Bitcoin 101: The Complete Beginner’s Guide

Bitcoin 101: The Complete Beginner’s Guide to Bitcoin

Bitcoin 101: The Complete Beginner’s Guide to Bitcoin

The buzz about bitcoin has been growing for years; but now, with the rocketing surge in bitcoin value that started late in 2020, even more people are paying attention.

Can bitcoin really be used in place of standard currency? How? When? Why? And is it a good idea to invest in bitcoin when the market for it is so volatile?

What Is Bitcoin?

Bitcoin is a type of software that can be used as currency through a network called a blockchain. In 2008, when bitcoin began, the terms “bitcoin” and “blockchain” were often used interchangeably. Today, it is more clearly understood that bitcoin is only one type of blockchain technology. Other examples of blockchain include everything from deeds and contracts to birth and death certificates. A blockchain is merely an electronic way of collecting and storing blocks of information.

Bitcoin achieves its versatility and value by eliminating middlemen from transactions, and, therefore, any collecting by middlemen of a transaction fee. The direct way that bitcoin reduces the risk of interference in transactions and protects the privacy of transactions appeals to many businessmen and corporations.

Bitcoin is entirely digital. There are no tangible forms of this currency, no paper bills representing bitcoin the way paper dollars once represented specific weights of gold. Transactions are tracked entirely online through the use of a public ledger. These transactions are not approved or supported by any one physical institution such as banks or government agencies; they are verified only electronically.

In most cases, you can’t even use bitcoin as a commodity, for it is not a widely approved form of payment—at least, not yet. But if bitcoin isn’t yet generally accepted as a currency, then why use it? How, exactly, does it work?

How Does Bitcoin Work?

There are three main components of a bitcoin transaction: input, output, and amount. These represent different aspects of a single transaction. Input pertains to where the money is coming from, output to where the money is going. The amount is the value tendered to the recipient.

How A Bitcoin Transaction Works

Illustration: Bryce Durbin; Infographic: Joshua J. Romero, Brandon Palacio & Karlssonwilker Inc.

When you send a bitcoin payment to a recipient, the funds are drawn from your bitcoin wallet to cover the exchange. A bitcoin wallet consists entirely of digital money received from other people. The whole bitcoin network is a cycle: every transaction depends on assets received from someone else.

That said, in order to acquire bitcoin, you don’t have to buy in whole numbers—you can buy any fraction of a single bitcoin. Bitcoin’s smallest unit is called a “satoshi.” It represents one hundred millionth of a bitcoin, or 0.00000001 BTC, and is named after Bitcoin’s anonymous creator, Satoshi Nakamoto. These smaller units pave the way for acquiring small chunks of bitcoin, which means you can buy in extremely small denominations.

The History of Bitcoin

The founder of bitcoin is the pseudonymous Satoshi Nakamoto, the person or persons who proposed this decentralized cryptocurrency in 2008. The term “decentralized” refers to the fact that there is no central authority facilitating transactions; all exchanges occur in an accessible public ledger.

The idea took some time to gain traction. Before bitcoins had any real value, mining and trading them was mostly a leisure activity. The first real monetary transaction wouldn’t occur until 2010, when somebody ordered two Papa John’s pizzas for 10,000 bitcoins. Pizza had not suddenly become a rare and expensive luxury; at the time, the value of four bitcoins was one penny, so that 10,000 bitcoins would have been worth about $25—then. Today, 10,000 bitcoins are worth about $596 million.

After 2010, bitcoin continued to increase in value for several years . . . until it crashed . . . after which it began to increase in value again. This trajectory is why bitcoin is often regarded as a volatile form of currency. Even so, many investors are now interested in cryptocurrency and bitcoin in particular. Two of the most famous proponents of bitcoin are Tyler Winklevoss and Cameron Winklevoss, the identical twin brothers who sued Mark Zuckerberg in 2004 for allegedly stealing the social-networking idea that would become Facebook.

Although the future of bitcoin is uncertain, cryptocurrency may well be the preferred method of payment in years to come.

How to Buy and Sell Bitcoin

It’s easy to buy and sell bitcoin. First you need to download an app that makes bitcoin exchanges possible. The most popular is probably Coinbase. You may also try Ether or Litecoin. Coinbase also serves as your bitcoin wallet; other apps, including Ether and Litecoin, require a separate wallet app to perform this function. If, for example, you download Ether as your exchange app, you also need to download an app to hold your digital assets. Options include Ethereum, Nexo, and the eponymous Bitcoin Wallet.

Once you have set up methods of exchanging and storing bitcoin transactions—a setup that includes providing your bank account numbers—you can begin buying and selling. Before you get going, it’s essential to check the current value of one bitcoin and see how the cryptocurrency has been trending. This will help you decide whether to buy immediately or wait for a more opportune time.

When you’re ready to purchase bitcoin, it’s usually as simple as typing in the dollar amount you want to spend and using your wallet app to submit the money. You should be redirected to a confirmation page if the transaction is successful.

Most good cryptocurrency apps make it as easy to sell bitcoin as it is to buy. The setup is similar, but now you select “sell” options. Note that different apps impose different limits on buying and selling bitcoin.

How to Store Bitcoin Safely

Since the entire bitcoin experience occurs virtually, it’s only natural to wonder whether bitcoin can be stored securely. The good news is that it’s very possible to protect your bitcoins from hackers, as well as to access them in the event of software malfunction. It all starts with a private key and understanding the difference between hot and cold wallets.

The importance of bitcoin wallets

  • A hot wallet is an online bitcoin wallet used to make transactions. It should contain a moderate amount of bitcoin. Think of a hot wallet as your spending money or your checking account. The Bitcoin Foundation recommends that this wallet be stored digitally on your mobile device or desktop.
  • A cold wallet also holds cryptocurrency, but does so offline. It should contain most of your bitcoin. If a hot wallet is your checking account, then a cold wallet is your savings. It should be stored offline and in a secret location.

You can store cold wallets on hardware like a USB flash drive or a mobile phone that is used solely to store bitcoin. This hardware can then be hidden or locked in a secure physical location. Hardware wallets designed specifically for this purpose enable anonymous transactions and are impervious to malware. You may also store your cold wallet in a digital location (such as your desktop computer), so long as the digital location is completely offline. Hardware wallets are arguably more hack-proof than your PC.

Where you store and access your private key depends on where you store your cold wallet. The key may be stored electronically in the same computer as your digital cold wallet or in a small object like a USB stick. No matter how you store your cold wallet, be sure to back up your bitcoin as often as possible with many keys and in many locations. Although having all these backups may, if you’re careless, increase the risk of access by third parties, the backups will also help you avoid locking yourself out of your own safe.

Final Thoughts

Despite its staggering growth, bitcoin is still a relatively new and volatile form of currency. More than once over the years, bitcoin has reached all-time highs of value only to crash a short time later. No one knows what the future of bitcoin may hold. But no one can deny that this cryptocurrency has enjoyed considerable success since its humble beginnings.

Frequently Asked Questions

Do I have to pay tax on bitcoin gains?

It depends. If you’ve owned bitcoin longer than a year and have now sold it for a profit, congratulations. But you will have to pay a long-term capital gains tax rate on the profit. This means a tax of zero percent if you earn $40,000 or less per year, 15 percent if you earn between $40,000 and $441,450 per year, and 20 percent if earn more than $441,450.

If you lost money selling bitcoin, or if you have owned it for less than a year, your income tax will remain the same.

Can I buy less than one bitcoin?

Yes, you can buy less than one bitcoin. The smallest unit you can purchase is called a satoshi (after its pseudonymous founder, Satoshi Nakamoto), and it consists of one hundred millionth of a bitcoin. This makes it easy to spend the amount you want in dollars in exchange for a small part of a bitcoin. Keep in mind that depending on the exchange or the wallet app you’re using, there may be daily minimum or maximum purchasing limits.

Is bitcoin safe and legal?

Investing in bitcoin is a little like playing the stock market. You can analyze the trends, but you can never be quite sure whether you’re going to win or lose. Buying and selling bitcoin comes with financial risks, but the rewards can be huge. Minimize your risk by learning about how bitcoin has been trending and by investing only what you can afford to lose.

Bitcoin is not yet a standard form of tender in Canada. The Canadian dollar is still the country’s only official currency. You can invest in bitcoin or exchange it with friends, but you cannot buy a home or pay off a college loan with bitcoin. One day, perhaps, you will.

Should you invest in crypto?

The unprecedented performance of Bitcoin both as a currency and as an investment has attracted lots of investors in recent years. And cryptocurrency investments have other advantages over traditional investments. People invest in cryptocurrency just like they would other assets, but you can actually use it to buy regular goods and services. Cryptocurrency is an exciting asset class. However, purchasing it can be risky. Wondering if you should invest in cryptocurrencies? Consider the advantages and disadvantages here.