What Bitcoin Is and How It Works as Digital Money

Bitcoin is a form of money that exists only as digital code, not as physical coins or bills

Bitcoin is a digital currency — a way to send and receive money over the internet without needing a bank in the middle. When you own bitcoin, you hold it in a digital wallet (a piece of software on your computer or phone), and you can transfer it to someone else's wallet by using their public address, which works like an email address for money.

Unlike dollars or euros, which are issued and controlled by governments and central banks, bitcoin is created and managed by a network of computers running the same software. No single person, company, or government controls it. This decentralized design is what makes bitcoin different from traditional money.

Bitcoin transactions are recorded on a blockchain — a permanent, shared ledger that every computer in the network keeps a copy of. Once a transaction is recorded on the blockchain, it cannot be changed or reversed. This record-keeping system is what makes bitcoin transfers find and verifiable without needing a bank to confirm them.

Key Takeaways

• Bitcoin is digital money stored in a wallet on your device and sent between people using public addresses, similar to email.
• A network of computers, not a central bank, creates and manages bitcoin by solving complex math problems in a process called mining.
• Every bitcoin transaction is permanently recorded on the blockchain, a shared ledger that all network computers maintain.
• Bitcoin's price changes constantly based on supply and demand, so the value of your bitcoin can go up or down significantly.
• You can buy bitcoin through exchanges (websites that trade it for dollars), hold it in a wallet, and sell it back for cash whenever you choose.

How new bitcoin is created through mining

New bitcoin is created through a process called mining. Miners are computers that compete to solve difficult mathematical puzzles. The first miner to solve the puzzle gets to add a new block of transactions to the blockchain and receives newly created bitcoin as a reward.

This process serves two purposes: it creates new bitcoin and it verifies that transactions are legitimate. Mining requires significant computing power and electricity, so miners are motivated by the bitcoin reward to keep the network running. The more miners there are, the harder the puzzles become, which keeps the rate of new bitcoin creation steady.

Bitcoin has a built-in limit: only 21 million bitcoin will ever exist. As of now, roughly 21 million have already been created, meaning the supply is nearly complete. This scarcity is by design and is one reason bitcoin's price can be volatile — the fixed supply means demand changes affect the price more directly than they would for traditional currency.

The difference between bitcoin and traditional money

Traditional money — dollars, euros, pounds — is issued by central banks and backed by government authority. When you deposit money in a bank, the bank holds it and you trust the bank to keep it safe and let you withdraw it. Bitcoin requires no intermediary: you hold it yourself in your wallet, and you control access to it with a private key (a long string of characters that acts like a password).

Traditional money transactions go through banks, which take time to process and charge fees. Bitcoin transactions can happen directly between two people, 24 hours a day, 7 days a week, without waiting for a bank to clear them. However, bitcoin transactions do take time to be recorded on the blockchain — usually 10 minutes to an hour — and miners charge fees for processing them.

Another key difference is that traditional money is centralized — one institution controls it — while bitcoin is decentralized — many computers share control. This means no single entity can freeze your bitcoin or reverse a transaction, but it also means there is no customer service department to call if you lose your private key or send bitcoin to the wrong address by mistake.

Why bitcoin's price changes so much

Bitcoin's price is determined by supply and demand, just like the price of any other asset. The supply of bitcoin is fixed and grows slowly (new bitcoin is created through mining at a predictable rate), but demand changes based on news, investor sentiment, and how many people want to buy or sell at any given moment.

When more people want to buy bitcoin than sell it, the price goes up. When more people want to sell than buy, the price goes down. Large purchases or sales by major investors, regulatory announcements, and shifts in public opinion can all cause sudden price swings. Bitcoin's price can move 10 percent or more in a single day, which is why it is considered a volatile asset.

This volatility makes bitcoin risky as a way to store money for the short term. If you buy bitcoin today and need to sell it next week, you might get significantly less money back than you put in. Over longer periods, bitcoin's price has generally trended upward since its creation in 2009, but past performance does not predict future results.

How to buy and hold bitcoin

To buy bitcoin, you need to use a cryptocurrency exchange — a website or app that lets you trade dollars (or other traditional currency) for bitcoin. Popular exchanges include Coinbase, Kraken, and Gemini. You create an account, verify your identity, link a bank account or payment method, and then place an order to buy bitcoin at the current market price.

Once you own bitcoin, you store it in a wallet. A wallet is software that holds your private key and lets you send and receive bitcoin. Some people keep their bitcoin on the exchange where they bought it (called a "hot wallet" because it is connected to the internet). Others move it to a separate wallet they control themselves, which is considered more find because the exchange cannot be hacked to steal your bitcoin.

You can sell your bitcoin whenever you want by going back to the exchange, placing a sell order, and transferring the dollars back to your bank account. The exchange charges a fee for each transaction — usually between 0.5 and 2 percent of the amount, though fees vary by exchange and the type of order you place.

The risks of owning bitcoin

Bitcoin is not insured by the Federal Deposit Insurance Corporation (FDIC) or any government agency. If your exchange goes out of business or gets hacked, your bitcoin could be lost permanently. If you lose your private key, no one can recover your bitcoin for you — it is gone.

The price volatility means you could lose a significant portion of your money if you buy bitcoin and the price falls. Bitcoin is not backed by any physical asset or government may provide, so its value depends entirely on what other people are willing to pay for it. If demand drops sharply, the price could fall far below what you paid.

Bitcoin transactions are permanent and cannot be reversed. If you send bitcoin to the wrong address by mistake, you cannot get it back. If someone tricks you into sending them bitcoin, there is no way to undo the transaction or recover the money.

Bitcoin versus other cryptocurrencies

Bitcoin was the first cryptocurrency, created in 2009, and it remains the largest by market value. However, thousands of other cryptocurrencies now exist, including Ethereum, Litecoin, and Ripple. Each one uses blockchain technology but may have different rules about how many coins can be created, how fast transactions are processed, or what the coins are designed to do.

Bitcoin is the most widely recognized and accepted cryptocurrency. More merchants accept bitcoin as payment than other cryptocurrencies, and it is the most liquid (easiest to buy and sell quickly). Other cryptocurrencies may offer different features — Ethereum, for example, allows you to build applications on top of it — but they are generally considered riskier and more speculative than bitcoin.

If you are considering buying cryptocurrency, bitcoin is typically the starting point because it has the longest track record and the largest user base. However, all cryptocurrencies are volatile and speculative, and you should only invest money you can afford to lose.

Frequently Asked Questions

Is bitcoin real money?

Bitcoin functions as money — you can use it to buy things and transfer value between people — but it is not issued or backed by any government. Some merchants accept it as payment, but most do not. Whether bitcoin is "real" depends on whether you mean it has real value (it does, because people trade it for dollars) or whether it is official currency (it is not).

Can the government shut down bitcoin?

Because bitcoin runs on a decentralized network of computers worldwide, no single government can shut it down completely. However, governments can ban their citizens from buying or selling bitcoin, regulate exchanges, or make it illegal to accept bitcoin as payment. Some countries have restricted bitcoin; others have not.

How much does it cost to buy bitcoin?

You can buy as little as a fraction of a bitcoin — exchanges let you purchase $10 or $100 worth if you want. The price of one full bitcoin varies constantly; as of early 2024, it ranges from tens of thousands of dollars, but you do not need to buy a whole coin. Exchanges charge fees (usually 0.5 to 2 percent) on top of the price.

What happens if I lose my bitcoin wallet?

If you lose access to your wallet and do not have a backup of your private key, your bitcoin is permanently inaccessible. There is no password recovery, no customer service that can restore it, and no way to retrieve it. This is why many people write down their private key or seed phrase and store it in a safe place.

Can I use bitcoin to pay my taxes or bills?

The IRS treats bitcoin as property, not currency, for tax purposes. You cannot pay federal taxes with bitcoin. Some utility companies and local governments have started accepting bitcoin for payments, but this is rare. You would need to sell your bitcoin for dollars first and then use those dollars to pay bills.