Bitcoin 101

Bitcoin is a form of digital currency introduced in 2008 by a mysterious person, or group of people, known only as Satoshi Nakamoto.

Unlike traditional currencies, Bitcoin operates as a decentralized system, free from the control of central banks or governments. Instead, it relies on a network of users who collectively maintain its operations via a digital ledger called a blockchain.

The Bitcoin protocol is built on three essential components:

• Public-private key cryptography: Wallet software assigns Bitcoin owners both a public key and a private key. A public key is used to create a public wallet address for receiving inbound transactions and verifying digital signatures. A private key functions like a password, and is used to create digital signatures that prove you own funds when sending transactions.
• Peer-to-peer networking: Nodes (computers running the software) review transactions to ensure the software’s rules are being followed. Bitcoin miners (nodes that use a specialized computer program that allows them to verify newly submitted transactions) then compete for the right to propose a new batch of pending transactions to join the blockchain.
• A finite supply: According to the software rules, no more than 21 million Bitcoin can ever be in circulation—a limit that gives Bitcoin value.

Bitcoin was created to function as a digital medium of exchange, enabling users to buy, sell and trade without centralized intermediaries. Its decentralized nature and strict supply rules contribute to its unique value proposition.

By understanding Bitcoin, you can gain insights into a revolutionary financial technology, explore its potential benefits and risks, and discover how it's reshaping the global financial landscape. In this guide, we'll delve into the fundamentals of Bitcoin, explore its various use cases and discuss the factors that influence its price.

Satoshi Nakamoto is the pseudonym used by the unknown creator of Bitcoin and Bitcoin's blockchain technology.

Despite the widespread use and popularity of Bitcoin, the true identity of Satoshi Nakamoto remains a mystery. Over the years, many people have claimed to be the real Satoshi Nakamoto, but none of them have been able to provide convincing evidence to support their claims.

Whoever Nakamoto is or was, they went to great lengths to remain anonymous. This mystery has helped increase the allure and fascination surrounding the origins of Bitcoin. Nakamoto mined the first Bitcoin block, called the Genesis Block, on January 3, 2009.

Notable cryptographers, such as computer programmers Nick Szabo and the late Hal Finney, are often speculated to be Nakamoto. In January 2009, Nakamoto sent 10 BTC to Finney, marking the first recorded Bitcoin transaction. This transaction demonstrated Bitcoin's potential as a digital currency and laid the groundwork for its future use.

The first known usage of Bitcoin as a form of payment occurred when a developer named Laszlo Hanyecz bought two pizzas with 40,000 Bitcoin. The online payment, which occurred on May 22, 2010, is now known as Bitcoin Pizza Day.

While Bitcoin can safely claim its title as the world’s first successful cryptocurrency, its technology is built on decades of ideas for how cryptography could help create digital money.

These formative projects include:

• B-money (1998): Proposed by Wei Dai, an anonymous, distributed digital cash system.
• Bit Gold (1998-2005): Created by Nick Szabo, an attempt to create a type of scarce online commodity.
• eCash (1983): Developed by David Chaum, the first major attempt to create anonymous online payments.
• Hashcash (mid-1990s): Designed by Adam Back, a proof-of-work system designed to prevent email spam.
• Reusable proof of work (2004): Developed by Hal Finney, a precursor to Bitcoin’s proof-of-work (PoW) consensus mechanism and network security.

Nakamoto began writing the code for Bitcoin as early as 2007. This work led to the publication of Bitcoin's white paper in 2008, explaining the proposed system, and the release of Bitcoin 0.1, the first version of the software, on January 9, 2009.

Nakamoto authored a trove of emails and forum posts offering his or her thoughts about the future of Bitcoin prior to leaving the project in 2011.

Today, the Bitcoin network is collectively managed by a global network of developers, miners and nodes who contribute to Bitcoin’s code and its operations.

Bitcoin (BTC) is a virtual currency that operates through the decentralized Bitcoin network, meaning no government or financial institution controls it. All transactions are stored on a public ledger called the Bitcoin blockchain, which serves as a transparent, accessible database.

The Bitcoin network is a decentralized virtual currency system that operates without a central bank, government authority or middlemen. Instead, it relies on a network of computers around the world to maintain the integrity of the system.

A globally distributed community of nodes makes up the Bitcoin network. Nodes are computers that are connected to the Bitcoin network and help validate transactions. Anyone in the world can run their own node and participate in the network, ensuring that no single entity controls the blockchain. This decentralization helps make the system resilient and secure.

When someone sends Bitcoin to another person, the transaction is verified by a network of "miners." Miners use their machines to generate hashes in a trial-and-error process, aiming to produce a hash that meets or exceeds a target set by the network. This process is designed to encourage miners to propose valid new blocks, by requiring them to expend time, energy and money to participate in the network.

This method for generating agreement among users without relying on centralized control is known as a consensus mechanism.

Successful miners who generate winning hashes are granted the right to add their proposed block to the blockchain. The remaining miners in the network then collectively verify the block transactions. They do this by checking that the sender has enough Bitcoin to make the transaction and is not trying to double-spend their balance.

Once the network verifies the proposed block, it permanently joins the Bitcoin blockchain. No one can alter the data stored in blocks once they're committed to the blockchain.

There are approximately 20 million Bitcoin in circulation.

To incentivize miners to continue competing against each other to propose new blocks and secure the network, winners of the Bitcoin mining competition are rewarded with a block reward. This reward consists of newly minted Bitcoin, plus any fees attached to the transactions included in the proposed block.

Satoshi Nakamoto designed the Bitcoin network to be self-regulating. Bitcoin’s mining difficulty adjusts automatically every 2,016 blocks (about every two weeks) to maintain a 10-minute average block discovery time. If blocks are mined too quickly, the algorithm raises the difficulty; if too slowly, it lowers it. This ensures a steady and predictable flow of new Bitcoin entering circulation.

As of April 2024, the block reward is 3.125 BTC per block. This reward is halved every 210,000 blocks in a process known as the Bitcoin halving. Once the number of Bitcoin in circulation reaches 21 million, the maximum limit, the protocol will release no more coins.

While Bitcoin mining is energy-intensive, recent advances in technology have reduced the greenhouse gas emissions associated with it. Many major miners now focus on using renewable energy sources. However, those mining at home may still need specialized hardware and software that contribute to higher energy consumption.

Bitcoin was initially designed as a peer-to-peer payment system.

However, its expanding use cases are driven by factors such as its growing value, competition from other blockchains and cryptocurrencies, and advancements in the underlying technology that processes information for the Bitcoin blockchain.

Payments

One of the earliest and easiest uses of Bitcoin was as an electronic cash system. It allows users to transfer funds online without the need for a trusted intermediary like a bank or payment processor. Bitcoin transactions are often faster and more cost-effective than traditional international payment methods.

To make payments with Bitcoin, users need a digital wallet that stores their private keys. This component is essential for accessing and spending their Bitcoin. The Bitcoin network verifies and processes transactions, ensuring their accuracy and security.

Many merchants now accept Bitcoin as a payment method, including online retailers and even some physical stores. However, it is still not as widely accepted as traditional payment methods like credit cards or PayPal.

Store of Value

Another use of Bitcoin is as a store of value.

Because the supply is managed by computer code and follows a strict issuance schedule, some people see it as a more stable and secure form of currency.

Bitcoin's limited supply, resistance to counterfeiting, and portability further enhance its appeal as a store of value. Compared to gold, Bitcoin is easier and cheaper to store, more divisible, and highly portable. Some people buy Bitcoin as a speculative investment, hoping that its value will steadily increase over time.

However, Bitcoin's value can be volatile, and its price has fluctuated widely in the past. This price volatility means that it may not be suitable for everyone as a short-term investment.

Other Bitcoin Use Cases

While Bitcoin serves as a viable medium of exchange and store of value beyond the traditional financial system, it is much more than that.

Today, Bitcoin is being used in a variety of ways, far beyond its initial purpose as "a peer-to-peer electronic cash system." Many forward looking individuals all over the world are building on Bitcoin and finding innovative

The most common way to buy Bitcoin is on an exchange, which allows you to exchange your pounds/dollars into bitcoin. Whilst BPUK recommend Coincorner for those in the UK, you should be aware of the following, whatever exchange you pick:

Research And Reputation: Dive deep, looking beyond just the exchange's website. Seek reviews, news articles, and firsthand experiences on platforms like Reddit, specialist forums, and Twitter.

Fees And Hidden Costs: Most exchanges impose fees on trading or withdrawals. While some advertise zero fees, they might profit through other means, such as arbitrage. Carefully assess the fee structure, and be wary of any hidden costs.

Security Protocols: Ensure the exchange adopts top-tier security. Look for features like two-factor authentication (2FA), cold storage options, withdrawal whitelists, and encrypted email communication.

Regulatory Compliance: Choose exchanges that are compliant with local regulations. While not a foolproof safety net, regulatory adherence can add an extra layer of protection.

Transparency: Opt for exchanges that are open about their operations. Regular audit reports, clear communication channels, and detailed operational procedures can be positive indicators.

Liquidity: Liquidity is a vital factor. An exchange with higher liquidity indicates a vibrant market, often leading to better price discovery and easier trades.

User Experience and Support: A seamless interface combined with stellar customer support can be a hallmark of a reliable exchange. Conversely, frequent complaints about platform usability or support should raise red flags.

Insurance: If you want your bitcoin to be insured by an exchange, you must pay attention to the small print. Insurance often covers the entire exchange, not individual users. Typically, the major creditors receive payment first.

Peer-to-peer (P2P) exchanges allow users to trade directly with each other, eliminating the need for a central authority and giving participants full control over transaction terms, which enhances flexibility. To ensure security, these platforms use escrow services to hold funds until both parties confirm the transaction’s completion, reducing the risk of fraud. Unlike centralised exchanges, P2P platforms act mainly as facilitators, providing listings, communication tools, and escrow services, while users independently determine pricing, timing, and trade conditions.

Advantages of P2P exchanges are:

1. Enhanced Privacy and Anonymity - they enhance privacy by often skipping mandatory KYC procedures, making them attractive to users concerned about financial surveillance
2. Decentralised Control of Funds - users maintain direct control over their funds, eliminating custodial risk and dependence on central entities
3. Lower Entry Barriers - users can start trading quickly, without the need to complete checks and questionnaires ahead of trading

Disadvantages of P2P exchanges are:

1. Higher Risk of Scams and Fraud - these exchanges are more prone to scams and fraud due to limited oversight, leaving users responsible for judging counterparties’ credibility
2. Longer Trade Completion Times - trades often take longer to complete because they depend on manual agreement and responsiveness from both parties.
3. More Difficult to Use - user experience on P2P platforms can be inconsistent due to delays, disputes, and unreliable participants, unlike the predictability of centralised platforms.

Examples of P2P exchanges are Hodl Hodl,  Bisq and Vexl.

Bitcoin can be stored using a custodial service, such as an exchange, ideally offering an insurance policy and segregating funds. Holders must adopt risk mitigation tactics and conduct thorough research on how the funds are segregated and the specifics of the insurance policy.

Advantages of using a custodial service are:

1. Ease Of Use: This is especially beneficial for bitcoin novices or those who aren't technologically inclined.
2. Convenience: No need to generate, protect, or store your own keys. You can access your bitcoins anytime and anywhere with an internet connection and a password.
3. Support: Access to customer service and technical support if issues or queries arise.
4. Recovery Options: The ability to recover your account if your password is forgotten or if you lose your device.

Disadvantages of using a custodial service are:

1. Trust Dependency: You must rely on the custodial service to securely handle your keys without misuse.
2. Security Concerns: Potential risks of hacks, shutdowns, or compromise by regulators/malicious entities.
3. Regulations And Restrictions: Compliance with the service's rules may mean sharing personal information, identity verification, or transaction limits. You may also face taxes, reporting duties, or other legal obligations.
4. Rehypothecation Risks: Following the FTX downfall, it was revealed that the exchange might not have had bitcoin in custody, even though user balances indicated otherwise.

These disadvantages are partially, but not completely, mitigated by Multi-Institutional Custody providers, such as Onramp, where keys are distributed over multiple institutions. This helps to mitigate the risk of one institution being a single point of failure.

To reduce risks associated with custodial services, one can take full control of your assets by moving your bitcoin off exchanges and into a private wallet where you alone hold the keys - Bitcoin is one of the few assets where this is possible for a low cost. While technology and controls around institutional custody are constantly improving, Bitcoin's history is littered with custodians who have breached users' trust either by poor security practices or by fractionally reserving users' bitcoin. "Not your keys, not your coins" is a famous mantra in the space for good reason.

Single Signature Hardware Wallet

One of the most straightforward forms of self-custody is using a hardware wallet with a single signature setup. A hardware wallet is a small device designed to store and protect your private keys, giving you secure access to your funds. Typically, the device will generate a sequence of 24 random words, which you must write down and keep somewhere safe and hidden. Examples of popular hardware wallets include Trezor and Coldcard. When it comes to storage, always keep the hardware wallet itself in a secure spot (such as a home safe or a bank deposit box) and ensure your recovery phrase is stored separately—ideally somewhere durable, private, and resistant to both fire and water damage. As general best practice, purchase your hardware wallet directly from the manufacturer or one of their approved retailers. Buying from resellers on platforms like eBay or Amazon introduces the risk of tampered devices or hidden malware.

Although this method allows you to keep your bitcoin safely offline, relying on a single signature setup carries the risk of a single point of failure. For instance, if your backup phrase is misplaced or stolen, or if the device itself goes missing, you could lose access to your funds—an issue that becomes more critical as the value of your holdings grows. 

Multi-Signature Wallet ('Multisig')

Another method of securing your bitcoins is using a “Multi-signature" wallet. This security technique requires multiple private keys to spend funds, ensuring the safety of the assets even if one key is lost or compromised. A multi-signature wallet can be setup in many ways but a typical set-up is a '2 of 3' where 2 of out 3 signers must validate the transaction for it to be executed. 

It is possible to setup and maintain a multi-signature vault yourself using open source software such as Sparrow Wallet, together with some hardware wallets (such as the ones mentioned above). However, this requires a high degree of technical competence. 

There are several providers which makes setting up and managing a multi-signature vault more user-friendly, including Bitkey, Casa, Unchained and Nunchuk. The solution which is best for you depends on your personal situation (such amount of bitcoin held, technical knowledge of yourself / any potential inheritors, your attitude towards privacy/KYC, your view of the usability / security trade offs that different providers are making etc).

Whatever form of self-custody you choose, the key is ensuring that you have done the work to understand the benefits/risks of your particular setup. With great power, comes great responsibility - with self-custody it is ultimately you that is responsible for storing your bitcoin.

The Lightning Network (also referred to as Lightning, or LN) is a scalability solution built on top of Bitcoin that allows users to quickly send and receive BTC with virtually no fees. 

Lightning is considered to be an off-chain, Layer 2, solution, meaning that transfers are done via a new network of payment channels anchored in Bitcoin’s blockchain.

As the world’s first and leading cryptocurrency, Bitcoin has become an important means of transacting value because, for the first time, any holder has the freedom to:

• Hold bitcoin without unexpected supply inflation 
• Send and receive bitcoin without the need for an intermediary
• Verify transactions using their own nodes
   

However, many agree that Bitcoin still needs better functionality in order to become a global medium of exchange and a peer-to-peer cash system as originally laid out in the seminal whitepaper Bitcoin: A Peer-to-Peer Electronic Cash System. Currently, Bitcoin faces the following limitations:

• Fees – As block space is limited, mining fees can fluctuate wildly based on demand for transaction inclusion.
• Transactions per second – Bitcoin is only capable of approximately 7 transactions per second (TPS)
• Network congestion –  Slow block times and heightened use of the network can result in delays in transaction confirmations
   

The Bitcoin Lightning Network aims to solve these limitations by providing instant and inexpensive transactions while achieving a throughput of approximately 1 million transactions per second. 

While Lightning can be used for any type of transfer, most find it useful for micropayments or smaller transfers that are typically uneconomical due to base layer fees.

As of August 2021, Lightning Network stats show that more than 2,000 BTC have been transferred using the network. 

It is important to note that the Lightning Network does not implement a new token and allows for the same freedoms as Bitcoin – it’s decentralized, permissionless, and open source. Its security derives from on-chain Bitcoin transactions, which use smart contracts to enable instant, off-chain settlements. 

Bitcoin's Lightning Network was developed mainly to further the adoption of day to day bitcoin payments by increasing transaction speeds and decreasing transaction fees. However, opening payment channels on a second layer has brought several other benefits. 

Scalability

Bitcoin is a global broadcast system where everyone verifies every transaction before adding them to the blockchain. While this system allows Bitcoin to be truly decentralized, its main drawback is that it can only allow for roughly seven transactions per second (TPS). 

Lightning’s channel system allows for reusable routes that are added to the Bitcoin blockchain once channels are closed. Theoretically, this means that LN can help scale Bitcoin’s TPS to up to one million TPS.

Privacy

Transactions on the Bitcoin blockchain can be traced from wallet to wallet. Using the Lightning Network, only the opening and closing of channels is recorded to the chain, meaning that most micropayments will be nearly untraceable.

The Lightning Network is built off-chain for users to conduct bitcoin transfers in an effort to reduce on-chain network congestion. 

To start, a channel is opened between two parties where they can submit funds. They can then use this channel to send BTC between themselves instantly, with near-zero fees, without needing to broadcast every transaction to the base layer of the Bitcoin blockchain. 

Either party can settle on the Bitcoin blockchain and close the channel at any point in time. 

When the channel is closed and settled on the base layer blockchain, the funds are sent to each party according to the channel’s transfer history, which is summarized in its entirety as a single transaction on the Bitcoin blockchain. The only Lightning-related transactions that are broadcast to the Bitcoin network are the opening and closing of channels. This helps free up block space, resulting in lower network fees and an increase in economic activity per block.

The direct payment channel between the two parties can also become part of the larger Lightning Network. If two parties don’t have a direct channel, they may transfer funds through interconnected pathways. Lightning nodes on the network search for the best route to perform the transaction. 

For example, if your friend (who you have a channel with) takes you to their favorite coffee shop, who they have a channel with, Lightning Network would allow you to route your payment through your friend when you pay for coffee, without you needing to open a new channel with the coffee shop. This all happens in a few seconds and is not subject to long waits or high fees like on the main blockchain.

Of note, Bitcoin on-chain analysts can quickly identify these transactions as coming from the Lightning Network because they appear as complex smart contracts that include the various public keys and signatures used in the channel. This issue is tackled by the Bitcoin Improvement Proposals included in the Taproot upgrade, which aim to improve the privacy of each transaction.