A Guide to Bitcoin: History, Principles of Work, Legal Status, and Concerns

Bitcoin is the first cryptocurrency founded in 2009. It runs on a blockchain, being the first real-life implementation of this technology. The killer feature of Bitcoin is its decentralization — cryptocurrency is digital money that no single party like a bank or a government can control. Rather, Bitcoin is run by a distributed community of miners of which no one has the deciding vote. This makes Bitcoin more secure than traditional money: it’s impossible to freeze a transaction on the blockchain or reverse it.

12 years ago, Bitcoin was of interest to a small group of programmers, whereas by today, it has grown to a huge industry with thousands of various cryptocurrencies with a total market capitalization of $2 trillion. In 2021, Bitcoin is far from being the most convenient tool for daily payments — rather, it is a store of value for long-term investors. Let’s see what Bitcoin is, how it works, and what may be the future for the first cryptocurrency.

The story of Bitcoin: from geek forums to a trillion-dollar industry

It all started in 2008 when pseudonymous Satoshi Nakamoto sent out a document called “Bitcoin: A Peer-to-Peer Electronic Cash System” across a cryptography mailing list. The paper was describing the fundamentals of what was then called “crypto-currency” and was a subject of interest of a handful of programmers and cypherpunks.

On January 3, 2009, the so-called Genesis block of Bitcoin was mined with a 50 BTC reward given to the miner. The first block with a transaction was mined one week later — the recipient was Hal Finney, Bitcoin developer who now stands in the list of contenders for never-identified Satoshi Nakamoto.

Dorian Nakamoto who is often referred to as Satoshi — which is, however, most likely not true.

The first real-life purchase made with Bitcoin happened a year later — on May 22, 2010, a developer Laszlo Hanyecz bought two Papa John’s pizzas for 10,000 BTC worth $25 at the time. Today, the same BTC amount costs $440 million, and May 22 is celebrated as Bitcoin Pizza Day. 6 months later in 2010, BTC reached a $1 million market cap.

Faster than anyone would expect, cryptocurrency started to flourish. In 2011–2013, the first altcoins (alternative coins — cryptos other than Bitcoin) were created, expanding and improving Bitcoin’s use cases. Enthusiasts needed to trade the new coins somewhere — and this is how crypto exchanges emerged. However, there was much money, but very little security as the technology was yet immature, and several hacks took place where millions of dollars were stolen. It’s noteworthy that today, the story repeats — in the young and rapidly evolving decentralized finance (DeFi) segment with the lack of regulation, hacks and exit scams are very common.

The first massive crypto boom happened in late 2017 when the public realized the potential of cryptocurrencies and started extensively investing in any blockchain project that sounded cool. That was called Initial Coin Offerings (ICOs) that have quickly become notorious for the abundance of scams. Bitcoin skyrocketed to $20k, but the bubble popped, followed by a “crypto winter”. When the pandemic hit the market, BTC collapsed even lower, diving below $4k. But during the 2020 and 2021 bull runs, Bitcoin restored its value, the faith in it was rehabilitated, and institutional investors started massively investing in the first cryptocurrency.

How Bitcoin works: decentralization, mining, and scarcity

Bitcoin runs on a blockchain — a distributed database and the protocol that defines how transactions are processed in it. However, you may have seen this definition on Wikipedia and it may not have made sense to you. Let’s break it down.

Imagine there are 100,000 computers united in a network. All of them hold the same copy of the blockchain — a database that contains records about all transactions that ever happened in this network. The database is organized into blocks — packs of transactions processed simultaneously; in Bitcoin, new blocks are created every 10 minutes. When a new block is mined, it is added to the chain of blocks, and the blockchain updates for all these 100,000 computers.

This database is public and transparent — anyone can look into it and see any transaction ever sent between any wallets. Importantly, it is also immutable — once a transaction has been mined, it will never reverse or disappear.

New transactions are added to the blockchain by miners. To mine a block, they solve an energy-consuming mathematical task called hashing and get rewarded in return. The one who solves this task the fastest gets the right to add this block to the blockchain and wins the mining reward. In Bitcoin, it’s currently 6.25 BTC.

Today, Bitcoin mining is a billion-dollar industry, and to mine a block, you’d need enormous computational resources. Since it’s hard for anyone without gigantic computing power to mine a block, there’s a very low risk of attacks by malicious actors who would want to add arbitrary transactions to the blockchain in their favor. And since the biggest computing power is concentrated in the Bitcoin network, it’s considered the most secure cryptocurrency.

Besides security and decentralization of transaction processing, another key idea behind Bitcoin is its scarcity. New Bitcoins are produced with every block as a reward for miners: today, it’s 6.25 BTC, and it gets cut in half every 4 years. By roughly 2120, all 21 million BTC will have been mined. While the demand for Bitcoin is growing, the limited supply is supposed to push the price up. This resistance to inflation was implemented by Satoshi Nakamoto in response to the short-sighted economic policy of governments that are prone to printing money and thus reducing its value.

How is Bitcoin used today?

Bitcoin was designed as peer-to-peer electronic money: it was meant to become the means of daily value exchange between users. And to some extent, this goal was achieved: thousands of companies worldwide accept Bitcoin as payment, and there is an abundance of crypto wallets for secure storage of BTC.

However, as the crypto industry evolved, Bitcoin has become one of the least convenient ways to send money compared to other cryptocurrencies. Bitcoin’s block time is 10 minutes, so normally it will take you 2–10 minutes to complete a transaction — and if you pay for a good or service, you’d have to wait 20 minutes more for 2–3 confirmations. In the meantime, Ethereum offers a 10–15 sec block time, while in Solana, it’s a whopping 400 ms. And the fees in Bitcoin are very high: they can go from $5 up to $50 and beyond, whereas Bitcoin Cash or Litecoin offer transactions that cost less than 1 US Cent.

This is one of the reasons why Bitcoin has become more of a store of value than the means of daily payments. Its scarcity (total supply will never surpass 21 million coins) and the subsequent immunity to inflation make it a tool with an extremely good ROI: simply look at the Bitcoin price chart below. However, extreme volatility and risk are no strangers to Bitcoin as drawbacks of high returns.

The future of Bitcoin

Institutional adoption

Bitcoin is scarce and used as a safe-haven asset — which is why it’s often referred to as ‘digital gold’. Long-term investment in Bitcoin has been a prerogative of retail investors before 2020, when institutional investors started to massively embrace cryptocurrency. Such giants as Tesla and MicroStrategy have put billions in Bitcoin amid the global pandemic: the profitability of traditional financial tools collapsed, and companies started to seek new lucrative opportunities.

Speaking of resemblance to gold, Bitcoin acted a lot like this precious metal in 2020. And compared to the global fiat economy with governments printing trillions of dollars, Bitcoin looked much more inflation-proof.

MicroStrategy tech giant is leading the way in Bitcoin investment. The company has purchased BTC a few times and has reached a stake of $5 billion in BTC. CEO Michael Saylor was sharing his thoughts on preferring Bitcoin to gold: it’s more lucrative, technologically advanced, and valuable as “digital property on an open monetary network” — the thing that will drive its adoption worldwide.

Elon Musk’s Tesla has a huge influence on Bitcoin, too. First, the company was even ready to accept BTC as payment, but then reversed due to its environmental issues (we’ll consider these below). Interestingly, given the huge stake in Bitcoin that Tesla has, its CEO and founder Elon Musk often criticizes Bitcoin and is a huge proponent of a meme cryptocurrency Dogecoin.

Adoption across institutional investors is one of the core factors that drives Bitcoin’s price. Such enterprises raise trust in cryptocurrency and boost the interest of the public in Bitcoin, which, in turn, is also crucial for its adoption.

Adoption across different countries

In most countries, Bitcoin is legal, meaning that you can at least store it without any legal consequences. However, countries like Russia, India, and especially China have numerous restrictions that hinder the evolution of cryptocurrency in these countries. Governments in non-democratic and economically unstable countries have a poor understanding of Bitcoin and see more risks than profits in it.

The legality of cryptocurrency across the world. Grey marks regions with scarce cryptocurrency regulation.

However, that doesn’t mean their population isn’t using Bitcoin. In developing countries with local currencies that are volatile and prone to inflation, BTC serves as a hedge against financial risk. For instance, this is the case for Nigeria and Venezuela. In some countries, the government takes a step forward and embraces Bitcoin — in El Salvador this year, BTC has become legal tender for the first time in history.

Besides protection from inflation, Bitcoin offers unprecedented inclusion: you need nothing more than a device with an internet connection to leverage cryptocurrency. Unlike the traditional economy with its identity and credit checks, Bitcoin allows anyone to participate.

Environmental concerns

Bitcoin’s impact on the environment has been ignored for quite a while. But as mining difficulty rose, Bitcoin’s energy consumption skyrocketed: today, BTC takes 110 Terawatts-Hour per year, which is more than the whole of Argentina or Malaysia. Tesla has even suspended accepting Bitcoin as payment before these issues are resolved.

Today, there are many discussions on how to make Bitcoin greener. Elon Musk has proposed to organize a committee that will force miners to transfer from charcoal to renewable energy — however, this initiative was criticized in the crypto community as it potentially violates the philosophy of Bitcoin: decentralization, independence of nodes, and resistance to censorship. This issue remains a tough one yet, but some actors have already started to make changes: aforementioned El Salvador is planning to build green Bitcoin mining farms powered by volcanos’ heat.

Is Bitcoin the future of payments?

One of the main obstacles that keep Bitcoin from becoming the means of global payment is that the coin transfers are lengthy and expensive. There’s also the scalability problem: Bitcoin simply can’t handle more than about 10 million transactions per month due to throughput limitations built in its code:

Number of Bitcoin transactions per month on a logarithmic scale

However, there is a way out. The so-called layer-2 solutions enable Bitcoin transactions that are not processed through the blockchain separately, but are put in packs and processed as one. This enables micropayments and raises the functionality of Bitcoin. Lightning Network is the most successful of L2 solutions and is gaining traction today.

Finally, for the mass adoption of Bitcoin, it’s important to reduce the coin’s volatility. Retail and enterprise investors are concerned with the constantly fluctuating purchasing power of Bitcoin. However, as the first cryptocurrency remains volatile to date, the number of its users is constantly growing. This hints that the long-term value that people see in Bitcoin is stronger than even the most severe price drops.