Why do bitcoins work
Cryptocurrency explained: this is how bitcoins work
Bitcoin causes a sensation with rapid price jumps and lures with supposedly quick profits. Stock market experts even speak of digital gold. What's behind the currency? We clarify the most important questions.
It was a record hunt that is second to none: The course of the crypto currency Bitcoin constantly cracked the limits of imagination in winter 2020. A digital coin was worth more than 40,000 US dollars at the beginning of 2021, and within a year the price rose by 308 percent - before the currency finally fell sharply.
Many investors are now hoping for quick money. But what is actually behind the digital currency? Is it safe? And where do you get the digital coins from? We give an overview.
What are bitcoins?
Bitcoin is a digital currency that a person named Satoshi Nakamoto developed in 2009 in response to the global financial crisis. To this day it is not known who is behind the pseudonym.
The only arithmetic unit of the so-called cryptocurrency is the bitcoins themselves. They have no tangible equivalent, like gold coins, but only exist as bytes on computers, hard drives or smartphones. The rate indicates how much a single one of these coins is worth in a conventional currency such as dollars or euros.
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The original idea of the Bitcoin inventors: Whoever uses the currency should be able to carry out transactions, i.e. business, without the influence of banks, governments or financial institutions. This is made possible by what is known as blockchain technology. It is comparable to the bookkeeping of banks. Put simply, every transaction with Bitcoins is secured on the blockchain and the blockchain is stored on all computers that trade directly with Bitcoin.
So it is not an institution in control of the currency, but everyone who trades in Bitcoins. Due to the complex computing tasks with which the individual blocks - and thus the transaction data - of the blockchain are encrypted, it is considered a very secure concept. This makes fraud much more difficult.
How serious are bitcoins?
That depends on whether you're asking a fan of the cryptocurrency - or a critic. One thing is certain: the digital currency has long had a bad reputation. Many people still associate cryptocurrency with the dark side of the Internet - not least because many criminals also use Bitcoin to trade drugs or weapons online.
However, this image is changing a lot: In March of last year, the BaFin (Federal Financial Supervisory Authority) officially recognized Bitcoin as a financial instrument. However, BaFin has not declared Bitcoin to be an official currency, but much more as a private means of payment that is accepted by many parties. Bitcoin does not have the status of a legal tender.
The boom in the currency since the Corona crisis can therefore not only be explained by enthusiastic technology fans - but also by a better reputation in society.
This is also due to the fact that the payment service provider PayPal has been allowing its customers to buy and sell cryptocurrencies such as Bitcoin or the smaller siblings Ether and Litecoin with PayPal since October 2020. From 2021, Americans should also be able to pay for goods with digital currencies - so far, only a few companies and businesses have accepted crypto currencies as an everyday means of payment.
Big investors are discovering Bitcoin
And another development strengthens the legitimacy of Bitcoin and gets it out of the former dirty corner of the Internet: In the meantime, more and more fund managers are investing their investors' money in Bitcoin. In the most recent Bitcoin boom in 2017, however, it was mainly private investors who invested in the cryptocurrency.
The background to this phenomenon is that during the Corona crisis, many countries are keeping their economies afloat with large sums of aid money and investors are increasingly fearful of inflation.
According to analysts, the digital currency has blossomed as a form of investment with supposed protection against the devaluation of classic money. Bitcoin is therefore being treated more and more by investors like other raw materials - such as gold - and is thus increasing in price.
How do you get bitcoins?
So if you believe in the future of digital currency and want to get in before all bitcoins are dug up, you have various options for investing in bitcoins.
- Centralized exchangeswhere you can buy or sell bitcoins directly
- Decentralized exchangeson which you can trade bitcoins anonymously
- Bitcoin ETPs, special securities whose price is derived from Bitcoin
The most common are the so-called centralized exchanges. Bitcoins can be easily bought or sold on them. The best-known providers such as Coinbase, Binance, Kraken and Geminini fall into this category. Behind the trading venues are private companies that require their customers to identify themselves with identification documents - they are therefore not anonymous.
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The major exchanges have a high trading volume, high liquidity and some issue insurance on the money in the wallets. However, this only applies if an investor loses coins due to a mistake by the company.
Popular target for hacking attacks
Because with their private servers on which customer data and bitcoins reside, the exchanges also offer a target for criminals. Hacking attacks have occurred time and again in the past. With the provider Binance, one of the largest stock exchanges was also affected.
In addition, the Bitcoins are not stored on their own computers, but on the providers' servers. Security features such as the recovery key and the security key are also not in the hands of the user. For this, these providers are easy to use for newcomers and access to the Bitcoins is possible from anywhere with an Internet connection.
If, on the other hand, you want to manage the bitcoins yourself, you can use bitcoins decentralized exchanges and save your wallet on your own hard drive.
In the case of decentralized exchanges, every computer is part of the system. This structure ensures that the trading venues are much more secure from hacker attacks, but regulations cannot be enforced in this system either. Identification is usually not required on these exchanges. Every investor can use the platform as they wish - for legal as well as illegal purposes.
Trade cryptocurrencies on Deutsche Börse
Things are more familiar on the Xetra exchange, where investors have been able to invest in Bitcoins since 2020. Here with the special securities called ETPs(Exchange Traded Products) a form of bearer bond. The ETP's assets are fully backed by the issuer of the bond with bitcoins, so that the product replicates the price trend one-to-one.
Instead of creating a wallet online, investors can trade Bitcoin ETPs like stocks. With some offers, they are even free to have their shares paid out in bitcoins. This saves you having to go through third-party providers. The stock exchange is also associated with liquidity and high regulatory standards.
Can you make money with bitcoins?
Yes. But it can be lost just as quickly. Because bitcoins are - at least currently - mainly an object of speculation. Its value is subject to strong fluctuations.
After the first hype, Bitcoin catapulted the great hope for quick money out of the tech niche. Sudden Bitcoin millionaires sparked a kind of digital American dream for many investors. But the cryptocurrency also poses a great risk for investors: During the last boom in 2017, the price rose to almost $ 20,000 and later slipped back to just under $ 3,000.
The future of bitcoin divides even the market experts. In January 2021, Bank of America called Bitcoin the “mother of all bubbles” and made comparisons with the 2008/2009 house bubble or the Dotkom bubble at the end of the 1990s.
Bitcoins are created more and more slowly
In contrast, the investment company Blackrock is convinced that Bitcoin was here to stay. The fact that bitcoins are an ending resource makes some analysts positive. The demand for Bitcoins is currently increasing much faster than new currency units can be generated.
In fact, as the number of bitcoins increases, the production of new units slows down - that's part of the programming too.
How do Bitcoins actually work?
New bitcoins are created through what is known as mining. This process is in turn linked to the blockchain. In order to understand the creation process of a bitcoin, it is important to understand the flow of the blockchain.
The blockchain is comparable to a register that has many individual cards. Every transaction is written down on a tab by every user. When the card is full, it is stored and encrypted.
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This encryption is carried out using a highly complex computing task. This can be illustrated with a magic cube. The full but unencrypted tab is the not yet solved cube. All people in the network try to find out with which movements the cube can be completely sorted by color and write down the solution. When the cube is solved, the encryption is complete and it is stored as a so-called "block". Several of these blocks ultimately make up the blockchain.
Computing power is rewarded with bitcoins
If someone tries to change something on a stored block, this can be discovered by every user. Because then suddenly the solution would no longer match the result of the block - to stick with the example of the cube: it would no longer be neatly sorted by color.
There is a reward for this arithmetic problem: If a computer solves the problem, the owner receives bitcoins. This yield is halved every four years, it is called halving.
If a so-called miner received 50 bitcoins per encrypted block in 2009, it was only 6.25 bitcoins in 2020. So the process is slowing down, the bitcoin amount growth is finite. It is estimated that the last Bitcoin will be created in 2140.
As long as there is interest in the cryptocurrency, it is possible that the demand can repeatedly exceed the supply - and this leads to price increases.
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