone into the middle of a small pond. As the metaphorical pond continues to grow, the ripples generated by events will have less of an impact.

The Taxman Cometh – The currency from Bitcoin is recognized as an item of value, so you’re still expected to pay taxes when some virtual coinage comes your way. While other forms of payment suffer from the same drawback, I wanted to mention it to demonstrate that Bitcoin isn’t some miracle system where the usual rules don’t apply. Please note that the exact laws regarding Bitcoin and taxes differ from one nation to the next.

Lack of Insurance – If armed robbers show up at your local bank, you’re not actually going to lose any money (as long as you’ve already deposited it). The same assurance protects PayPal customers from online fraud. This isn’t the case with Bitcoin, as anyone unlucky enough to have their account hacked is simply out of luck. It should be noted, however, that there has never been a successful theft from a block chain.

I hope this covers the basics of how Bitcoin works, as well as some of the pros and cons of the service. If you’re still undecided about whether or not to jump aboard the virtual currency bandwagon, be sure to check out some of our other articles on the subject.