what is bitcoin

This article aims to provide an overview of Bitcoin, how it fundamentally works, and its pros and cons. It references blockchain technology and cryptocurrency. If you are unfamiliar with the basics of crypto, do read our articles on DeFi, blockchain, and crypto before reading this article.

What Is Bitcoin? 

Bitcoin (BTC) is the world’s first decentralized digital currency that uses peer-to-peer (P2P) technology to facilitate instant payments. It was created to provide an alternate payment method without the involvement of a trusted third-party intermediary such as a government, financial system, or company. 

This financial alternative was created against the backdrop of the global financial crisis in 2008. With large financial institutions and banks such as the Lehman Brothers and Bear Sterns falling apart, there was a growing distrust of the fiat financial system. In 2008, the Bitcoin whitepaper was published pseudonymously by “Satoshi Nakamoto”. The first Bitcoin was mined the following year in 2009 when Genesis Block started the Bitcoin Network.

How Does Bitcoin Work?

Every transaction involving BTC is tracked and recorded on the blockchain, which contains public ledgers, with copies held on servers situated around the world, also known as nodes. Every transaction is publicly broadcasted to the network and shared from node to node. These transactions are then compiled into a group called a block and added permanently to the blockchain, which acts as the BTC “account book”.

Bitcoin Mining

BTC is virtually “mined” by a decentralized network of computers that constantly verify and secure the blockchain’s accuracy. This is the process behind the Proof of Work (PoW) consensus mechanism that adds new blocks of transactions to the blockchain. PoW generates a hash, which is a long string of characters, that solves the mathematical problem for the next block. The first BTC miner who completes the cryptographic problem successfully adds the block to the blockchain and is rewarded with BTC. A similar concept applies to other PoW chains.

Why Bitcoin?

User Anonymity and Transparency 

BTC users are identified by numerical codes and public keys, ensuring no tracking of user transactions. Compared to traditional finance (TradFi) systems where personal information can be leaked by banks, no other personal information is required to conduct BTC transactions, increasing user privacy. BTC transactions do not require disclosure of any confidential information. Instead, they use two keys: a public and a private key, which helps to make BTC secure.

International Transfers

International settlements and transactions in TradFi systems not only take a longer time to process but also incur high transaction fees. Often, this time frame ranges from 24 hours to 5 days, depending on the country. Meanwhile, BTC users can send and receive BTC payments without the involvement of any banks or institutions within 10 minutes to an hour

Decentralized Issuance

BTC is a decentralized currency, meaning that there is no regulation by a single government or central bank, giving users autonomy and control over their money. Since no one has the authority to freeze, charge, or demand coins, users have maximum control over their own assets.

Hedging Capabilities

BTC’s decentralized design can present hedging characteristics against inflation. Some see Bitcoin as a store of value or “digital gold”. Therefore, investors may look to diversify some of their assets by allocating a portion of their portfolio to BTC. Find out more in our Insights article!

Bitcoin Drawbacks

Volatility

BTC has a hard cap, meaning there will only ever be 21M BTC in existence. While this scarcity makes BTC so valuable, it also makes it volatile, since price is the only variable that can change according to demand. Like other cryptocurrencies, BTC is susceptible to wild price swings over short periods. For instance, following a US Senate committee hearing formalizing that BTC will be considered as “legitimate financial services,” BTC’s value spiked by more than 50%. After rallying to nearly US$20K in 2017, BTC’s price collapsed to just US$3,122 in 2018, wiping out billions of dollars from the total crypto market value. 

Environmental Impacts

BTC mining is extremely energy inefficient. The University of Cambridge estimates that BTC alone generates 132.48 terawatt-hours (TWh) annually. The US, where 35.4% of BTC mining takes place, generates 0.85 pounds of carbon dioxide per kWh. As a result, nearly 40B tons of carbon dioxide is produced from US BTC mining alone. 

Everyday Uses of Bitcoin

Payments

Now coined as “Bitcoin Pizza Day”, 22 May 2010 was the day of the very first commercial BTC transaction, where a man spent 10K BTC on 2 large pizzas worth US$41. Little did he know that 1 BTC would be worth over US$68K at some point. This famous story happened over 12 years ago. 

Since then, crypto adoption has been rapidly growing, with numerous companies and retailers across various sectors beginning to accept BTC for payments. To name a few, here are some examples:

F&B: Chipotle, Starbucks, Pizza Hut, Burger King

Tech: Microsoft, AT&T, Twitch

Luxury Brands: Gucci, Balenciaga, Off-White

Legal Tender

In 2021, El Salvador became the first country to adopt Bitcoin as their legal tender as an inflation hedge. The Central African Republic was the second country to adopt Bitcoin as legal tender, but this was paused due to backlash from the region’s central bank. Since then, many countries have started looking at Bitcoin, but none have made it official yet.

Company Treasury

Many companies have started using BTC as a token to be held in their treasury to diversify from other assets such as stocks and bonds. MicroStrategy and Square are a few of the companies currently holding BTC on their balance sheets.

How’s the Future Looking For Bitcoin? Will Bitcoin Ever Be Replaced?

Since BTC’s insurgence, thousands of new cryptocurrencies have been launched. Networks like Ethereum support smart contracts, where users can initiate and execute transactions without acknowledgment by a third party. With evolving technology, there is a possibility that one of the altcoins could eventually replace BTC in the near future. 

The increasing popularity of BTC and crypto has led to polarizing views concerning the technology. While crypto’s decentralized nature has brought benefits to investors, the nascency and lack of regulation in the industry might surface as a double-edged sword. 

Need a quick summary? Read our Twitter threads on the what and why of Bitcoin.

Disclaimer

This publication is provided for informational and entertainment purposes only. Nothing contained in this publication constitutes financial advice, trading advice, or any other advice, nor does it constitute an offer to buy or sell securities or any other assets or participate in any particular trading strategy. This publication does not take into account your personal investment objectives, financial situation, or needs. Treehouse does not warrant that the information provided in this publication is up to date or accurate.

New to DeFi? If you found this useful, check out our other Learn DeFi articles to dive deeper into the wonderful world of DeFi! Alternatively, browse our Insights section to read more in-depth analyses on the DeFi space. You can also try out our flagship product, Harvest, to get a comprehensive analysis of your DeFi assets. Lastly, subscribe to newsletter updates in the box below!