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Bitcoin: How it works, its advantages and limitations

- Reading Time: 4 minutes

Bitcoin is one of the most popular cryptocurrencies today. And it's as popular with seasoned traders as it is with budding investors. So what exactly is it? How does Bitcoin work? What are its advantages? And the drawbacks? Find out in this article.

What is Bitcoin?

A reminder about cryptocurrencies

Bitcoin is a cryptocurrency (in fact, it’s the first, the most popular and the most expensive). In other words, it’s a digital asset secured by cryptography. While these virtual currencies are not physically available (like banknotes or coins), they can nevertheless be exchanged like these currencies and act as a means of payment.

But beware: they are not traditional currencies. The special feature of cryptocurrencies is that they are totally decentralized. There is no government, financial institution or other authority to regulate them. Instead, they are managed by users, and their value depends on supply and demand. It’s a peer-to-peer system.

The birth of Bitcoin

Getting back to Bitcoin, this technology was developed in 2009 by an anonymous individual by the name of Satoshi Nakamoto. At present, no one knows whether this is a single developer or a group of individuals.

According to its creator, Bitcoin aims to create “a new, completely decentralized electronic money system, with no server or central authority”. The idea is to design a system in which there are no intermediaries for financial transactions.

In the absence of a trusted third party, investors wishing to purchase Bitcoins must open a wallet. These exchange platforms enable cryptocurrencies to be bought, sold and traded.

How does Bitcoin work?

To function, Bitcoin uses blockchain technology. This is an information storage and transmission technology that connects buyers and sellers. All in complete security and transparency.

While the aim of blockchain is to structure large volumes of information, it is no ordinary database. And for good reason: this technology takes the form of a set of interconnected blocks managed by electronic devices. Each block contains information which, once stored, cannot be modified. As soon as new information is received, the block is sealed by a computer code and added to another code. This forms a chain of blocks (hence blockchain).

All new transactions are grouped together in blocks. To add new data to the blocks, you need to mine Bitcoins. This means performing increasingly complex mathematical equations to verify the accuracy of the blocks.

These equations are necessary because Bitcoin’s founders limited the amount of currency in circulation to 21 million units. However, at the start of 2023, there are already 18.3 million Bitcoins in circulation. The idea is to divide Bitcoins into small fractions (down to one hundred millionth) to ensure their availability. And all the while guaranteeing their accuracy.

How to use Bitcoins

As cryptocurrencies go, Bitcoin is primarily a payment system. Even if they are not yet accepted everywhere, their use is becoming increasingly democratized. It is possible, for example, to buy a Tesla car with Bitcoins.

As well as being a means of payment, Bitcoins are mainly used as financial investments. And with good reason: the high volatility of crypto-currencies means they can generate colossal gains over the long term (but also significant losses). In fact, the first cryptocurrency investors were able to earn several billion dollars from their investment.

What are the advantages of Bitcoin?

Bitcoin is so popular because of its many advantages:

  • Security: this is guaranteed by the blockchain technology that supports cryptocurrencies. But beware: for investors, this security can be undermined through a poor choice of asset platform.
  • Transparency: by cutting out the middleman in financial transactions, Bitcoins offer users maximum transparency.
  • Transaction speed: through the virtual wallet, it is possible to buy or sell Bitcoins in just a few seconds.
  • Opportunities: investing in a digital currency such as Bitcoin also represents excellent financial opportunities for holders of these assets. But beware: while the potential gains are particularly high, so are the risks of loss.

What are the disadvantages of Bitcoin?

Despite the opportunities, Bitcoin also represents a colossal risk for investors. And for good reason: these crypto-currencies are extremely volatile. As proof, in November 2021, the value of Bitcoin reached a record $68,513. In the space of a year, the Bitcoin price fell to less than $16,000. During this period, this crypto asset lost over 75% of its value. So it’s a good idea to be well-informed before investing too heavily in Bitcoins.

In addition to its high volatility, Bitcoin is also a victim of its lack of regulation. Indeed, it is particularly popular with criminals. Particularly in the case of cyber attacks, ransom demands are most often made in cryptocurrencies.

This also poses a problem in the event of loss or theft. Bitcoins are virtually impossible to recover. And with good reason: as soon as a transaction is recorded on the blockchain, it is definitive.

Finally, Bitcoin is also a very energy-intensive technology. According to a study by Cambridge University, Bitcoins consume an average of 97.11 TWh per year (taking into account the computing power of network computers, the price per kWh and the average consumption of a machine). Against a backdrop of global warming, such energy expenditure poses a real problem.

Bitcoin: towards a new monetary order?

While Bitcoin is still popular, despite wild fluctuations, the future of this cryptocurrency is still uncertain. Proponents continue to claim that Bitcoin will replace centralized, government-controlled money. This is a possibility, but nothing is less certain.

So will Bitcoin surpass more “traditional” currencies? Will it disappear altogether in a few years’ time? Or will it continue to coexist with other payment methods?

We can’t give you an answer. What is certain is that Bitcoin has revolutionized the banking sector by demonstrating that a virtual currency can function perfectly well without the intervention of a central authority.

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