Bitcoin (BTC) has become commonplace in many different conversations, especially around those of investing and trading, but what is often lacking is a true understanding of the fundamental principles of the cryptocurrency.
Bitcoin is quite revolutionary as a financial tool, and even more so, it is attached to a technology that runs in the same circles as IoT, AI, and other new and emerging digital improvements. Yet, for most people looking to trade the cryptocurrency, they are more interested in the rising and falling price rather than what is making it move.
It is important to have a good grasp of the guiding principles of Bitcoin before you start trading this new technology, asset class, digital currency, and cryptocurrency. Once you better understand how it works, and why it works as it does, the trading side of the game will become much clearer.
What is Bitcoin
Because Bitcoin is not physical, it is sometimes hard to understand. But, essentially, it is a coin that is used on a distributed ledger where all transactions are stored. This digital asset derives its value from the market that utilises it, and as it is decentralised, there is no controlling force affecting how it operates.
Bitcoins are the fuel that run the underlying blockchain technology. This is the ongoing decentralised and distributed ledger that keeps a record of every transaction. So, to understand what Bitcoin is, you need to think of it as a financial system rather than a simple asset or commodity with a fluctuating value.
As mentioned, Bitcoin operates on a new technology called blockchain. The blockchain is an ongoing ledger that records transactions on blocks, and these transactions are all done in BTC. What makes this technology so special is its decentralisation, which means it is nearly impossible to hack or alter, and also it’s transparent nature.
The blockchain records every true Bitcoin transaction on a public ledger that can be viewed by anyone; however, the transactions remain [pseudonymous] anonymous. The technology also has far-reaching capabilities as it can be used to remove intermediaries thanks to things called smart contracts, a second-generation evolution of the blockchain well known in Ethereum.
The principle of decentralisation is one of the biggest pillars of Bitcoin and the entire cryptocurrency ecosystem. As the cryptocurrency was created in the wake of the 2008 financial collapse, it was aimed at being a financial system that had no ultimate controlling or centralised power — like banks in today’s modern financial system.
This trait allows for Bitcoin to run and continue operating thanks to the efforts of a decentralised network of peers and nodes that work towards the same goals, but with only individual incentivisation driving them. This means there are no other agendas in this financial system, and no high-end decisions that can be made to alter the Bitcoin network.
However, Bitcoin is constantly evolving and changing, and there are always upgrades being made to the system. These upgrades are also made in a decentralised and democratic manner. If there is a change that needs to be made to the Bitcoin system, such as the introduction of SegWit (an upgrade to help with scaling), then the protocol is suggested by a party and voted on by those involved in the network.
If there is a consensus and the majority of the network agrees to the upgrade, the protocol can be implemented and become part of the network going forward. This is one way that Bitcoin stays relevant and makes improvements on its own network.
Mining is an important component of the Bitcoin ecosystem that helps not only create new blocks where the transactions can be written, but also to validate the transaction. The process of mining involves solving complicated equations to unlock new blocks — one about every 10 minutes. When this happens, the person who solved the equation is rewarded with new Bitcoin, which then enters the circulating supply.
Miners also validate transactions and write them into the ledger. Because of the decentralised system, this requires ensuring that the transaction is true and received across the network. For doing this, miners also charge a small fee.
Because Bitcoin is not physical, it has to be stored digitally and securely. This is where Bitcoin wallets come into play. A Bitcoin wallet allows the user access to the Bitcoin network and allows them to send, receive, and store the cryptocurrency through private and public keys.
The private key is the one that is the gatekeeper to a person’s wallet and grants them access and use of their coins. This is similar to the password on your online bank. Then, there is the public key that you send to people who want to interact with your wallet — much like your bank account number.
While wallets can be seen as bank accounts for Bitcoin, the exchanges are the banks that help transact the coins. As mentioned, Bitcoin is its own financial system, and it can operate totally decentralised, but there are instances where traditional fiat money needs to be traded for Bitcoin, and this is where the majority of exchanges come in.
These exchanges allow people to buy Bitcoin, they also provide a number of either services, but they are most important as a link to the traditional financial world and the exchange of cash for digital currency.
Exchanges also often offer one of the two main types of trading — or both. These are spot trading (buying and selling at different prices) or margin trading.
Popular spot trading exchanges include Coinbase and Kraken, while Derivatives trading can happen at exchanges like Binance and Overbit; the latter offers users up to 50,000 USDT to try trading on the demo account, before diving into the live account.
Because Bitcoin does branch out and mix in with traditional finance, and it can be used to move and shape money — as well as potentially launder it — there is a big need for regulation. Regulation of Bitcoin and the cryptocurrency space has grown rapidly as lawmakers look to ensure that Bitcoin does not become a tool for illegal and illicit uses.
Regulation is a balancing act as it can stifle some of the more innovative aspects of Bitcoin, but without it, Bitcoin would not be able to operate and integrate with the traditional financial world. If Bitcoin is cut off without full regulation, there is a lot less chance of adoption and integration.
Bitcoin has become an asset that many people simply want to have and own because its biggest draw so far has been how it has appreciated over the years. In the last ten years, Bitcoin has not been matched in terms of gains from any other asset on the planet.
Buying Bitcoin, as mentioned, is predominantly done through cryptocurrency exchanges where traditional fiat money is traded for the equivalent in Bitcoin. Once owning the cryptocurrency, the rest of the ecosystem is opened up and can allow the buyer the chance to sell, send, and trade.
Trading Bitcoin has also become a big business in recent times because the coin has become similar to an asset, and has even been labelled digital gold. It is a highly volatile asset that makes it an attractive, if not a risky investment.
Bitcoin is even being recognised by the likes of Wall Street and other major trading houses, such as CME, and there are bigger drives to include it into more traditional trading spaces as the coin gains more legitimacy and is further normalised.