Bitcoin is the world’s first and most well-known cryptocurrency. It was introduced in 2009 and is based on blockchain technology. The virtual currency is transparent, secure, decentralized — and there’s not much of it, which is why it’s a serious alternative to traditional money. But what is Bitcoin exactly? Read on to learn about the origins of Bitcoin, how transactions work, and what the pros and cons are of using it. Also discover how Avira Phantom VPN can help make your transactions more secure.
What is Bitcoin and where did it come from?
Most people have heard of it, but what is Bitcoin actually? Bitcoin (BTC) is a digital currency (or cryptocurrency). It was created in 2009 by a person or group using the pseudonym Satoshi Nakamoto and released as open-source software. To this day, nobody knows who’s behind the name Nakamoto. Whoever he (or she) is, his fortune is estimated to be over $70 billion, but this can fluctuate greatly as it depends on the current Bitcoin price.
Basically, Bitcoin works like any traditional currency and is based on monetary transactions between two parties. The special thing about Bitcoin is how the currency gets from the sender to the receiver: This is known as the blockchain — a decentralized technology in which all transactions are documented publicly, transparently, and securely. This makes it almost impossible to manipulate transactions. Although all transactions are publicly visible, the personal user data you need to enter on a service portal to use Bitcoin is pseudonymized.
Miners play a key role in ensuring Bitcoin remains secure as a closed system and is not manipulated. These are users who provide their computing power to solve complex tasks. As a reward for their work, they receive a portion of the transaction fees in the form of Bitcoins.
By the way: Cryptocurrencies such as Bitcoin are also preferred as a means of payment in the illegal corners of the internet due to their high level of anonymity — learn all about that in our other article on the dark web.
What is a Bitcoin wallet?
Similar to cash in your physical wallet, Bitcoins are stored in a digital wallet. The wallet is used to receive, send, and manage Bitcoins.
Each wallet contains two very important components that are crucial for owning and transferring Bitcoins: Public and private keys.
- The public key: This is the address to which other people can send Bitcoins. Since it’s publicly visible, you’re free to share it. Think of the public key as being like your traditional bank account’s IBAN.
- The private key: This key gives you access to your own Bitcoins and authorizes the sending of Bitcoins to other people. It is not visible to others and should never be shared with third parties under any circumstances.
Note: The wallet doesn’t actually store Bitcoins. Instead, it stores the keys that give access to your Bitcoins and make transactions possible.
There are also different types of wallet, each with its own advantages and disadvantages:
- Software wallets: These purely virtual wallets can be accessed via a computer, tablet, or smartphone. They allow quick and easy access, but are also vulnerable to hackers and ransomware attacks.
- Hardware wallets: These are special physical devices that store the wallet’s private key offline. They only work if you have them with you, but are more secure than apps on your computer or mobile phone.
- Online wallets: Third-party providers offer and host online wallets as virtual wallets, similar to cloud services. Although they’re very easy to use, these providers always have access to your private keys.
- Paper wallets: Paper wallets are printouts of the private and public keys. They offer the best protection against cybercrime, but can easily be lost, stolen, or damaged.
Earn money with Bitcoin: Here’s how to invest
Bitcoin offers numerous ways to make money, be it through buying it directly, trading, or via alternative investment models. As with other investments, it’s important to understand the different options and associated risks before investing in Bitcoin. Here are some of the most common ways to invest in Bitcoin and potentially make profits:
- Buying and trading Bitcoin
Buying Bitcoin directly on crypto exchanges is the most common method. Platforms such as Coinbase, Binance, and Kraken allow you to buy Bitcoin with conventional currency. Once you’ve purchased Bitcoin, you can hold it in your digital wallet and speculate that the price will rise so that you can sell it later for a profit. However, it’s important to note that the Bitcoin market is extremely volatile, which can result in both large gains and significant losses.
- Investing through traditional brokers
Many traditional brokers now also offer cryptocurrencies such as Bitcoin. In addition to stocks, bonds, or exchange-traded funds (ETFs — more on these below), you can invest in Bitcoin through these platforms. This option is particularly attractive for investors who are already familiar with traditional financial markets and want to diversify their investments. Some brokers also offer derivative financial products such as Bitcoin futures, allowing you to speculate on future price movements.
- Bitcoin funds and ETFs
Another way to invest in Bitcoin without buying the currency directly is through Bitcoin mutual funds or ETFs. These financial products track the Bitcoin price and allow investors to profit from price fluctuations without having to hold Bitcoins themselves. This provides a hassle-free way for people who don’t want to deal with managing a digital wallet.
- Investing in blockchain companies
Those who don’t want to invest directly in Bitcoin can also participate indirectly in the development of Bitcoin through shares in companies that use blockchain technology. Companies that are built on blockchain technology are essential for the continued growth and improvement of cryptocurrencies. Investing in such companies or ETFs that pool these stocks can be a less volatile way to participate in the growth of the cryptocurrency industry.
- Bitcoin mining
Mining is another way to earn Bitcoin. As mentioned at the beginning, miners provide their computing power to verify transactions in the blockchain and create new blocks. They then receive Bitcoins as a reward. However, as a result of what’s known as “Bitcoin halving”, the reward for mining is halved roughly every four years. This means that over time, miners receive fewer Bitcoins per block, making mining less and less profitable — plus, this process also demands significant investment in hardware and outlay in terms of power costs. All this means that mining’s no longer as profitable as it was in the early years of Bitcoin, especially for individuals. Nowadays, it’s mainly large companies that do the mining.
What are the pros and cons of Bitcoin?
Bitcoin has some pros and cons as a cryptocurrency. Let’s take a look.
The advantages of Bitcoin
While Bitcoin is a novel way to send and receive money, it’s important to recognize that it’s a sophisticated system that’s no simpler than older, traditional money transfer methods. That said, the advantages of this cryptocurrency include:
- Decentralization: The cryptocurrency Bitcoin is controlled neither by banks nor the state. There is no central administrative authority that controls the transfer of money. Bitcoin is therefore not vulnerable to external interference or manipulation.
- Transparency: Absolutely all Bitcoin transactions are stored in the blockchain. This means that every single transfer is publicly visible and it can’t be altered or deleted once confirmed.
- Security: Because all transactions are openly visible, Bitcoin is a secure way to transfer money. The high level of security and transparency inherent in blockchain technology make it very difficult for anyone to manipulate or steal from the system as everything is recorded.
- Anonymity: Transactions are made between private and public keys and don’t involve personal details, so buyers and sellers remain anonymous.
- Fees: The transaction fees for sending Bitcoins are significantly lower than with traditional bank transfers.
- Speed: You can transfer Bitcoin anywhere in the world relatively quickly — another way Bitcoin differs significantly from traditional bank transfers.
The disadvantages of Bitcoin
Besides its numerous advantages, Bitcoin also has disadvantages — making it impossible to wholeheartedly recommend trading the virtual currency. These downsides include:
- Price fluctuations: Bitcoins are a risky investment because their value can fluctuate greatly depending on supply and demand — the more people buy Bitcoins, the more its value gets driven up. The way its value changes over time is similar to how the value of stocks on a traditional stock exchange changes, making it a speculative investment.
- Security: Even though blockchain is considered a very secure technology, as with all virtual spaces there are security risks. Cybercriminals and especially hackers can access software wallets, which is why experts recommend hardware wallets.
- Environmental impact: The mining process through which new Bitcoins and blocks are created requires a lot of computing power and therefore energy. Because of the amount of energy that’s consumed to process Bitcoin transactions, Bitcoin’s eco-footprint is greater than traditional banking methods.
- Complexity: Bitcoins are a purely virtual, sophisticated system. This means that beginners and technically inexperienced users in particular will find it difficult dealing with the cryptocurrency.
How does blockchain technology work?
The cryptocurrency Bitcoin is based on blockchain technology. The basic principle behind this is simple: A block stores multiple transactions transparently. Many blocks connect to form a chain. This chain contains all the transactions where Bitcoins have been sent or received. Each block contains the list of transactions and the unique hash value of the previous block, ensuring the integrity of the entire chain. This hash value is generated based on the unique information stored within a block. If even the smallest change is made to the block, the entire hash value changes immediately. Any potential manipulation would be spotted straight away and the network would be informed.
The blockchain is a decentralized system for data transfer because no single administrator controls all the data. The blockchain is distributed across the computers of all users in the network, where each computer is its own node. All transactions are always communicated directly between the users involved or between nodes, which is why the transfer of Bitcoins is also referred to as peer to peer. What’s special about this is that each individual node has a copy of the entire blockchain, making manipulation almost impossible.
In short: The blockchain is transparent, secure, and immutable, providing a decentralized way to manage and store data independently of central authorities.
How Bitcoin transactions work
For a blockchain to function properly, all the nodes involved must agree on the current state of the blockchain — ensuring there’s only one, universally accepted version of the data chain. This agreement and verification of the blockchain is achieved through a consensus mechanism, in which special algorithms are used to ensure that the majority of nodes agree on the same copy of the blockchain and that all transactions are correct and immutable. Bitcoin relies on what’s known as proof of work (PoW) to achieve this.
Every Bitcoin transaction requires a sender and a receiver. Both parties have their own Bitcoin address, which is comparable to their own account number. These addresses are generated using a cryptographic, or encrypting, process. This process also creates the public key and the private key for the user. Here’s a recap: The public key is the Bitcoin address, while the private key enables access to and management of Bitcoins.
Basically, a Bitcoin transaction works like this:
- The amount: The sender specifies the amount they want to send from their wallet to another wallet.
- The signature: The sender signs and authorizes the transaction using their private key.
- The transfer: The sender transmits the transaction to the Bitcoin network.
- The mempool: The transaction ends up in the mempool with all the other global transactions. This is a kind of catchment area for all transactions that are yet to be confirmed.
- Mining: This is where volunteer miners come in, using their computers to complete or solve complex tasks. This is referred to as PoW.
Let’s take a quick look at PoW: Every 10 minutes, the miners’ nodes collect and group the open transactions from the mempool into new blocks. Once the 10 minutes have elapsed, complex cryptographic tasks must be solved to add a new block to the existing blockchain. The miner who first solves a computational problem and so initially creates the new block is rewarded with one unit of the cryptocurrency. Important to know: The higher the fee for a transaction, the higher the priority in the mempool.
Once a block is created, the entire network is informed. The other nodes check the solution to the task for correctness and confirm the work. This is the eponymous proof of work. Once the network confirms the block, it officially becomes part of the blockchain. From this point on, the transaction is considered confirmed.
In short: Think of the blockchain as a kind of digital public ledger. All transactions are stored chronologically within the blockchain and are transparently visible to all users in the network. Several Bitcoin transactions are grouped into a block in the blockchain and attached to the preceding block. It’s referred to as the blockchain as hashes connect the individual blocks. The miners in the network verify all the transactions, solve complex computational tasks, and confirm each individual block. Once a block has been created, it cannot be changed afterwards.
What are the risks of Bitcoin?
Although Bitcoin and the associated decentralized blockchain technology are very secure, they are not entirely risk-free. Let’s take a look at the biggest threats.
51% attack
The 51% attack is a theoretical scenario in which a miner (or group of miners) controls more than 50% of the computing power within the entire Bitcoin network. This majority control would enable the single entity or group of entities to manipulate the blockchain. In this case, the miners would expand their own version of the blockchain more quickly and overwrite the official, legitimate blockchain in their favor.
A typical example of this is double spending, where confirmed transactions in the blockchain could be reversed, allowing the issued Bitcoins to be used again. Due to the enormous size of the network, such an attack is not only unlikely in practice but also economically unattractive.
Phishing/social engineering
In the case of phishing, users are tricked into sharing their personal login information to their wallets, their private keys, or the user details for their crypto accounts. In this way, cybercriminals gain access to victims’ Bitcoins and steal them.
The most common forms of phishing include:
- Spoof emails: Cybercriminals pose as legitimate individuals or organizations, most often as reputable crypto services. In the majority of cases, these emails link to fake websites that look very similar to the official ones.
- Bogus websites: Links from emails, text messages, and forums, for example, take potential victims to websites that look like legitimate wallets and crypto exchanges. Users go to log in as usual and in doing so reveal their sensitive login data and private keys.
- Fake support: Using social engineering techniques, cybercriminals pose as support staff for a Bitcoin service where potential victims are proactively contacted and informed of problems with their account. To help them out straight away, users are required to share their private key and access details.
Malware and viruses
Malicious malware is spread primarily via phishing emails, bogus websites, and even apps. With cryptocurrencies, malware often manipulates the user’s clipboard, allowing cybercriminals to alter the recipient’s Bitcoin address without being noticed. The user thinks that their money is being sent to a legitimate address when in fact the transaction goes to the criminal’s address.
Here’s an example: A user copies the recipient’s correct Bitcoin address to their wallet. But in the background, the malware manipulates the recipient’s public address so the transaction goes to the cybercriminal.
How to protect your crypto wallet
Take the following security steps to protect your crypto wallet from cybercriminals and unauthorized access.
Protect your PC and mobile devices: Install antivirus protection on every internet-enabled computer and device that you use to manage your Bitcoins. In doing so, you prevent keyloggers and spyware from ending up on your device, plus you close backdoors and other security holes that cybercriminals can exploit to get their hands on your money.
Secure your internet connection: Make sure your network router’s firewall is on — and never use public or unencrypted Wi-Fi hotspots when trading cryptocurrencies.
Back up your data regularly: Use a backup service that encrypts your data both during transmission and storage. And turn on two-factor authentication (2FA) to add an additional layer of security when using web services like Dropbox and the like.
Protect your passwords: Keep your passwords to yourself and never ever share them with others — especially if asked to do so by email or text.
Surf even more securely with Avira Phantom VPN
Transferring Bitcoins is secure, transparent, and anonymous. With Avira Phantom VPN, you can also protect yourself from cybercriminals gaining unauthorized access and spying on you. The tool secures your internet connection when using public Wi-Fi hotspots by routing everything you send and receive through an encrypted, private tunnel. It also prevents advertisers and internet spies from determining your location and tracking what you do online.
Another of Avira Phantom VPN‘s practical features is that it helps you bypass geo-blocking — so when you travel, you can enjoy media and website content that’s normally restricted to specific geographic locations.
