How bitcoin works

For the majority of users, bitcoin works in a similar way to most digital payment methods like PayPal. Special software for your PC, tablet or phone allows the creation of a bitcoin wallet. You can use your wallet to send money to other users, or make payments on sites that accept the crypto-currency.

Unlike other digital payment methods, though, bitcoin isn’t tied to any traditional (or ‘fiat’) currency. Bitcoin works via a public ledger called the block chain, which accounts for every bitcoin currently in circulation. Whenever bitcoin is transferred, a record of the transaction is added to the block chain in the form of a hash: a one-off string of characters that contains details of a series of transactions.

Because each hash contains data from both the transaction it is processing and all previous transactions, a fake hash can be spotted extremely easily. That is how bitcoin is kept secure despite information being publically available.

Bitcoin mining

The process of generating hashes is called ‘mining’ and it is central to how bitcoin works. Miners use powerful computers and specialist software to create a hash that ‘seals off’ a block of bitcoin transactions. As payment for doing so, they are given bitcoins for each hash generated. Those bitcoins are newly minted, so the mining of blocks also governs the supply of new bitcoins.

Mining rewards

The reward for solving a block of bitcoin varies over time, and will halve every four years (or 210,000 blocks). For the first four years of bitcoin the blocks were worth 50 bitcoins. Bitcoin’s algorithm is set up to measure the speed at which bitcoins are being mined, and constantly regulate it so that a bitcoin block is mined roughly every 10 minutes. In order to keep mining consistent, bitcoin’s algorithm contains a concept called ‘proof of work’.

Bitcoin is set up so that there can never be more than 21 million bitcoins in existence, which means that all possible bitcoins will have been mined by around 2140. Each bitcoin is divisible to eight decimal places, or a hundred-millionth of a bitcoin. This value is referred to as a satoshi, after bitcoin’s creator Satoshi Nakamoto.

Getting started with bitcoin

There are three ways to acquire bitcoin:

In the form of a payment
By buying them off of an exchange or person
Earning it via mining
Option two will be the way in which most people first acquire some bitcoin. In order to purchase bitcoin from an exchange or individual, a bitcoin wallet is needed.

Bitcoin wallets

A wallet is bitcoin’s equivalent of a bank account. Unlike traditional bank accounts though, a wallet is extremely easy to set up and needs no verification. They come in two forms: a software-based wallet that exists on the hard drive of your computer, and an online cloud-based service.

There are several ways to fund a bitcoin wallet, but most exchanges and individuals will not accept credit cards or PayPal because it is too open to fraud. Instead, bitcoin ATMs and bank transfers are the most common methods of buying bitcoin.

Trading without a wallet

Alternatively, IG offers bitcoin derivatives trading.Trading this way allows you to speculate on bitcoin’s volatility. Bitcoin trading is instead undertaken via spread bets, CFDs or digital 100 trades and no actual bitcoin is ever traded. You should be aware, however, that there is still the potential to make substantial losses, as well as gains.

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