Updated 9 July 2020
Bitcoin was established in 2009. It was the world’s first cryptocurrency and is still the most popular and best known.
A cryptocurrency is a digital or virtual currency that is secured and traded using cryptography – a system of complex mathematical algorithms or codes.
Bitcoin was created by an anonymous person (or group of people) known as Satoshi Nakamoto. They aimed to establish an electronic cash system that was completely decentralised, operating on a peer-to-peer system.
Bitcoin is not owned by a central authority or government institution. It can be sent directly from user to user without any need for a middle-man, such as a bank.
Users can remain anonymous through the use of encrypted keys so bitcoin transactions cannot be traced back to them. Bitcoins can also be transferred and withdrawn anywhere around the world.
Bitcoin is notoriously volatile, as has been well-documented in the media in recent years. This high volatility means there is the potential to make good profit margins.
With the added incentive of low entry levels, trading bitcoin has become an attractive option for many. However, anyone trading in any market should be aware that there are always risks involved.
In this article, we explore the basics of trading bitcoin, looking at how the cryptocurrency operates, reasons to consider trading bitcoin and what you will need to know before you get started.
Unlike paper money, bitcoins are not printed. Instead, they are ‘mined’ on computers.
Bitcoin mining requires high-powered computers and a lot of painstaking work, so miners are currently rewarded with 12.5 bitcoins for every new bitcoin they create.
Around 1,800 new bitcoins are mined every day and the most that can ever exist is 21 million – this was decided by Satoshi Nakamoto when they created Bitcoin.
As well as creating new bitcoins, mining serves to verify bitcoin transactions that have been made in the past.
Miners check that blocks of transactions are accurate before adding them to the blockchain – the blockchain is the technology behind bitcoin and is a series of blocks of data providing an immutable record of historical bitcoin transactions.
Crucially, this verification checks that bitcoins are not being duplicated. The blockchain acts as a ledger that anyone can download and check, but no-one can tamper with data that has already been added to the chain.
To earn their bitcoin, miners must verify 1MB worth of transactions and solve a complex mathematical problem, also known as a ‘proof of work’.
To solve this problem, they must essentially guess a 64 digit-hexadecimal number, known as a hash, that is equal to or less than the target hash (hexadecimal is a system used in maths and computing that represents numbers using 16 different symbols, rather than the usual 10).
The chance of coming up with the correct hash is around 1 in 13 trillion and miners are racing against millions of others to be the first to complete a proof of work, so bitcoin mining is highly specialised and competitive.
While mining bitcoin is not a viable option for most, trading bitcoin is fairly straightforward once you understand the basic principles.
As mentioned previously, bitcoin’s volatility is one of its main attractions to traders. This means we can see rapid price swings both up and down, and if bitcoin traders anticipate the market correctly, they can make significant profits. Of course, they can also make significant losses.
Another benefit of bitcoin is that you can trade around the clock. Most stock markets are limited to the working hours of the countries where they operate. However, bitcoin can be bought and sold on exchanges around the world so it is possible to trade day and night. And as bitcoin is a global currency, it is not affected by the financial stability or situation of any single country. In fact, it can go up while other markets are falling.
Finally, the relative lack of regulation makes it an easy market to get started on, as you do not need to go through a lengthy verification process.
The first thing you will need to trade bitcoin is a good, secure internet connection.
The next step is to open an account on a bitcoin exchange. This is a digital marketplace where you can buy or sell bitcoin.
There are two types of exchange:
To open an account with a bitcoin exchange, you will need to register and go through a verification process to authenticate your identity. Once your account is open, you can transfer funds to start buying bitcoins.
The price you pay for bitcoin depends on the exchange you use, there is no single global price.
Some of the most well-known bitcoin exchanges include Coinbase, Kraken, Binance and Bitstamp, but as there are many available, it is important to do your research before settling on one.
Things you should check include:
Once you start buying bitcoin, you will also need a bitcoin wallet to store it in. This consists of a public address, which is where your bitcoins will be sent, and a private key which is used to unlock your funds and send bitcoin to others.
Unlike a bank account, when you store funds in a bitcoin wallet you are wholly responsible for their security.
There are different kinds of bitcoin wallets and the type you choose will depend on how you want to use your bitcoin and the level of security you want:
Bitcoin has become very successful over the past few years and many are rushing to capitalise on the opportunities it presents.
However, cryptocurrency is still a very new market and remains highly risky. So while there is the potential to make money trading bitcoin, you should have a clear idea of the pitfalls you may encounter before getting started.
As mentioned previously, the price of bitcoin is constantly going up and down so it is very hard to predict what will happen in a given period.
While this can lead to healthy profits, it can also mean big losses if you misinterpret what is likely to happen next.
As there is little regulation of the bitcoin market, security is a major issue. While many bitcoin exchanges are reputable, others are not and there have been instances of investors being defrauded by fake exchanges.
As discussed in the previous section, bitcoin exchanges are very attractive to hackers and if your bitcoins are stolen by a hacker there is no way to retrieve them.
Bitcoin is a digital currency completely based on technology. This not only leaves it more open to cyber-attacks and fraud but it also means that it is not backed up by any physical collateral, such as gold or property. If the technology fails or is shut down, bitcoin is worth nothing.
Bitcoin is still in its early stages so there is little data or experience to draw on. There is a lot of uncertainty around how it will evolve in the coming years.
There are different methods for trading bitcoin and other cryptocurrency and, in this section, we look at some of the most popular approaches.
It is also important to note that there is a difference between investing in bitcoin and trading it.
Bitcoin investors will buy the currency and then hold on to it for a lengthy period in the belief that its value will ultimately go up.
Bitcoin traders, on the other hand, are looking to make a profit by buying bitcoin and then selling it again after a short period.
They may do this by adopting one or more of the following approaches:
Day traders will make several trades during one day to benefit from short-term price movements.
Day traders may hold their assets for a few minutes or a couple of hours but the idea is always to sell them by the end of the day to make quick, small profits.
This is similar to day trading but taken to the extreme. Scalp traders will buy and sell bitcoin very rapidly, holding their assets for a matter of minutes or even seconds before selling up.
They may operate around the clock, making hundreds of trading moves within a 24 hour period. As with day trading, the aim is to make many small, quick profits in a short timeframe.
This involves holding a position for longer than a day.
Swing traders will look at the bigger picture, studying trends in the market and trying to predict when price movements will begin and end. Once they have entered the market they may hold their position for days, weeks or even a couple of months as they monitor the market before trying to sell up at the best time to profit from movements in price.
There has been a lot of media interest and hype around bitcoin in recent years, with reports of people making their millions by trading and investing in the cryptocurrency.
Bitcoin and other virtual currencies have made trading more accessible, with lower entry levels and the opportunity to trade wherever you are in the world as long as you have an internet connection.
As a young and volatile market, bitcoin offers exciting opportunities, but there are also many risks involved. With the potential to make a lot of money there comes the potential to lose a lot too.
If you are considering trading bitcoin, you should make sure you have learned all you can about the market, researched your trading strategy and identified a reputable exchange platform. And, as with all kinds of trading, you should never invest more than you can reasonably afford to lose.
WikiJob does not provide tax, investment or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.
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