What is bitcoin?
Bitcoin is a cryptographically secured digital currency that operates outside of the mandate of a central authority. It was launched in 2009 by the pseudonymous Satoshi Nakamoto, and originally conceived as a method of payment that wouldn’t be subject to government oversight, transaction fees or transfer delay – unlike traditional ‘fiat’ currency.
Bitcoin has proven to be a particularly volatile asset with frequent swings. Its price rose in spurts between 2010 and 2017 from around 0.003 cents to nearly $20,000, before falling dramatically in 2018 to hit lows under $6000 (as of 21 August 2018). In that time, hundreds more cryptocurrencies have emerged, all with unique features and applications. Few of these have any significant value, but bitcoin does have its rivals in the form of ether and bitcoin cash, and – to a lesser extent – litecoin, ripple, stellar, EOS, and NEO.
Bitcoin was initially devised as a method of payment, and in certain cases functions as exactly that. But it both lacks widespread adoption and is currently far too volatile to provide a real alternative to fiat currency: vendors need to revise their prices constantly in response to its swings in value. It therefore has little in common with traditional currencies.
As a result, bitcoin and other cryptocurrencies should really be thought of as a separate asset class – one that is primarily used for speculative trading and is somewhat immune to the factors that affect traditional assets’ prices.
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How does bitcoin work?
Bitcoin needs two underlying mechanisms to function: the blockchain and the mining process.
The blockchain is a shared digital ledger composed of all the bitcoin transactions that have taken place up to that point. These transactions are grouped together in ‘blocks’, which are cryptographically secured during mining and linked to one another.
The blockchain is accessible to everyone at any given time, and can only be altered with the will and computing power of the majority of the network. This means it is almost impossible to be retroactively amended, won’t fall victim to human error and lacks a single point of failure.
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What is mining?
Mining is the process required to secure each of these blocks and, in doing so, releases new units of the cryptocurrency. These units are known as the ‘block reward’. In bitcoin’s case, the block reward is currently 12.5 bitcoins, though this halves every four years or so.
The miner’s role is to carry out this process by solving complex algorithms – an ongoing task which can be made easier or more difficult. By altering the complexity of the algorithms, miners can ensure they keep the processing time of blocks roughly constant. Because of their crucial role in the network, miners exert significant control over bitcoin, especially as mining has now become big business.
Once these tokens are in circulation, they can be freely exchanged via an exchange, and stored in a digital wallet. When you trade bitcoin with IG, you never actually own the underlying asset, so you won’t need a wallet or an exchange account.
What is a bitcoin fork?
A fork occurs when one blockchain splits into two, creating two separate records of data. It is up to the network of bitcoin miners to agree which one of these to continue using, and which should be discarded.
Forks are the result of a misalignment of the community’s mining programs, and enable the blockchain to undergo essential software updates. The two main types are soft forks and hard forks.
- Soft forks: the upgraded blockchain is now responsible for validating all transactions (blocks), but the existing blockchain will still recognise and record these transactions. Keep in mind that this only works one way: the upgraded blockchain will not recognise any blocks mined via programs using the existing blockchain.
- Hard forks: the upgraded blockchain is now responsible for validating all transactions, but the existing blockchain no longer recognises these blocks as valid, nor records them. This means all users of outdated programs must update to access the upgraded blockchain.
Generally, forking is resolved with little to no disruption. But differences of opinion in how a cryptocurrency should scale or function have proven insurmountable in the past. The most high-profile example of this is bitcoin cash, which came about when bitcoin hard forked and divided bitcoin miners along with it. This ultimately resulted in two distinct cryptocurrencies, bitcoin and bitcoin cash, albeit ones with the same transactional history up until July 2017.