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How Does Bitcoin Work and How Valuable is it?

Updated: Dec 15, 2022

Popular for being the decentralized alternative to central banking, the famous digital currency that emerged with the goal of putting middlemen out of their jobs is known as Bitcoin. After years of innovative trial and error by many programmers and relying on a wide range of technologies, Bitcoin was the first engineering solution built on the blockchain that allowed for digital payments without relying on a trusted third-party intermediary.


How was Bitcoin Created?


Bitcoin was established in 2008 by Satoshi Nakamoto, a pseudonymous individual or group, and it represented a pivotal moment in cryptography. Each Bitcoin is a computer file produced due to the mining process and saved in a "digital wallet" application on a smartphone or computer. Unlike a bank's ledger, the Bitcoin blockchain is distributed and authenticated over a network of computers.


Satoshi Nakamoto's motivation for Bitcoin was to create a “purely peer‐to‐peer form of electronic cash” that would not require trust in third parties for transactions and whose supply could not be altered by any other party. In other words, Bitcoin would bring the desirable features of physical cash (lack of intermediaries, finality of transactions) to the digital realm and combine them with an ironclad monetary policy that could not be manipulated to produce unexpected inflation to benefit an outside party at the expense of holders.


Nakamoto succeeded in achieving this through the utilization of a few important though not widely understood technologies: a distributed peer‐to‐peer network with no single point of failure, mining, hashing, and proof‐of‐work.



The Blockchain


The blockchain is a decentralized digital ledger that works without the involvement of intermediaries. Bitcoin employed this peer-to-peer networking technology to become a decentralized digital currency that can be safely stored, verified and transferred from one user to another.



Nakamoto built Bitcoin on a foundation of very thorough and ironclad proof and verification. Every transaction must be recorded by every member of the network so that they all share one common ledger of balances and transactions. The central operational feature of Bitcoin is verification.


Nodes compete to be the first to update the ledger with a new block of transactions every ten minutes. In order for a node to commit a transaction to the ledger, it has to expend processing power on hard mathematical problems. This is the proof-of-work (PoW) system. Once a node solves the proof‐of‐work correctly, other nodes on the network vote for its validity. Crucially, the node that commits a valid block to the network receives a block reward consisting of brand-new bitcoins added to the supply along with all the transaction fees paid.


Bitcoin Mining


This is analogous to the mining of precious metals and is why nodes that solve proof‐of‐work are known as miners. Bitcoin mining is a process in which thousands of computers, known as mining rigs, compete to record and validate network transactions worldwide.


Nakamoto programmed Bitcoin to produce a new block roughly every ten minutes, and for each block to contain a reward of 50 coins in the first four years of Bitcoin's operation, to be halved afterwards to 25 coins, and further halved every four years. The quantity of bitcoins created is preprogrammed and cannot be altered no matter how much effort and energy is expended on proof‐of‐work. This is achieved through a process called difficulty adjustment, which is perhaps the most ingenious aspect of Bitcoin's design.


Difficulty Adjustment


Difficulty adjustment is the most reliable technology for making hard money and limiting the stock-to-flow ratio from rising. As Bitcoin's value rises, more effort to produce bitcoins does not lead to the production of more bitcoins. Instead, it just leads to an increase in the processing power necessary to commit valid transactions which only serves to make the network more secure and difficult to compromise. Bitcoin is the hardest money ever invented: growth in its value cannot possibly increase its supply; it can only make the network more secure and immune to attack.


Hashrate


Hashrate is the computational power used to mine and process transactions on a proof of work cryptocurrency network. It measures the number of calculations the network performed per second. Bitcoin hashrate is an important metric and a direct indicator of the network's ability to verify and store incoming transactions. A higher hashrate indicates the network is more secure with a large number of miners verifying transactions. The increase in hashrate means more mining power is being added to the Bitcoin network. This is because each miner requires more attempts each second to solve the calculations for winning the block rewards.


Why is Bitcoin Valuable?


The cryptocurrency's current adoption rate is higher than the internet's, with a user base in 2021 that is about comparable to the internet's user base in 1998. Bitcoin developed a devoted following of investors who saw it as the long-awaited potential replacement for the physical monetary system. It has become a household name as institutions and governments seek methods to accommodate their clientele's rising desire for exposure. What value do investors see to buy Bitcoin?


Unlike paper currency, digital currencies do not require storage facilities and have faster and easier mobility. To add to this, ordinary individuals may defend themselves against governments and giant corporations via the decentralized cryptographic blockchain network. This censorship resistance gives the cryptocurrency value and keeps it in demand. In light of this, Bitcoin is a cryptocurrency that has these amazing perks but also an inherent scarcity from which its immense value is derived. It has a first-mover advantage and many more use cases than any other cryptocurrency, but the maximum supply of the coin is only 21 million. Today, about 18 million are already in circulation.



What Is Bitcoin Backed By?


Many individuals regard Bitcoin as a profitable investment since it exists without a central bank or primary administrator on the blockchain. But for some others like the former U.S President, Donald Trump, and the renowned Warren Buffet, the coin has no value considering that no physical commodity or centralized entity backs it. However, without this perceived backing, the value of a Bitcoin is over $40,000, and its current total market capitalization sits at $780 billion.


Bitcoin maintains its very high value with only the backing of very advanced computational mathematics on a complex but effective blockchain network that keeps it limited in supply and grants users the benefit of censorship resistance. In this way, the esteemed power of cryptography is fully demonstrated.



Why Do People Trust Bitcoin?


At first, many were reluctant to adopt digital currency. However, Bitcoin wallets today number above 10 million. There are several reasons why people trust cryptocurrency enough to tell a friend. One major reason is security. The Bitcoin blockchain, including all of the information kept on the Bitcoin ledger, has been safe since its inception in 2009. Its value has also continued to rise, especially as it approaches the maximum capped quantity. To add to this, Bitcoin’s financial market is accessible to anyone, transparent, and maintains individuals’ anonymity.


Conclusion


In light of the erratic nature of the Bitcoin market, it is highly recommended that Bitcoin enthusiasts seek help from reputable and experienced consulting companies.


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