Bitcoin for Beginners

As part of my own learning and development, I've been diving into the world of blockchain and Bitcoin. As part of that learning, I've had a few people ask me about both subjects, so I thought I would write a blog to try and explain Bitcoin for beginners. I've tried to keep this as simple as possible.

And remember, none of this is financial advice! Don't start investing money on the basis of this blog.

Bitcoin For Beginners: What is it?

To understand Bitcoin, you need to understand blockchain - they are two different things. Blockchain is the technology on which Bitcoin is built and it's what's know as a distributed ledger; which is a fancy name for a spreadsheet. The difference with this spreadsheet is that, in essence as the word 'distributed' suggests, everyone has a copy and everyone can see it.

So imagine this: if I sell something to a friend, we record that sale in our spreadsheets in a 'block'. But at the same time, everyone else around the world records it too in their sheet.

That's how Bitcoin works. If I give my friend a Bitcoin, we update that record around the world so that everyone knows it has moved from one person to another. Blockchain technology can be used for lots of other things too, as well as Bitcoin.

How is that secure?

This is where the miners come in. They're the record-keeping service and they keep the blockchain consistent, complete and unalterable. They do this by verifying new transactions into a new block, and each new block contains a 'cryptographic hash' of the previous block. That's a complicated expression for a complex action; but essentially it's creating a finger print of the data to ensure it is uniquely identifiable.

Finally for that block to be accepted in the chain, it must contain a 'proof of work'. This is quite complicated too but it requires the miners to find a specific number that is time-consuming to generate, and increases in complexity as time goes on.

This hashing and proof-of-work is what makes hacking the blockchain near-impossible - an attacker would have to modify all subsequent blocks in order for changes on one block to be accepted. Like the image says below.

What else should I know?

A few things: first, the miners are rewarded for their work with new Bitcoins, and often transaction fees too. That's why they do it. And that's why it's incredibly competitive. Some people jokingly label mining as 'competitive book-keeping'. But that's a good metaphor.

Secondly, the way the Bitcoin system was designed, means there will only ever be 21 million Bitcoins in total. At the moment, about 16 million have been mined and because the amount of coins given as a reward for mining decreases over time, it's estimated that the last coin will be mined in 2140.

Finally, Bitcoin has some scaling issues. It uses a lot of power to make the complicated calculations needed to confirm a transaction and that power usage is getting more and more. There's talk of ways to solve this but no-one has actually put forward a legitimate solution as yet.

There's also an issue that the blocks in Bitcoins blockchain are only 1MB in size and this restricts the number of transactions capable of taking place per second. That slows down transactions and creates bottlenecks. And with a decentralised currency where no-one person is in charge, different people have different ideas of to solve these issues.

What's a Bitcoin 'fork'?

Not the tool you use with a knife, but a like a 'fork' in the road. This is where two (or more) sets of miners disagree with how to solve the scaling issue and release different upgrade versions of the Bitcoin code. Sometimes this bizarrely duplicates the entire chain and creates a new currency. Sometimes it doesn't. That's why there are additional currencies called Bitcoin Cash and Bitcoin Gold out there. They're different versions of the same thing.

Who invented it?

The idea was published in a white paper on 31st October 2008 by Satoshi Nakamoto. Now, no-one knows who Nakamoto is and despite attempts to work out who he is, he still remains anonymous.

However, to have come up with the idea, at least four different skill sets would have been required which has led to the assumption that Nakamoto is actually a group of people. It's also likely that they're polymaths - which is another word for 'genius'.

What's the point of it?

And here lies the big question that 'experts' debate across the internet. You can buy things with Bitcoin but that is - at the moment - clunky and somewhat slow. There are roughly 100,000 merchants globally that accept Bitcoin. One of the main benefits is that you can transact without the need for a third party in the middle (like a bank for example).

It's been labelled as a new transactable currency, a store of wealth (like gold and silver) and even a potential new reserve currency (a currency that is held in significant quantities by governments and institutions as part of their foreign exchange reserves). Some people believe it could be all three.

One of my favourite 'reasons' for Bitcoin is that, as it's decentralised and isn't run by a particular government, it acts a 'peg' to stop central banks printing more and more money in order to prop up stock markets and economic growth.

Suffice to say, people are still working it out. Some think it's a Ponzi scheme, some thing its the future of global currency. Some people think nothing will happen for at least five years whilst we all try and work it all out.

It's unlikely to impact on the strength of major global currencies in the short term, but in countries where their currency is much weaker, it could be an attractive alternative for people to start using it, or another cryptocurrency.

How do I buy it?

You buy it through a market like Coinbase or BTCMarkets - the latter being the one I use. They all have different fees and different speed of transaction so it's worth testing which one you want to use with smaller transactions.

You don't have to buy a whole coin either. You can buy a fraction. My Bitcoin number runs to 8-decimal places. Be aware there is normally a minimum amount to buy and transfer.

How do I store it?

Like 'real' money, you need to store it somewhere. If it's not stored somewhere secure and someone else can get access to it, they could transfer it to themselves and that's the last you'll see of it. Although technically, you're not storing the Bitcoin (because it can't be separated from the ledger) but you're storing the credentials to access that coin.

There are four basic option to storing Bitcoins:

1. Leave it in the marketplace you bought it from. This is generally fine unless that marketplace or your account get hacked.
2. Transfer it to a 'wallet'. This is a piece of software you can put on your phone or laptop (or both), that stores the coins. This is also fine, unless you lose your laptop and phone (although see below). I recommended Jaxx.
3. Transfer it to an external hard-drive wallet and lock it in a safe. Some people store those in bank vaults. If you have a lot and have no plans on touching it for a while, then this is what you should do.
4. A paper wallet. Yes, ironically, one of the safest ways is to print out your public and private keys (the numbers you need to access your Bitcoin) onto a piece of paper and store it somewhere.

Whatever you choose, like normal money, the more you own, the better your security should be.

There seem to be lots of cryptocurrencies. Which one is the right one?

Last time I looked there were 1,360 with a total market cap of $700 trillion plus. There are more being created every day. Bitcoin is just one of those. I'm going to write another piece about other cryptocurrencies and which ones seem worth choosing. Each have their own pros and cons, some more tenuous than others.

But Bitcoin was one of the earlier coins and as such, had first mover advantage. That could mean very little in the long run and it could quite easily be usurped by another currency. It's also worth considering where the trust lies, and due to its longevity, people might trust it more in the future than other coins, even if they're easier and cheaper to transact with.

Then again, it might be this fact that it isn't easier and cheaper to transact with that protects it against other coins.

Is it just criminals using it?

Well, criminals use all sorts of currency too, but yes, there has been a fair few people point out that criminal enterprises can use this anonymous 'money' to do all sorts of things. Even the small business owner could theoretically be paid in Bitcoin and avoid paying tax by depositing the proceeds in a personal bank account.

But as it grows, legitimate businesses have started using Bitcoin and it stops beginning the domain of criminals. Suffice to say governments are looking at Bitcoin for multiple different reasons, and will start looking at it in more depth over the next few years.

Should I buy some Bitcoin?

As of writing this, the price of one Bitcoin was AUD$23,264 or AUD$25,143, depending on what exchange you look at. Some people speculate that it could reach six figures, at which point you'd have quadrupled your money if you took a position now. Some believe it could eventually reach seven figures  - at which point you've 40x'ed your money. Some people think the bubble will burst and it will vanish. Whilst people have compared this to other 'bubbles' in the past, there's no real precedent.

Whatever you choose to do, make sure you do it with money you can afford to lose. Some people have been remortgaging their houses to invest in Bitcoin which is, of course, madness.

The best Bitcoin for beginners advice I heard was to put a small amount in and forget about it for ten years.

Who should I follow to find out more?

My go-to-guy for Bitcoin and all things crypto is this dude, TuurDemeester. Just be careful how you pronounce his name if you say it out loud.

Also worth following is Mark Yusko. He's the Founder & Chief Investment Officer Morgan Creek Capital Management. He knows his stuff.

To conclude

The market is, at the moment, bonkers, to say the least. Some people have been made very rich and no doubt, there will be people who will be made very poor. But also remember, these are very early days of a very new technology. Yes, bubbles burst - point in question the Dot Com Bubble in 2000 to 2002.

But that wasn't the end of the internet.