What Is Bitcoin (BTC) And How Does It Work?

People once traded physical assets such as gold and silver for goods and services. But these were hard to carry and vulnerable to theft and loss, so banks offered to hold them for us, issuing notes that proved the wealth we had in the bank.

Eventually, the link between these notes and the commodities they represented was broken. Instead, governments said the notes themselves had value.

We trust banks and governments to honour the value of our currency so that we can accept cash as payment and trust others will accept it from us.

Bitcoin, the first and most widely recognised cryptocurrency, is essentially a digital version of cash that exists outside the established framework of national governments and central and private banks. It enables two people to exchange value without the likes of Westpac or NAB needing to facilitate the payment.

In other words, each party involved in the transaction trusts that bitcoin has inherent value based on its scarcity, decentralisation, and the robust network that secures it.

The exceptional characteristic that makes bitcoin unique is its borderless nature. Whether you are exchanging value with someone across the counter or half the world away, you can send bitcoin to them in seconds. Bitcoin was the first ever borderless, peer-to-peer currency that enabled this incredibly easy transfer of value.

Making a bitcoin payment is as simple as sending an email. To complete a transaction, you transfer Bitcoins from your digital wallet, which you obtain when purchasing the currency on a crypto exchange, to someone else’s wallet using an app or website. This process involves the sender specifying the recipient’s unique wallet address and the amount of bitcoin they want to send.

Bitcoin payments rely on wallet addresses, which are unique digital identifiers that enable secure and transparent transactions between users. When you initiate a payment, the transaction is broadcast to the entire bitcoin network.

These transactions are then processed and verified by a network of miners who run specialised software on their computers to solve complex mathematical problems, thereby validating the transactions and adding them to the blockchain, which is a public ledger of all bitcoin transactions. This decentralised approach to transaction validation ensures that the bitcoin network remains secure, transparent, and trustworthy for all users without the need for intermediaries like banks or payment processors.

These computers are known as bitcoin miners, and are essential for the operation of the bitcoin network. Bitcoin mining is a process in which  miners compete to solve intricate mathematical puzzles. This process not only verifies transactions but also maintains the integrity and security of the entire Bitcoin network. Each time a miner cracks one of these complex puzzles, they earn the right to create a new “block” that records a group of transactions, including details like the sender’s and recipient’s bitcoin addresses and the amounts transferred.

These blocks are added to a shared online ledger called the blockchain, which creates an immutable, transparent, and indisputable record of all bitcoin transactions. Since everyone’s copy of the blockchain must match, it’s virtually impossible for someone to falsely claim they have more bitcoin than they actually possess—any discrepancies would be immediately noticeable.

Mining bitcoin is a resource-intensive process that requires high-end computer hardware and consumes a significant amount of energy. However, this energy-intensive process plays a critical role in securing the decentralised nature of the bitcoin network. By distributing the responsibility of transaction validation and record-keeping among multiple miners, the network achieves a decentralised consensus that ensures its trustworthiness and resistance to fraud or manipulation.

In essence, bitcoin mining is a fascinating and essential process that combines cutting-edge technology, mathematical prowess, and the principles of decentralisation. Together, these elements create a secure, transparent, and indisputable record of all bitcoin transactions—forming the backbone of the world’s first truly decentralised digital currency.

A bitcoin miner who adds a block to the chain is issued with new Bitcoins worth thousands of dollars. While this may seem like free money, but the investment required to build and run a machine capable of processing a block is significant and increases over time. As more bitcoins are mined, the rate at which new bitcoins are created gradually reduces due to the bitcoin protocol’s design, which halves the mining reward every 210,000 blocks, which is around every four years.

Around 450 bitcoins are “minted” every day. At today’s prices, their total value is more than $45 million AUD. The total supply of bitcoins is limited to 21 million. Once the limit is reached, it won’t be possible to mint any more. At the current trajectory, it’s predicted the last bitcoin will be mined by 2140 unless current protocols are changed.

You can buy it, sell it and use it to purchase goods and services wherever it’s accepted. You don’t have to spend whole bitcoins—each one can be subdivided into 100 million individual units known as Satoshis.

Bitcoin payments aren’t exactly mainstream, but big names like Microsoft, Express VPN and Wikipedia take bitcoin payments.

Many people simply invest in bitcoin in the hope that it will go up in value. Bitcoin reached almost $US69,000 in November of 2021, but later fell by a dramatic 70% in value over 2022. More recently, bitcoin has once again pushed to new highs of over $US70,000 following the approval of 11 spot BTC Exchange Traded Funds (ETFs) for trade in the US.

At the time of writing in May 2024, one Bitcoin was valued at around $US67,000, meaning that you would need almost $100,000 AUD to buy one coin. 

This kind of market volatility has raised regulators’ eyebrows. The Federal Government, through its Moneysmart website, points out that crypto is, in most cases, not considered to be a financial product and therefore your crypto platform may not be regulated by the corporate regulator, the Australian Securities and Investments Commission (ASIC).

As Moneysmart states: “When a cryptocurrency fails, investors will most likely lose all the money they put in.”

The Federal Government is planning a review of cryptocurrency that will offer greater protections to consumers—including mandating financial licences for exchanges.

Anyone can buy bitcoin from crypto exchanges, such as Kraken and Coinbase. According to Roy Morgan research, more than one million Australians aged 18 and over, or 5% of the population, invest in cryptocurrency.

However, unless you have a spare $US67,000 in your account to buy a single coin, you’re going to be buying a fraction, or a share, of one bitcoin.

Smaller denominations of bitcoin are called Satoshis after the pseudonym used by its anonymous inventor(s). One Satoshi is worth 0.00000001 bitcoin.

As mentioned previously, bitcoin and the cryptocurrency market are still unregulated in Australia. This means there are no rules in place to protect you from losing everything, and no watchdog to ensure everyone involved plays fair.

Related: The Future of Crypto Regulation in Australia

According to bitcoin expert and journalist Connor Sephton, miners need three things to succeed: access to cheap electricity, hardware known as application-specific integrated circuits (ASICs), and mining software that connects them to the bitcoin network.

The most capable ASICs can cost thousands of dollars to buy and run, making them prohibitively expensive for the average person.

While Bitcoin remains the largest, most well-known and widely adopted cryptocurrency, there are numerous other cryptocurrencies, too. These coins are collectively referred to as altcoins, and millions of them have emerged since Bitcoin’s creation in 2009.

Some of the most prominent altcoins include Ethereum, which focuses on smart contracts and decentralised applications; Solana, known for its high-speed and low-cost transactions; and BNB, the native token of the Binance ecosystem. These altcoins, along with millions of others, offer various features, use cases, and levels of adoption.

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Bitcoin proponents point to a range of benefits, including:

Financial inclusion: Bitcoin levels the financial playing field, allowing anyone with an internet connection to send and receive value, regardless of their location, socioeconomic status or credit score. This provides a level of financial freedom previously unavailable for individuals living in developing nations or areas with poor access to banking infrastructure. 

Hedge against inflation: Over the past few years, central banks around the world have been printing fiat currencies at an unprecedented rate. For example, the amount of Australian dollars in circulation has increased by over 50% over the past four years. Bitcoin’s fans argue that its scarcity and decentralised nature make it an attractive option for preserving purchasing power.

Censorship resistance: Bitcoin transactions cannot be easily censored or blocked by governments or financial institutions. This is particularly important for individuals living under oppressive regimes or facing financial discrimination. 

Decentralised infrastructure: Bitcoin operates on a decentralised network, which makes it resistant to single points of failure and manipulation. This decentralised infrastructure enhances the security and resilience of the network, ensuring that it remains operational at all times.

Cross-border transactions: Bitcoin enables fast and low-cost cross-border transactions without the need for intermediaries or the challenges associated with traditional international money transfers. This is particularly beneficial for remittances, allowing migrant workers to send money back home more efficiently and cost-effectively.

Financial sovereignty: By holding and transacting with bitcoin, individuals can have greater control over their financial lives. They can store and manage their own funds without relying on banks or other financial institutions. This financial sovereignty is especially valuable in countries with unstable economies or untrustworthy banking systems.

As bitcoin continues to gain mainstream adoption and recognition, its potential to reshape the global financial system and provide greater financial inclusion and economic stability becomes increasingly evident. However, it is important to acknowledge that bitcoin is still a relatively new technology, and its long-term impact and sustainability are subject to ongoing development and regulatory considerations.

While Bitcoin offers numerous benefits, it is essential to consider some of its drawbacks:

Self-custody responsibilities: Holding bitcoin requires you to take responsibility for the security and management of your private keys. Losing access to private keys can result in the permanent loss of funds. This additional effort may be challenging for some users who are accustomed to the convenience of traditional banking services.

Limited acceptance: Although the number of businesses accepting bitcoin is growing daily, it is not yet universally accepted. 

Regulatory challenges: Governments and traditional financial institutions typically have a negative stance towards crypto. As a result, crypto users have faced increased scrutiny from these authorities, and it is now common for Australian bank accounts to not allow crypto transactions. 

Price volatility: Bitcoin’s price is known for its volatility, which can be a deterrent for some users and merchants. The value of bitcoin can fluctuate significantly in short periods, making it challenging to use as a stable medium of exchange. (However, as the market matures, some argue that this volatility will likely decrease over time.)

Despite these drawbacks, many individuals and organisations continue to see the potential in bitcoin and are working to address these challenges. As the ecosystem evolves and matures, solutions to these issues may emerge, making bitcoin more accessible, stable, and more widely adopted.

Related: How to Buy Bitcoin in 5 Mins