Summary: Here’s what to know about Bitcoin, including how it works and the risks of investing.
What is Bitcoin?
Bitcoin is considered the first cryptocurrency, launched in 2009 by an anonymous person or group named Satoshi Nakamoto. It allows users to make peer-to-peer transactions with digital money without a third-party intermediary, such as a bank or credit card company. Instead, Bitcoin uses algorithms to verify transactions, which are recorded in the blockchain. There is a limited number of bitcoins that can be created, and of the 21 million total, more than 19 million have been mined already.
By design, Bitcoin is public. So, theoretically, anyone with a computer and internet can become a miner—no one person or group owns or controls it. It’s decentralized, meaning it doesn’t have a single server, organization, or computer “running Bitcoin.” Instead, different stakeholders control different aspects.
The Bitcoin network includes two main components: the actual currency, bitcoin; and the blockchain, the technology behind transaction verification. The Bitcoin blockchain, a roughly 450 gigabyte file, is a record of all bitcoin transactions since Bitcoin was introduced. Approximately every 10 minutes a new block of transactions is added to the blockchain.
Miners are the people that use their computing power to make the Bitcoin network run. Miners are continuously competing to verify Bitcoin transactions by solving highly complicated math problems. The first miner to confirm the pending transactions and create a new block on the blockchain is awarded a newly minted bitcoin.
While technically anyone can mine bitcoin, the amount of processing power and electricity needed to mine competitively is huge. This means most mining is done by specialized companies or groups who pool their resources together to maximize their chances of successfully solving the complex math problems required to unlock new bitcoin.
Risks and investing considerations
While enthusiasts may look to Bitcoin as a new frontier in financial markets, the risks of investing in Bitcoin abound. It’s important to understand these risks:
Increasing processing power and techniques like quantum computing could eventually crack the encryption backing Bitcoin, opening the possibility that owners’ wallets will be hacked.
Flaws in the code could cause an unpredictable supply of Bitcoin or cause the network to stop working as expected.
Laws that prohibit or discourage activity in Bitcoin and other cryptocurrencies can suppress demand or disrupt the network.
Bitcoin is one of the most volatile assets—significantly more volatile than the S&P 500® or Nasdaq-100®.
Many cryptocurrencies including bitcoin have concentrated ownership. If one or more of the addresses that hold the majority of total bitcoins was forced to sell, or had their assets stolen and sold, the price could be impacted.
Lack of central governance
Since Bitcoin is not issued or controlled by a particular person or group, there may not be any recourse if it’s lost or stolen.
Association with illegal activities
New technologies like cryptocurrency are often used to perpetrate fraudulent investment schemes.
Because cryptocurrencies are relatively new, there may be unforeseen risks in the future that are not evident now.
Bottom line when investing in Bitcoin: Proceed with caution. Like other emerging technology, the fate of Bitcoin is unpredictable, and some challenges are likely still unknown.
Investors who are looking to gain exposure should do their homework. Get familiar with the unique crypto terminology, use cases, investment products, and risks.
Ultimately, all investing decisions should align with financial goals and individual risk tolerance.