Introduction
Bitcoin is a decentralized digital asset and payment network that launched in 2009. It allows people to transfer bitcoin, commonly abbreviated BTC, through a public blockchain without a bank keeping the central transaction record.
Bitcoin is best known for its limited supply and large price movements. Supporters often focus on its scarcity and decentralized structure. However, investors also need to consider volatility, custody, regulation, competition, and technology risks.
To understand Bitcoin, it helps to separate the Bitcoin network from bitcoin the asset. The network records transactions, while BTC is the digital asset that moves through it.
How Bitcoin works
Bitcoin uses a blockchain to keep a public history of transactions. Computers running Bitcoin software can check for themselves whether transactions follow the network’s rules.
Users approve transactions with cryptographic keys. After a user sends a valid transaction to the network, miners can include it in a block. As the network adds more blocks afterward, reversing that transaction becomes increasingly difficult.
For a broader introduction to blockchains and cryptographic keys, see what a cryptocurrency is.
Bitcoin mining and proof of work
Bitcoin uses a system called proof of work to keep the network in agreement. Miners use specialized computers to compete for the right to add the next block of transactions to the blockchain.
A successful miner can receive newly created bitcoin plus transaction fees under the network’s rules. In this way, Bitcoin gives miners a financial reason to provide computing power and help secure the network.
However, mining requires substantial computing resources and electricity. Therefore, mining profits can depend on bitcoin prices, energy costs, equipment efficiency, transaction fees, and mining difficulty.
Bitcoin supply and the halving
Bitcoin’s protocol limits the total supply to 21 million BTC. Miners bring new bitcoin into circulation through block rewards, but the rate of new supply declines over time.
Roughly every 210,000 blocks, the Bitcoin protocol cuts the block subsidy in half. People commonly call this event the Bitcoin halving. As a result, the schedule makes future issuance relatively predictable under the current protocol rules.
Still, scarcity alone does not guarantee a higher price. Bitcoin needs continued demand, network security, liquidity, and market confidence for that scarcity to have economic value.
What drives the price of Bitcoin?
Investor demand
Demand from individual and institutional investors can move Bitcoin prices sharply. For example, periods of strong optimism or fear can lead to large price changes.
Supply structure
Bitcoin has a fixed maximum supply and a declining issuance schedule. However, the amount available for trading also depends on whether existing holders choose to sell.
Regulation and market access
Changes in regulation, custody services, trading products, and access to crypto markets can affect demand. Therefore, legal and market developments can also influence investor sentiment.
Economic conditions
Interest rates, market liquidity, risk appetite, currencies, and wider financial conditions can all influence demand for Bitcoin.
How investors can gain Bitcoin exposure
One option is to buy BTC directly through a cryptocurrency trading platform. After buying, investors can leave the bitcoin with a custodian or transfer it to a crypto wallet they control.
Alternatively, investors may have access to exchange-traded products that hold or provide exposure to Bitcoin. These products can make Bitcoin easier to access through a brokerage account. However, investors own shares of the financial product rather than BTC in their personal wallet.
Bitcoin-related stocks offer another form of indirect exposure. In that case, returns also depend on the company’s operations, costs, financing, management, and stock-market valuation.
Bitcoin versus traditional money
| Characteristic | Bitcoin | Traditional currency |
|---|---|---|
| Issuer | No central issuer under the Bitcoin protocol | Issued within a national monetary system |
| Supply | Maximum of 21 million BTC under current rules | Managed through monetary institutions and policy |
| Ledger | Distributed public blockchain | Banking and payment-system ledgers |
| Price stability | Historically highly volatile | Designed for use as a unit of account and medium of exchange |
| Transaction reversal | Users generally cannot simply reverse confirmed transactions | Some payment systems provide dispute or reversal processes |
Bitcoin versus Ethereum
Bitcoin and Ethereum both use public blockchains, but they focus on different goals. Bitcoin mainly serves as a decentralized digital asset and payment network.
By comparison, Ethereum is a programmable blockchain that runs smart contracts and applications. Users also use its native asset, ether, within that computing environment.
Therefore, comparing BTC and ether involves more than comparing two prices. Their supply rules, network uses, methods for keeping the network in agreement, and sources of demand differ.
Risks of investing in Bitcoin
Bitcoin has experienced extreme price swings. For example, periods of large gains have also been followed by deep declines. In addition, there is no guaranteed minimum value.
Direct holders face custody risk as well. Losing private keys or a recovery phrase can permanently remove access to bitcoin. On the other hand, leaving assets with a third party creates counterparty and security risks.
Finally, regulation, taxation, market structure, technology, network security, and competition can change over time. Our guide to the risks of cryptocurrency investing covers these issues in more detail.
Key takeaways
- Bitcoin is a decentralized digital asset and blockchain network that launched in 2009.
- The protocol limits total supply to 21 million BTC under its current rules.
- Bitcoin uses proof-of-work mining to check transactions and secure the network.
- Bitcoin’s price depends on demand as well as its supply structure and can be extremely volatile.
- Investors can gain exposure directly or through financial products and related companies.
- Custody, regulation, technology, and market volatility are important risks.