What Is Bitcoin?

Bitcoin Explained

Bitcoin is a decentralized cryptocurrency that uses peer-to-peer technology for instant payments between people or businesses. It can be bought and used as a currency and also as a type of investment.

Learn more about how Bitcoin works and how people use it.

Definition and Example of Bitcoin

Bitcoin is a form of digital currency that is created and held electronically on a computer. Bitcoins are not physical money like dollars nor are they recognized as an exchangeable currency by central banks or monetary authorities.

Bitcoin is widely considered to be the first cryptocurrency. It is produced, or "mined," using advanced computer software that solves mathematical problems.

The Commodity Futures Trading Commission (CFTC) in the U.S. designates bitcoin as a commodity since bitcoin exchanges offer derivative contracts or options on the value of the cryptocurrency. Even with the introduction of bitcoin-linked ETFs, it is difficult to categorize bitcoin because it is still new and different from other assets available.

Bitcoin has several attributes that set it aside from traditional currencies as a pan-global means of exchange. Central banks or monetary authorities do not control the number of bitcoins, and bitcoin is decentralized, making it global. If you have a computer, you can set up a bitcoin address to receive or transfer bitcoins in seconds. Bitcoin is somewhat anonymous and allows you to maintain multiple addresses—setting up an address requires no personal information.

How Bitcoin Works

Mining is the term for the work that is done to create a bitcoin. A bitcoin is created when the mining software solves an increasingly complex mathematical problem. When a bitcoin is created, it enters circulation and can be used in transactions or stored.

A bitcoin is also be divided into smaller increments, called satoshis. There are 100 million satoshis to one bitcoin that can be used in transactions based on their market value. For example, if one bitcoin is worth $66,000, then one satoshi is worth $.00066. You'd need 1,515 satoshis to purchase an item that was $1.

Bitcoin is a fixed asset because there are only 21 million coins—there are nearly 19 million in circulation.

One of the most interesting inventions that came with bitcoin is distributed ledger technology (DLT), also called the blockchain. DLT has amazing potential for businesses and consumers who need a secure way to record asset transactions. The blockchain cannot be edited by anyone, tracks ownership, and allows for immediate and efficient bitcoin transfers.

You can use bitcoin via computer, phone, or other devices to pay for items independent of banks or governmental authorities. For this reason, it is often stereotyped as being the currency used in black-market transactions. However, as the technology grows in popularity, mainstream retailers are beginning to adopt it as a means of payment.

Bitcoin does not flow through the traditional banking system; rather, it flows from one digital wallet to another. Bitcoin cannot be held or kept in a pocket or physical wallets like coins or paper currency; it is purely a computer-based means of exchange.

Notable Happenings

The anonymous creator(s) of bitcoin, known by the name Satoshi Nakamoto, first proposed bitcoin in a 2009 white paper as a means of payment based on mathematics. The idea behind bitcoin was to create a currency system that didn't involve banks; instead, it would operate using a decentralized ledger known as a blockchain.

Bitcoin's value first surpassed $1,000 in January of 2017 before hitting a peak later that year. Since that time, its value has seen periods of tremendous growth as well as big sell-offs. Bitcoin’s price raced to more than $19,000 by the end of 2017, falling to nearly $3,000 just a year later. Bitcoin reached a high of nearly $65,000 by April 2021. That high was smashed in October 2021 when ProShares introduced the first bitcoin-linked exchange-traded fund on the New York Stock Exchange.

Is Bitcoin Legal?

Bitcoin and other cryptocurrencies are legal in the U.S. and several other countries around the world. However, bitcoin and other cryptocurrencies are not legal tender, which means they are not backed by any government; therefore, consumers or businesses that use cryptocurrency do so at their own risk.

In June 2021, El Salvador became the first country to adopt bitcoin as legal tender.

Where Are Bitcoin Transactions Prohibited?

Some countries have banned transactions in cryptocurrencies such as bitcoin. The latest report from the Library of Congress lists examples of countries that have banned cryptcurrencies:

  • Algeria
  • Bolivia
  • Morocco
  • Nepal
  • Pakistan
  • Vietnam

As of September 2021, China has banned all cryptocurrency transactions in the country.

Common Bitcoin Restrictions

There are other countries that don’t completely ban cryptocurrencies but have restrictions that make it difficult for transactions to take place. For example, Qatar and Bahrain prohibit cryptocurrency locally, but citizens may transact in cryptocurrency outside their borders. Countries such as Bangladesh, Iran, Thailand, Lithuania, Lesotho, and Colombia indirectly prohibit cryptocurrency transactions by imposing restrictions on financial institutions that may facilitate them.

Do I Need to Pay Taxes on Bitcoin?

Bitcoin is viewed as property by the Internal Revenue Service. If you make a profit buying and selling, the IRS requires that you report it as a capital gain, similar to buying and selling other property.

Additionally, if you are paid in bitcoin for performing a service or selling a product, you are required to report income equivalent to the value of the amount of bitcoin you received at the time you received it.

Alternatives to Bitcoin

Bitcoin is not the only cryptocurrency available, but its market cap is higher than the combined market cap of the 10 largest cryptocurrencies. Bitcoin's market cap has topped 2 trillion; Ethereum's market cap is near $500 billion, and Binance is over $80 billion. In addition, the list of cryptocurrencies and their values is growing—there are more than 20 different cryptocurrencies with market caps of at least $10 billion.

Key Takeaways

  • Bitcoin is a virtual currency held on computers and not controlled by any single bank, nation, or monetary agency.
  • The Commodity Futures Trading Commission (CFTC) treats bitcoin as a commodity.
  • The IRS treats cryptocurrencies like bitcoin as property and taxes them as such.
  • Since late 2017, the value of a single bitcoin has fluctuated between about $3,000 and nearly $67,000.