Absolute Beginners Guide to Bitcoin

If you’ve heard the term on the news or seen it online, you’ve heard people have made lots of money from it, but you don’t have a clue what it’s all about, then this guide is for you. What it is, Why it is (and why you should care) and how you go about getting some.

The What & The Why

OK, start with the basics. What is it?

Bitcoin is a virtual currency that was created in 2010. Like any other currency, you can buy it, sell it, save it or trade it. Unlike other currencies, and despite what the name may suggest, there’s no physical coins or notes.

The technology which underpins it means that unlike other digital items such as the files and photos on your computer, Bitcoins cannot be duplicated. Each Bitcoin is unique and, although they can be traded, they can only be owned by one person at a time. New coins are created (‘mined’), but as time passes, it becomes increasingly harder to mine new coins. There will only ever be 21 million Bitcoins in existence.

It’s a currency? So I can buy things with it?

In theory, yes — though there aren’t many shops or services which have the infrastructure to accept payments in Bitcoin. It’s also much slower for the transaction to be completed compared to buying something with a credit or debit card. However, many people do trade privately in Bitcoin. People have bought everything from pizza to houses. You will soon be able to buy a Tesla with Bitcoin.

In practice, it’s better to think of it as a store of value; a commodity, like Gold.

But I can touch Gold; I can’t touch a Bitcoin…

True, and this is the biggest psychological barrier to Bitcoin adoption. How can something that was created out of nothing, and which exists virtually, have any value? When you buy a Bitcoin, you’re buying an entry in a digital ledger. That’s it. There’s nothing tangible to go along with it.

There are very prominent critics including respected economists who think it’s all complete nonsense and people have lost their minds. Billionaire Warren Buffet described it as a “worthless delusion”.

But take a step back and think about it. Gold has value, for sure. But why? It’s just shiny metal. There are lots of other shiny metals and glittery rocks which don’t have as much value as Gold. Why is the yellowish shiny metal so valuable? Its relative scarcity is one reason, and it does have some intrinsic value as a relatively malleable, inert metal. But it is mainly valuable because thousands of years ago, someone decided they wanted the pretty nugget their friend had and was willing to trade something for it.

If someone wants something someone else has and is willing to pay for it, then it has value. At the moment, people want Bitcoin and are willing to pay for it. The only difference is, if Bitcoin becomes worthless, you won’t be left with something pretty to look at. It’s also worth remembering that fiat currency like USD and GBP also has no intrinsic value. GBP hasn’t been ‘backed’ by Gold or any other commodity since 1931. The Euro, a currency that was, like Bitcoin, invented out of thin air relatively recently, has never been backed by a commodity. Fiat currency, like Bitcoin, is made up of exchangeable tokens representing units of wealth. Fiat is just stabilised by governments and central banks, while Bitcoin is not.

OK, but why WOULD I want some?

Well, there are ideological and practical reasons. For some people, cryptocurrencies are the future of money; decentralised systems not under the control of any central bank and free from government manipulation (a government can’t simply ‘print new Bitcoin’). As a result, it doesn’t suffer from inflation. It’s also anonymous — which is useful for privacy-conscious individuals (and, unfortunately, criminals). There are those who believe traditional currency markets are not fit for purpose and Bitcoin is the answer.

But chances are, you don’t care much about that. So the practical reasons? Greed. You can potentially make money. Like any currency, the price fluctuates against other currencies. In the same way that £1 can be $1.40 one month and $1.50 a few months later, the price of £1 vs 1 Bitcoin fluctuates.

As a new currency, Bitcoin is still finding its level. The price has gone from less than 1p in 2010 to around £1,000 in 2016 to over £32,000 ($45,000) in 2021.

While the current bull run may (and probably will) come crashing back to Earth at some point, there are many who believe that the increasing scarcity built into the very heart of the technology will mean that demand will increasingly outstrip supply and its natural level may top out way higher than its current levels. Some analysts predict prices of well over $100,000 within the next few years.

Of course, you should take future predictions with more than a pinch of salt. People who are invested in the currency are obviously going to want to talk it up. It very well may go in the other direction. But many of the early optimistic predictions of Bitcoin growth actually turned out to be way too conservative.

Sounds risky…

Yes. It is. Like investing in the stock market, it’s a gamble. Prices may go down as well as up. In the same way that a company you’ve bought stock in may go bust and render the stock worthless, Bitcoin’s price may tank leaving your investment worth a fraction of what you paid.

The price of Bitcoin is notoriously volatile; way more volatile than normal currency. Wild swings of 10–20% per day can make it extremely dangerous to try and day-trade and take short-term wins from Bitcoin. But long-term investment, known as a HODL (“hold on for dear life”) has proven extremely lucrative for many investors. The more people that HODL, the more scarce available coins become, and (theoretically) the higher the price that can be demanded for those coins. The Bitcoin price is a reflection of the constant battle between the HODLers and the speculators looking for a quick return.

The hundreds of billions of dollars now invested in Bitcoin and the fact it is more than 10 years old have reduced the risk that the whole market will simply evaporate and everyone will suddenly collectively decide it is worthless. But if something happens, such as a major flaw in the technology being discovered or a new invention rendering it useless, demand may collapse and the price will plummet.

Like investing in stocks and shares, investing in Bitcoin requires you to understand the risk and only invest what you can afford to lose.

Given the price, it sounds like I have missed the boat though

Everyone who starts investing in Bitcoin wishes they could send a note to themselves in 2010 and tell them to get in on it then. A £100 investment in the very early days would now be worth over £500 million.

Because of this, in 2011 when it reached £1, people said they’d missed the boat. In 2016, when the price hit £1000, people said they’d missed the boat. When it hit £10,000 in 2017, people said they’d missed the boat. When it hit £20,000 in 2020, people said they’d missed the boat.

You get the idea.

It’s a common issue many people have when they want to get started. You don’t want to buy into the currency at the top of a peak, you want to buy in a trough. That way, you can start making instant returns. But you can’t ever know what it’s going to do. The need to ‘get in’ is driven by FOMO (“fear of missing out”). There’s always the risk that the current price isn’t a peak… it’s just the foothills of a major peak to come.

Without a crystal ball, you just have to go with your gut. Investment methods like Dollar-Cost Averaging (DCA) can be used to soften the blow. With DCA, you invest a small amount at regular intervals, regardless of the price. Doing this means the peaks and troughs even themselves out.

But I don’t have £32,000 to invest in a Bitcoin

Remember, it’s a currency. Like Cents into Dollars or Pence in Pound, Bitcoins are divisible into units called Satoshis. There are a million Satoshis in a Bitcoin. 1 Satoshi is currently worth three-hundredths of 1p.

In theory, you can trade any value, but in practice, the fees would make a small transaction of a few satoshis pointless. But investing £100 would get you 0.0031 Bitcoin. Very few of the millions of trades that take place each day are for whole coins, most are for small fractions of a coin.

Can I get my money back if I need it? Or change my mind?

Yes. Like any currency, you can buy and sell as much and as often as you want. Obviously, when you sell, the price may be higher or lower than when you bought it, so you either make a profit or a loss. It’s worth remembering that, like with a Bureau de Change, there are transaction fees that you have to pay when you exchange currency which will eat into any profit. You also need to be aware that if you make big profits on cryptocurrency trading, you will need to pay Capital Gains Tax.

The How

So how do I get started?

Ok, so some terms you need to know first. fiat currency is a mainstream currency like GBP or USD. A fiat bank account is where you keep your fiat money. An exchange is a company that allows you to buy and sell a cryptocurrency, as a Bureau de Change like Travelex does for fiat currency. A market is a pair of currencies to be traded against each other like when you change GBP into Euros and back again. Exchanges don’t typically have a market between Bitcoin and every fiat currency, although most of them have markets with big currencies like USD, EUR and GBP. A crypto wallet is where you keep your Bitcoin (this isn’t technically true, but just roll with it for now).

The Exchange

There are lots of exchanges such as Crypto.com, Coinbase and Kraken. Most of them do the same sort of thing, but there are a few things you need to be aware of and check before you pick one. Ensure they are reputable, check what protections they offer in the event they are hacked, and investigate their fees. Some exchanges aren’t allowed to operate in some countries. Google the “best crypto exchange” for your country and do your research.

When you sign up with an exchange, you’ll be asked to provide identification such as a scan of a Passport. This is a process known as KYC (“know your customer”) and is part of anti-money-laundering checks. It might seem worrying to provide this kind of information, but I would be more concerned about the reputability of the exchange if they didn’t do this check.

Once you’ve signed up, your account has been verified and KYC checks have been done, you can link a fiat bank account to your exchange account. Some exchanges offer you the ability to use a debit card to buy cryptocurrency, but you may find that your bank blocks the transaction. Bank transfer is the best way to do it.

Transfer some fiat currency into your exchange account, wait a day or two for it to arrive, and you’re good to go.

The Trade

Trading can be complex, but most exchanges offer a nice simple interface for doing a basic trade. In Kraken, the simple interface asks you to specify how much Bitcoin you want. You click the Market button to specify that you’ll pay the market price (which is the current ‘going rate’), it will tell you how much fiat currency it will cost you. You can then tweak the amount of Bitcoin you want to most closely match how much you want to spend.

When you click the Buy XBT button, the exchange will create an order for you. That means it will match the amount you want with the amount you’re willing to pay against other traders who are selling. When/if a match is found, their Bitcoin is transferred to your exchange wallet.

You can create orders much lower than the current market rate. For example, you can create an order to buy 1 whole Bitcoin for £1,000. Of course, no seller will accept this… for now. But your order won’t expire unless you cancel it. A long time in the future, if the price totally bombs and the price of Bitcoin drops to £1,000, your order will execute (as long as you have the fiat currency funds still available in the exchange).

The Exchange Wallet

You now own Bitcoin! Sort of.

The Exchange has created a crypto wallet especially for you. This is where the Bitcoin has been transferred. It’s handy because you can trade into and out of your exchange wallet quickly.

However… there is a mantra in the cryptocurrency world; “not your keys, not your coin”. Meaning, if you don’t actually hold the keys to the wallet, you can’t really claim to be the owner of the coin. In effect, the Exchange owns the coins, they’re just holding it on your behalf. If you’re trading frequently, this makes it easier. If you’re holding long-term, it’s not ideal. Exchanges may go bust. They may get hacked. And unlike a traditional bank, crypto exchanges are not covered by the Financial Conduct Authority. So if an exchange goes rogue or goes bust, you could lose your funds without any recourse. With large reputable exchanges such as the ones I mentioned earlier, this is less of a risk. But it is still a risk.

If you’re holding a lot of crypto or you’re holding it long-term, it’s best to move it out of the exchange into your own private wallet.

The Private Wallet

A private crypto wallet is yours and just yours. You own the cryptocurrency. There are two kinds; software wallets and hardware wallets. A software wallet is one that is stored on a computer or mobile phone app. These are usually free. The most popular is called Electrum. A hardware wallet is a physical device; these cost money.

A wallet has a public address that people can use to send money to you. It’s a long string of numbers and letters. Like a telephone number or email address, it uniquely identifies your wallet. It’s ok to share this with people.

Internally, the wallet has a set of private keys which are used to sign any transactions. Like a unique digital fingerprint, it can’t be faked and it stops anyone from pretending they have your wallet and trading away your Bitcoin. To access your wallet, you’ll need a password. You’ll set this when you first create your wallet. This lets you open the wallet in order to make a trade.

If you forget your password, you have a backup called the recovery key. This is usually a very long sequence of words (known as a ‘seed’). The recovery key is used to recreate a wallet. If you have a software wallet on your phone, and you lose your phone, you can use the recovery key to recreate the wallet again on your new phone. Although it can be difficult to wrap your head around, there’s no currency actually in the wallet. The wallet holds the digital fingerprint that identifies which Bitcoins (in the central ledger) are yours. So if you lose a wallet and recreate it somewhere else, you never lose any money.

Two VERY important things to remember about the recovery key.

1. If someone gets hold of it, they can clone your wallet and perform trades of your Bitcoin. The recovery key must be kept somewhere safe. Ideally, IN a safe. Or at the very least, locked away. NEVER store it digitally (especially in the Cloud). Physically write it down. You can actually buy kits to etch your recovery key into a metal plate so that you don’t lose it if the paper gets damaged.
2. If you lose your recovery key and forget your password, your Bitcoin is gone. It’s unrecoverable. Sorry… that’s just the way it goes. There are numerous stories of people who’ve lost their wallets or threw them away when Bitcoin was worthless and are now desperately trying to find them again. If they’d stored their recovery keys somewhere safe, losing the hard drive containing the wallet is not a big deal. There are estimated to be billions of dollars of Bitcoin lost forever because people didn’t store the recovery key properly.

A hardware wallet is a physical device that stores the keys. Because it’s a device that you only connect to a computer when you need it, it’s the safest way to hold cryptocurrency long-term. It’s known as cold storage; no matter how badly you get hacked, even if someone gets into your phone, your PC, your online accounts… they can’t get at your Bitcoin. It’s digitally disconnected from any network and locked away in a drawer somewhere. Even if someone actually steals your hardware wallet, unless they know your password, it’s useless (obviously, you should never store your recovery key in the same place as the device).

Hardware wallets can be expensive, but if your portfolio is valuable, the peace of mind alone can make it worth the investment.

Cashing Out

To cash-out Bitcoin, you just do the steps above in reverse. If the Bitcoin is in your exchange wallet, you just create a Sell order — specifying how much you want to sell and at what price. It’s virtually instantaneous, and you will have the fiat currency immediately, which you then transfer back into your fiat bank account. You’ll normally pay a transfer fee (usually a few Pounds).

If the Bitcoin is in your private wallet, you need to move it into the exchange first. You open your wallet, follow the instructions to Send and enter the wallet address for your exchange wallet.

There are two downsides to Bitcoin in this respect.

1. Fees. Whenever anyone trades Bitcoin, there is a small fee to pay called a ‘miners fee’. Because Bitcoin is decentralised, there’s not one single computer controlling everything. The computing power to make the transactions happen is spread across thousands of private machines. The miner's fee is a way of incentivising people to allow their machines to be used to make Bitcoin work. The fee is very small (normally only a few Pounds for a trade worth thousands) but you do need to remember that if you’re sending someone exactly £100 in Bitcoin, they will not receive £100; they’ll receive £100 minus the miner’s fee.
2. Speed. Transactions can be very slow as each one needs to be verified by multiple computers on the network. When you transfer Bitcoin to an exchange wallet, they will usually require at least three verifications before they will allow you to trade it. This can take anywhere from 30 minutes to several hours. You can elect to pay higher miner’s fees to speed things up, but you’re still looking at around 10 minutes per verification.

The net result is that if you want to sell the Bitcoin you’re holding in a private wallet, you may need to be patient. It’s certainly not ideal for speculating on short-term price movements. If you want to do this, you need Bitcoin in your exchange wallet. But if you’re holding the Bitcoin long-term, waiting 30 minutes to sell it is not usually a big deal.

Conclusion

It’s risky and definitely not for everyone. But it’s not as complicated as it first appears, and it is quite easy to get started. And you don’t need huge sums of money either; you can dip your toe with modest sums in order to learn how it works. Maybe it is the future of money or maybe it is a crazy bubble that will eventually pop and wipe out billions in investment. But YOLO, so don’t have FOMO.