Bitcoin is the original cryptocurrency, and the most famous. It continues to make headlines on a regular basis, notably crossing £50,000 for the first time in November 2021.
It is clear that many, many people remain fascinated by Bitcoin. But what exactly is it, how does it work, and should you get involved?
What is Bitcoin?
Bitcoin is an entirely digital currency – no physical bitcoins exist.
It isn’t issued or controlled by a centralised authority such as a bank or government. All transactions are completed online, and there are no brokers involved.
How does Bitcoin work?
All transactions made using Bitcoin are recorded on a shared public ledger called the blockchain, but the details of those using it are not shared, meaning its users are anonymous unless an individual can be linked to a particular Bitcoin address. In its early days, this lack of traceability boosted the appeal of Bitcoin for use on the dark web for criminal activity, and now other cryptocurrencies that offer even more privacy are thought to be replacing it.
Bitcoin is open-source, which means its design is public and no one owns or controls it.
How much is Bitcoin worth?
Bitcoin made its name on volatility, and 2021 has seen more of the same. It started the year trading just below £21,500, and rose to £46,000 by mid-April. It took about six months for it to revisit that price, after losing over half of its value as it returned to the low £20,000s at points in June and July.
Yet in mid-October it once again crossed £46,000, before rallying above £50,000 for the first time in its history in November 2021.
These kinds of sharp movements are typical of Bitcoin. For example, between September and December 2017 the cryptocurrency climbed from £3,000 to then-record highs above £14,000, only to fall back under £5,000 four months later.
This volatility is one reason why you should exercise caution when investing in not only Bitcoin, but cryptocurrencies in general. For while they can produce handsome growth, they can also suffer sudden, and significant, losses.
» MORE: Understanding cryptocurrency risks
How can I buy Bitcoin?
The most common way to buy Bitcoin is by using one of any number of the popular cryptocurrency exchange sites that exist. Simply sign up to a site, top up your account using one of the methods they provide, such as a debit card, and swap your balance into Bitcoin.
You can then buy and sell Bitcoin on the exchange, or remove it from the exchange by downloading a digital wallet on your phone or other device. This wallet works a bit like a virtual bank account, and generates a single-use address, similar to email, that you can use to send and receive the currency.
You can check the current price using various popular exchanges and sites such as CoinDesk, or just on Google Finance. At the time of writing Bitcoin was trading around the £39,000 mark. Once you own Bitcoin, you can use it to pay for things using your smartphone by allowing the other party to use their device to scan a QR code in your Bitcoin wallet app. You can also receive payments in the same way, or by touching two phones together.
You pay a fee to spend Bitcoin through a digital wallet, but not to receive payments. It can be useful for making international payments, with no limits on the amount you can send.
How to invest in Bitcoin
Bitcoin and cryptocurrency fans offer a variety of reasons for their enthusiasm. Some simply love the decentralised technology and believe it will play a significant role in the increasingly global economy. Others are investors who are attracted to its meteoric rise.
Bitcoin investors typically employ two major investment strategies: passive and active investing.
Passive investing: Buy and ‘Hodl’
Bitcoin investors who use a passive investment strategy typically ‘hodl’ (hold on for dear life) onto their Bitcoin in the hope that its value will continue to grow. They keep it safe in a digital wallet and watch its value. They will exchange the Bitcoin for legal tender once they see a satisfying return on their initial investment.
While Bitcoin is extremely volatile and does not offer protection on your investment, this passive investment strategy of holding on is likely the ‘safest’ method of investing in an explicitly unsafe asset.
Active investing: Long and short positions
Active investors use a more complicated method. They relish in the market’s volatility and rely on the large fluctuations in value to earn quick returns. These Bitcoin investors frequently buy, sell, and trade the cryptocurrency to generate profit. Generally, they purchase Bitcoin when they perceive the value is low and then sell it once the value increases.
- An investor pursuing a long position waits for the value to shoot up quickly and then sells it before they think the value will crash.
- An investor pursuing a short position waits for the value to decrease; they will sell their Bitcoin at a higher price and then try to repurchase it when the value crashes.
Both positions are extremely high risk and require investors to try to anticipate and predict the market, which is tough for even the most experienced investors.
Is Bitcoin safe?
Unfortunately, there are a lot of scams involving Bitcoin. Fake exchanges exist that lure people in with the promise of cheap Bitcoins, and criminals use malware to change bitcoin addresses so they can redirect transactions to themselves.
Bitcoin claims that transactions are “secured by military-grade cryptography”, so no one can take your money or make payments on your behalf. However, a number of exchanges have been subject to hacks to steal stored Bitcoins. For this reason, some Bitcoin users store them offline, such as in ‘cold storage’ on their PC desktop, or in a hardware wallet like a USB flash drive, and even write the security details down on paper.
No safety net
Something else to bear in mind is that there is no back-up from any kind of institution for lost Bitcoins. When you hold cash in a bank account, both you and the bank are responsible for keeping those funds safe. If you voluntarily give that cash to a scammer, you might struggle to get it back. But if the bank collapses and loses your money, as long as it was a regulated institution, you should be covered for up to £85,000 under the Financial Services Compensation Scheme. If you forget the login details to your savings account, your bank can remind you or reset it. With Bitcoin and other cryptocurrencies, there are no such protections or guarantees, and no such assistance.
That said, some exchanges and platforms are bringing in their own consumer protections – Ziglu, for example, uses both online and offline storage for its customers’ currencies – where they are stored online, it offers insurance against cyberattacks up to the value of £50,000.
It’s sensible to be sceptical and tread carefully when using Bitcoin, and only deal through reputable exchanges. The official Bitcoin website has a list of exchanges by region.
Do I have to pay tax on Bitcoin?
Bitcoin is legal in the UK and most other developed countries, but it’s not legal tender. If you are an individual holding crypto assets like Bitcoin as a personal investment, you may have to pay capital gains tax when you sell them because they are not eligible to be held in an ISA (a tax-free savings and investing account). They are also subject to income tax and National Insurance if you receive them from your employer as payment. If HMRC thinks you’re making money from cryptocurrencies as a business, you’ll be taxed in the usual way that applies to companies.
Bitcoin is highly volatile, so it usually isn’t recommended as a central part of your investment portfolio. But if you’ve got spare cash you’re not afraid to lose, you could be laughing all the way to the bank if you believe, like one prominent investor, that Bitcoin’s market cap could hit $5 trillion over the next decade.
WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you may get back less than originally paid in.
Image source: Getty Images
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