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- Bitcoin is a cryptocurrency, a type of digital, private money that operates without the involvement of a bank or government.
- Bitcoin trades on online exchanges, and since its price has mushroomed since its 2009 debut, it's increasingly attracting investors' interest.
- As an investment asset, bitcoin offers capital appreciation and an inflation hedge, but its volatile price swings make it a high-risk investment.
Scarcely a news cycle goes by without some mention of bitcoin. As the first and most widely traded cryptocurrency, bitcoin is often seen as a representation of the larger cryptocurrency ecosystem, for better or worse. Throughout its life since being created in 2009, its critics have been decrying its failure while advocates have been making wild projections, former Goldman Sachs hedge-fund chief Raoul Paul going as high as $1 million by 2025.
But while it has certainly attracted plenty of attention, bitcoin still remains a mystery to casual and experienced investors alike. This shouldn't really be the case, since the basics of bitcoin and how it works are relatively easy to understand.
Here's a brief bitcoin biography: An overview of its origins, operations — and how to invest in it.
What is bitcoin?
Bitcoin is a cryptocurrency, an electronic version of money that verifies transactions using cryptography (the science of encoding and decoding information).
As Bitcoin educator, developer, and entrepreneur Jimmy Song explains, Bitcoin is "decentralized, digital, and scarce money." Here are the other key characteristics of bitcoin:
- It's decentralized because this code is run by thousands of computers (i.e., 'nodes') spread across the globe.
- It's digital because it exists as a set of code that determines how it operates.
- It's scarce because its code caps its overall volume to 21 million bitcoins.
When you use bitcoin to buy something, it records the transaction on a blockchain, which is essentially a ledger or database whose entries can't be modified or erased.
What is bitcoin mining?
New bitcoin is created approximately every 10 minutes through a process known as mining.
"It's called mining because it's like looking for gold," Song says. "Anyone with a shovel can dig and look for gold, just as anyone with a computer can look for proof-of-work."
Every 10 minutes, a new block of information containing recent transactions needs to be updated on bitcoin's blockchain. The validity of these blocks is verified through a process known as proof-of-work, in which "miners" (i.e., people with computing hardware) race to calculate a cryptographic key — basically a very complicated math problem. The first miner to solve the key updates the information on the blockchain and gets a set amount of bitcoin in return. These puzzles vary in difficulty to make sure that it gets solved in roughly 10 minutes.
Currently, each validated block rewards a successful miner with 6.25 bitcoin, though this amount is halved every four years. The last time bitcoin was halved was in May of 2020. All 21 million bitcoin will be mined by the year 2140.
In the early days of bitcoin (late 2000s, early 2010s), anyone with a computer could mine bitcoin with some level of success. However, as bitcoin and bitcoin mining became more popular, the competition got steeper.
The miner with the most computing power, known as a hash rate, has the greatest chance of solving the puzzle and reaping the rewards. Computers got more powerful and more energy-consuming. They also got more specialized; a new type of computer known as an application-specific integrated circuit (ASIC) miner was developed specifically to solve proof-of-work puzzles.
Part of bitcoin's value is derived from this mining process — the energy, time, and cost of operating these mining rigs. Another major component to bitcoin's price is its market sentiment, which commonly boils down to "hype." This can backfire if something happens to undermine trust.
These technicalities aside, one of the main draws of Bitcoin — and one of the reasons why it has attracted so much hype in recent years — is that it's a form of private money that operates without the involvement of a central bank or government. This means that large amounts of money can be transferred across the world instantaneously.
"Bitcoin is used to transfer funds from one party to another without requiring a middleman such as a bank. Because the technology is open source and entirely decentralized, it is protected from influence by external sources such as governments, who typically control fiscal policy and fiat currency circulation," says Simon Peters, a market analyst at eToro.
Early uses of bitcoins
At the very beginning of its life, bitcoin was used to make trial purchases and payments, with developer Laszlo Hanyecz famously using 10,000 bitcoins to buy two pizzas on May 22, 2010 — at current market prices, each pizza would be worth $150 million. It then became more commonly used in online marketplaces and for international contracts and import/export operations.
It was also around this time that traders first began speculating with the currency, with the now-defunct BitcoinMarket.com launching as the world's first bitcoin exchange in March 2010.
Having been worth precisely $0 when it debuted in 2009, bitcoin has experienced more than its fair share of pricing ups and downs, with its worth rising or plummeting by hundreds of dollars in a matter of hours.
Concerns over bitcoin's legitimacy
One reason for bitcoin's volatility: Considerable suspicion and skepticism that have dogged the cryptocurrency throughout its history. Bitcoin's blockchain may be immune to interference, but bitcoin itself is not, skeptics have said.
Research published in 2019 concluded that "there was serious market manipulation in Mt. Gox exchange," which was the largest cryptocurrency marketplace until hacking forced its 2014 shutdown, incurring the loss of some 744,408 bitcoins.
Similar charges have been made against the cryptocurrency tether. A so-called "stablecoin," it's widely used to purchase bitcoins in regions (particularly Asia) where using traditional fiat currencies for such a purpose isn't legal. Its operators originally claimed that every Tether token was backed 1:1 by US dollars held in reserve, yet researchers have suggested that this backing is a myth and that Tether is a tool used just to inflate bitcoin prices.
Then there's Bitcoin's association with criminals and shady operators. Most notoriously, it was the medium of exchange used by Silk Road, a clandestine black market eventually shut down by the FBI in 2013.
This stigma has stuck ever since, and not without cause. While research from 2020 suggests that bitcoin is now mostly used for financial speculation or wealth preservation (much like gold), money laundering through bitcoin rose 30% from 2020 to 2021, a total of $8.6 billion.
Should I invest in bitcoin?
Bitcoin is in a weird place right now. It is still the most widely traded cryptocurrency on the market, and that doesn't show signs of stopping; over half of current bitcoin investors entered the market last year. But new developments in the cryptocurrency world, such as NFTs and web3, which are centered primarily around ethereum and proof-of-stake, seem to suggest a shift away from bitcoin. Ultimately, whether you should bitcoin depends on whether you think this particular cryptocurrency may still be valuable and sustainable as an asset in the long-run.
Despite its poor performance in 2022, bitcoin advocates believe that its fixed supply makes it the perfect way to store wealth and that it should appreciate significantly over the long term as more institutional investors — investment banks, mutual funds, pension plans — pile into it.
"We have already seen increased interest from institutional investors and corporations" in 2020, says Peters. "This is in part to the increasing view that bitcoin can act as a strong hedge against inflation in portfolios, as well as potentially growing in price and in consumer adoption substantially in the future."
How to invest in bitcoin
There are two main ways to invest in bitcoin. Either you set up an account with one of the many dedicated cryptocurrency exchanges now in existence, or you buy it through an investment platform that includes the option to buy cryptocurrencies.
While cryptocurrency exchanges were once shady, unregulated operations, the major exchanges now operating are all regulated and in compliance with applicable laws. In the United States, some of the most popular are:
- Coinbase
- Kraken
- Gemini
- Binance.US
- bitFlyer
- Coinmama
Alternatively, you can buy bitcoin through a number of financial apps and platforms, including Robinhood, Cash App, and PayPal. Such apps tend not to offer as wide a selection of cryptocurrencies as the dedicated exchanges, but if you're interested only in bitcoin then it doesn't make a real difference.
If you do decide to invest in bitcoin, here are five pointers worth keeping in mind in order to reduce your exposure to risk:
1. Consider buying a bitcoin wallet
If you're buying bitcoin through an exchange, and if you're planning on holding large sums of the cryptocurrency, it may be a good idea to transfer them to your own hardware wallet. Hardware wallets are basically small, offline computers that store the private keys controlling your bitcoin funds, with good examples being manufactured by the likes of Ledger and Trezor.
2. Invest only what you can afford to lose
This sage advice applies to any investment, but especially here. Bitcoin has fluctuated wildly since its inception, spiking well above $65,000 in November of 2021, later losing over half its value by May of 2022 as a result of a wider cryptocurrency crash, at one point dipping to $26,000. However, a similar swing occurred in April of 2021, when bitcoin rose to nearly $60,000 before dropping to $31,000 in May.
The moral is: Your holdings may decline significantly in the short-term, so don't invest any funds that you might need to call on for an emergency, lest you be forced to sell during one of these downswings.
3. Think long-term
Given its volatility, it usually pays to have more of a long-term perspective when investing in bitcoin. If you believe that bitcoin will gain value in the distant future — perhaps it will gain additional use cases other than a means of carrying out transactions — then it might be worth investing in.
4. Watch the stock market
Bitcoin's price is not held in a vacuum. Cryptocurrency investors are subject to the same interest rate increases — which negatively impact the stock market — that affect other investors.
Additionally, research has shown a positive correlation between bitcoin's price and the S&P 500. As such, it may be worthwhile watching stocks for telltale signs of an impending movement in the bitcoin market.
5. Remember tax liabilities
In the US, bitcoin is subject to the same tax rules as other assets. You are liable for capital gains taxes when selling the currency at a profit, or even just spending it (if the price has appreciated since you bought it). So be sure to keep records of all your transactions.
The bottom line
It's hard to say where Bitcoin will be in the next five or 10 years.
Its ability to operate at scale — meaning its ability to handle a growing number of transactions — has been seriously questioned. Without that capacity, it's unlikely that bitcoin will become a fully fledged currency, replacing traditional dollars or euros, anytime soon. But there are some advocates who still believe the cryptocurrency will bounce back.
"In my view, whilst adoption will continue to increase at a steady rate, the largest role I see bitcoin having is its increased use as an asset in investment portfolios," says Peters. Given that bitcoin has no real fundamentals besides a limited supply and a growing network of developers, users, and holders — and it's difficult to fully subscribe to such optimistic forecasts.