What is Options Trading?

An Option is a financial instrument, a derivative, and its value is derived from an underlying asset. That could either be a stock, market index, commodity, currency, or any other security. Options are basically contracts between two parties that allow holders to purchase or sell an underlying asset at a specific price on a pre-determined date.

Initially, Options trading may seem a little complex, however, they aren’t. Let us look at some basic terms to understand options.

Important terms in Options

• Derivative – Options derive their value from other assets, hence they are also referred as derivatives.

• Call and Put Options – The call option gives you the opportunity to purchase a security at a predetermined price on a specific date whereas a put option permits you to sell a security at a future date as well at a predetermined price.

• Strike price and expiry date – That predetermined price specified above is known as a strike price. The day on which future transactions will happen at the pre-determined price is the expiry date.

• Premium – It is the price you pay to buy an option contract.

• Strike price intervals – The interval between the subsequent strike prices of a stock or index. It is not constant and differs across stocks and indices.

• Intrinsic value – Option value based on the difference between a stock’s current market price and its option’s strike price.

Is Option a type of derivate instrument?

Yes, an Option is a type of derivative instrument that derives its value from an underlying asset, such as shares , commodities or currency.

Options are a type of derivate instrument where two parties agree to get into a contract to transact an asset at a specific price at a future date. However, the owner doesn’t have the obligation to buy or sell the underlying asset.

What is an Options Contract?

There are essentially two different types of an Options contract: Calls and Puts.

• Call Options: This gives you the right to buy the underlying asset at the strike price (mentioned in the option contract) on a specific future date. However, there isn’t any obligation for the call owner to buy the security. Investors tend to buy calls when they feel that the price of the underlying asset will increase and likewise sell if they feel the price will decrease.

• Put Options: A Put Option works exactly opposite to that of the call option. It gives the owner the right, however not the obligation to sell an underlying security at a particular price (strike price) specified in the contract on the expiration date.

Buying a Call Option

Call Option buyer buys the Call Option hoping that the price will rise by the date of expiry. Call buyer will be in profit zone when price of the underlying asset exceeds the strike price. If the price doesn’t go beyond the strike price, the buyer won’t exercise the option. The buyer will bear a loss equal to the premium of the Call Option.

Selling a Call Option

Call sellers anticipate the stock to remain flat or decline so that they can make profits. An option seller pays a margin to the Exchange to enter a position. They collect the margin paid by the call buyer. Call Selling is also called ‘Call Writing’.

Buying a Put Option

Thebuyer of Put Option profits when the stock price goes below the strike price on the expiry date. The option is exercised at the strike price by the put seller within the specified period of expiration. Option by them is used by selling the underlying stock to the put seller at the mentioned strike price.

Selling a Put Option

Put sellers take the position when they expect a bullish market. A Put seller is obliged to buy the underlying stock at the strike price if the option buyer exercises the option on expiry day. The price of a stock should remain the same or go above the strike price so that put sellers can possibly earn a profit.

Difference between Call & Put Option

The cost of a Call option premium is far less than the equivalent underlying security.

When you become a Call seller, you are referred to as an options writer. An option writer provides the margin to the Exchange to take position & collects the premium provided by the option buyer. If you have a stock that’s appreciated since your purchase. You could write a Call Option with a strike price equivalent to the current market price and collect a premium. This is called a “covered call” in options trading.

Advantages of Put Options

• One of the main advantages of buying Put Options is that it gives investors the opportunity to speculate on securities that they feel may decline in price.

• Investors benefit from buying a Put Option as they get to hedge. An investor having many shares in a particular stock may opt to buy a Put Option to secure against the price of that stock falling.

How Does Options Trading Work?

Options trading can be done via a Demat & Trading account . The price of options is derived from things like the value of securities and assets, and other underlying instruments. A trader visits the section of Options for index or stocks in the trading platform. A list of strike prices is displayed with corresponding premium rates & open interest on both PUT and CALL sides. The trader can select a particular strike price and enter the position as a buyer or seller. The respective amount has to be paid. The trader can hold the position till expiry or exit the position before the expiry date. If the position is held till the expiry date, the settlement between the 2 parties of the Options contract is executed.

Benefits of Options Trading

Options trading can help a trader with higher returns in a short time frame, give the benefit of leverage, and a hedge against uncertainties.

• A common practice is to use options to limit losses by using it as a hedge.

• Option traders get the benefit of leverage where they can take position in a large quantity of stock by just paying a relatively lower premium

• Several option traders hold position for intraday or a few days is they expect a major price swing is a short time. This can help them earn a high return in a short interval of time

Options enable in reducing the cost of holding a stock. If suppose you are holding a stock and the price isn’t moving at all. In that case, you can sell higher Call Options, earn the premium and decrease your cost of holding that asset.

How to Use Call Options

When you expect the market to rise, you buy a Call option. That’s because a Call Option helps you to buy the underlying asset at the predefined rate. So, you need to select a strike price that is expected to be below the market price of the asset on expiry date. If the situation is such, you will profit from the Call option, otherwise, you only lose the premium paid to buy Call option.

How to Use Put Options

Put Option provides investors with an opportunity to make profits if there’s a drop in the asset & security prices in the future. A trader expecting a market fall will buy a Put option. If the asset price stays lower than the strike price on expiry day, trader will profit.

How are Options Contract Priced?

Through the options contract, you can take a position in the underlying asset at a fraction of the actual price of the asset by paying an upfront premium. An option premium has two components – intrinsic value and time value. Intrinsic value is the difference between the strike price and the asset’s present price. The time value captures the component of premium owing to the time remaining till expiry.

The asset price, strike price and the expiration date, all play a role in option pricing. The asset price and strike price affect the inherent value and the expiry date might affect the time value.

Let’s look at some of the key terms to understand how the strike prices are categorized:

• In the Money : A strike price on Call side is said to be ‘In-the-money’ when the strike price is near the spot price. Conversely, a strike price on Put side is said to be ‘In-the-money’ when the strike price of the asset is near the spot price.

• At the Money : When the spot price is same as the strike price, it is said to be in the money

• Out of the Money : A strike price on Call side is said to be ‘Out-of-the-money’ when it is far higher than the spot price. Conversely, a strike price on Put side is said to be ‘Out-of-the-money’ when it is far lower than the spot price.

The term trading is simply referred to as buying and selling securities to make money on daily price changes.

If you want to trade in the share market, you should have a good grasp of the fundamentals of share trading. Investing is very much essential these days as savings alone is not adequate to beat inflation and fulfill all our financial goals. Several investment opportunities are available, and you can choose them as per your needs and convenience. It involves vigorous participation in the financial markets compared to investing, which primarily works on a buy-and-hold strategy.

This article allows us to study in-depth trading, types of trading, and how it works.

Types of Trading

Scalping: Scalping is also known as micro-trading. Basically, it is a subset of intraday trading. It is a trading style that specializes in profiting even with small price changes. It can be done several times in a day. Even though all transactions don’t yield profits and in some, a trader’s gross losses might exceed the gains. Thus, it requires a strong exit strategy for the trader to ensure that he does not incur large losses which can nullify his previous gains. In this case, the holding period of the securities is shorter compared to day trading. This requires market experience, proficiency, awareness of market fluctuations, prompt transactions, and strong mental resolve.

Day Trading : This form of trade involves buying and selling stocks in a single day. A trader involved in such trades needs to close the position before the day’s market closure. Day trading requires proficiency in market matters and a good understanding of market volatility. Therefore, day trading is mostly practiced by experienced investors.

Swing Trading : This form of trade is used to capitalize on short-term stock patterns. This style is used to earn gains from stock within a few days of purchasing it. In swing trading , investors primarily stick to technical analysis (looking at the charts, patterns etc.) to anticipate the direction of the market.

Momentum Trading : When stock price moves upward for a certain duration of time, they are said to have gained momentum. In momentum trading, the traders attempt to profit from this price move. They take position with the aim to sell when the peak is reached. Here, you might have to wait for a few hours or days to earn the desired profit. Moreover, the idea is to purchase stock in large quantities to earn substantial gains.

How Trade Works?

Share trading is buying and selling of companies listed on the 2 leading stock Exchanges:

• Bombay Stock Exchange (BSE)
• National Stock Exchange (NSE)

The one who buys the shares gets certain ownership in the company and he is entitled to a certain percentage of stake.

Share market works in the following manner:

• Through an Initial Public Offering (IPO) a company gets listed in the primary market

• In the secondary market, the shares get distributed

• Here, in the secondary market the stocks issued are traded by the investors

• The registered entities with the stock exchanges i.e., stockbrokers and brokerage firms, offer investors and traders to buy the share at a said price

• Then, your registered broker passes on your buy order to the exchange, which searches for a sell order for the same.

• Once both buy and sell orders are matched, then the order is set to be executed.

• This whole process takes T+2 days meaning your bought shares will get deposited in your Demat account in 2 working days from the day you placed the order.

What is online trading?

Online trading can be easily done just by opening a Demat and Trading Account with any SEBI registered broker, which offers online services

Opening an account can be done in a matter of just 10 minutes, all you need are the following documents- PAN card, address proof, AADHAAR card, a mobile number linked to AADHAAR, bank statement, canceled cheque leaf, and photograph.

In online trading , you can place your trade orders or cancel orders at your will and from the comforts of your home. You can also buy shares or invest in IPO or buy Mutual Funds.

What are the advantages of Trading?

Below are some advantages of trading in the share market-

Take advantage of the growing economy: When an economy grows, it also facilitates the growth of corporate earnings, this is because economic growth creates more job opportunities, resulting in more income and more sales. Thus, an investor investing his/her money in the stock of the business, influenced by economic growth helps it to grow better.

Easy process of buying and selling : Buying and selling of shares in the stock market is simple and easy for all investors, all you need is a Demat account which can be opened through a broker, financial planner, or online mode. Opening an account hardly takes 15 minutes to set up and start your investment journey. Once this is done, you can place your buy/sell orders.

Flexibility to invest in a smaller amount : A new investor can even start with a small amount by purchasing stocks of small-cap or mid-cap companies but in smaller units.

Liquidity : Stocks are known as liquid assets as they can easily be converted into cash at any point in time. When compared to other financial assets.

Trading vs Investing

When it comes to wealth creation, both trading and investing are two important attributes of it. For instance, you and your brother bought an equal amount of seeds and you sold them to someone on the same day because you could earn a profit. On the other hand, your brother sowed the seeds and let them grow for a year till they have new seeds. He sold the lot and continued to sow the new seeds and grow crops. By investing in his seeds, he too made profit however, took a different approach than you did.

• Identity Proof: PAN Card

• Address Proof: Either Aadhaar Card, Passport, Driving License, Voter id or last 3 months bank statement

• Photograph

• Signature on white paper

• Bank Details: Any Bank proof (cheque or Passbook) bearing client name, account number & IFSC code

• Income Proof: Either 6 months bank statement, 3 months’ salary slip, net-worth certificate, Holding Report, ITR Statement or Demat Holding Statement.

Advantages of Opening a Trading Account

Trading Accounts offer manifold benefits to the investors, making the share trading ecosystem more robust and efficient. A few of such advantages are detailed below:

This is the difference between both trading and investing in simple terms.

Let’s study below trading vs investing:

Period: In trading, stocks are usually held by the investor for a short period (for a week or a day), whereas investing is an approach that works on the buy-and-hold principle, and the investor may invest for several years as well.

Capital growth: In trading, traders look at the price movements of stocks, and if they notice an increase in price, they sell the stock to book profits. Whereas in investing, it requires a patient approach. Wealth is created by compounding interest over the years.

Risk : Both trading and investing imply risks. Trading comparatively involves higher risks as the price might go high or low in a short interval. On the other hand, investing is an art, it takes a while to develop. Therefore, it involves lower risk.

Final Thoughts

Investors need to be cautious while making investment decisions. A basic understanding of the concepts involved with trading and investing will help them lessen their risk and improve gains.

What Is Cryptocurrency?

A cryptocurrency is a digital or virtual currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. Many cryptocurrencies are decentralized networks based on blockchain technology—a distributed ledger enforced by a disparate network of computers.

A defining feature of cryptocurrencies is that they are generally not issued by any central authority, rendering them theoretically immune to government interference or manipulation.

Understanding Cryptocurrencies

Cryptocurrencies are digital or virtual currencies underpinned by cryptographic systems. They enable secure online payments without the use of third-party intermediaries. "Crypto" refers to the various encryption algorithms and cryptographic techniques that safeguard these entries, such as elliptical curve encryption, public-private key pairs, and hashing functions.

Cryptocurrencies can be mined or purchased from cryptocurrency exchanges. Not all e-commerce sites allow purchases using cryptocurrencies. In fact, cryptocurrencies, even popular ones like Bitcoin, are hardly used for retail transactions. However, the skyrocketing value of cryptocurrencies has made them popular as trading instruments. To a limited extent, they are also used for cross-border transfers.

Blockchain

Central to the appeal and functionality of Bitcoin and other cryptocurrencies is blockchain technology. As its name indicates, blockchain is essentially a set of connected blocks or an online ledger. Each block contains a set of transactions that have been independently verified by each member of the network.

Every new block generated must be verified by each node before being confirmed, making it almost impossible to forge transaction histories.

The contents of the online ledger must be agreed upon by the entire network of an individual node, or computer maintaining a copy of the ledger.

Experts say that blockchain technology can serve multiple industries, such as supply chains, and processes such as online voting and crowdfunding. Financial institutions such as JPMorgan Chase & Co. (JPM) are testing the use of blockchain technology to lower transaction costs by streamlining payment processing.

Types of Cryptocurrency

Bitcoin is the most popular and valuable cryptocurrency. An anonymous person called Satoshi Nakamoto invented it and introduced it to the world via a white paper in 2008. There are thousands of cryptocurrencies present in the market today.

Each cryptocurrency claims to have a different function and specification. For example, Ethereum's ether markets itself as gas for the underlying smart contract platform. Ripple's XRP is used by banks to facilitate transfers between different geographies.

Bitcoin, which was made available to the public in 2009, remains the most widely traded and covered cryptocurrency. As of May 2022, there were over 19 million bitcoins in circulation with a total market cap of around $576 billion. Only 21 million bitcoins will ever exist.

In the wake of Bitcoin's success, many other cryptocurrencies, known as "altcoins," have been launched. Some of these are clones or forks of Bitcoin, while others are new currencies that were built from scratch. They include Solana, Litecoin, Ethereum, Cardano, and EOS. By November 2021, the aggregate value of all the cryptocurrencies in existence had reached over $2.1 trillion—Bitcoin represented approximately 41% of that total value.

Are Cryptocurrencies Legal?

Fiat currencies derive their authority from the government or monetary authorities. For example, each dollar bill is backstopped by the Federal Reserve.

But cryptocurrencies are not backed by any public or private entities. Therefore, it has been difficult to make a case for their legal status in different financial jurisdictions throughout the world. It doesn't help matters that cryptocurrencies have largely functioned outside most existing financial infrastructure. The legal status of cryptocurrencies has implications for their use in daily transactions and trading. In June 2019, the Financial Action Task Force (FATF) recommended that wire transfers of cryptocurrencies should be subject to the requirements of its Travel Rule, which requires AML compliance.

As of May 2022, El Salvador and the Central African Republic were the only countries in the world to accept Bitcoin as legal tender for monetary transactions.

 In the rest of the world, cryptocurrency regulation varies by jurisdiction.

Japan's Payment Services Act defines Bitcoin as legal property.

 Cryptocurrency exchanges operating in the country are subject to collect information about the customer and details relating to the wire transfer. China has banned cryptocurrency exchanges and mining within its borders. India was reported to be formulating a framework for cryptocurrencies in December.

Cryptocurrencies are legal in the European Union. Derivatives and other products that use cryptocurrencies will need to qualify as "financial instruments." In June 2021, the European Commission released the Markets in Crypto-Assets (MiCA) regulation that sets safeguards for regulation and establishes rules for companies or vendors providing financial services using cryptocurrencies.

Within the United States, the biggest and most sophisticated financial market in the world, crypto derivatives such as Bitcoin futures are available on the Chicago Mercantile Exchange. In the past, the Securities and Exchange Commission (SEC) took the stance that Bitcoin and Ethereum were not securities; however, in September 2022, SEC Chair Gary Gensler stated he believes cryptocurrencies are securities. This stance implies that cryptocurrency's legal status may become subject to regulation.

Are Cryptocurrencies Safe Investments?

Cryptocurrencies have attracted a reputation as unstable investments, due to high investor losses as a result of scams, hacks, and bugs. Although the underlying cryptography is generally secure, the technical complexity of using and storing crypto assets can be a major hazard to new users.

In addition to the market risks associated with speculative assets, cryptocurrency investors should be aware of the following risks:

• User risk: Unlike traditional finance, there is no way to reverse or cancel a cryptocurrency transaction after it has already been sent. By some estimates, about a fifth of all bitcoins are now inaccessible due to lost passwords or incorrect sending addresses.

• Regulatory risks: The regulatory status of some cryptocurrencies is still unclear, with many governments seeking to regulate them as securities, currencies, or both. A sudden regulatory crackdown could make it difficult to sell cryptocurrencies, or cause a market-wide price drop.

• Counterparty risks: Many investors and merchants rely on exchanges or other custodians to store their cryptocurrency. Theft or loss by one of these third parties could result in the loss of one's entire investment.

• Management risks: Due to the lack of coherent regulations, there are few protections against deceptive or unethical management practices. Many investors have lost large sums to management teams that failed to deliver a product.

• Programming risks: Many investment and lending platforms use automated smart contracts to control the movement of user deposits. An investor using one of these platforms assumes the risk that a bug or exploit in these programs could cause them to lose their investment.

• Market Manipulation: Market manipulation remains a substantial problem in the cryptocurrency space, and some exchanges have been accused of manipulating prices or trading against their customers.

• Despite these risks, cryptocurrencies have seen a major leap in prices, with the total market capitalization rising to over $1 trillion.

•  Despite the speculative nature of the asset, some have been able to create substantial fortunes by taking on the risk of investing in early-stage cryptocurrencies.

Advantages and Disadvantages of Cryptocurrency

Cryptocurrencies were introduced with the intent to revolutionize financial infrastructure. As with every revolution, however, there are tradeoffs involved. At the current stage of development for cryptocurrencies, there are many differences between the theoretical ideal of a decentralized system with cryptocurrencies and its practical implementation.

Some advantages and disadvantages of cryptocurrencies are as follows.

Advantages

Cryptocurrencies represent a new, decentralized paradigm for money. In this system, centralized intermediaries, such as banks and monetary institutions, are not necessary to enforce trust and police transactions between two parties. Thus, a system with cryptocurrencies eliminates the possibility of a single point of failure, such as a large bank, setting off a cascade of crises around the world, such as the one that was triggered in 2008 by the failure of institutions in the United States.

Cryptocurrencies promise to make it easier to transfer funds directly between two parties, without the need for a trusted third party like a bank or a credit card company. Such decentralized transfers are secured by the use of public keys and private keys and different forms of incentive systems, such as proof of work or proof of stake.

Because they do not use third-party intermediaries, cryptocurrency transfers between two transacting parties are faster as compared to standard money transfers. Flash loans in decentralized finance are a good example of such decentralized transfers. These loans, which are processed without backing collateral, can be executed within seconds and are used in trading.

Cryptocurrency investments can generate profits. Cryptocurrency markets have skyrocketed in value over the past decade, at one point reaching almost $2 trillion. As of May 2022, Bitcoin was valued at more than $550 billion in crypto markets.

The remittance economy is testing one of cryptocurrency's most prominent use cases. Currently, cryptocurrencies such as Bitcoin serve as intermediate currencies to streamline money transfers across borders. Thus, a fiat currency is converted to Bitcoin (or another cryptocurrency), transferred across borders, and, subsequently, converted to the destination fiat currency. This method streamlines the money transfer process and makes it cheaper.

Disadvantages

Though they claim to be an anonymous form of transaction, cryptocurrencies are actually pseudonymous. They leave a digital trail that agencies such as the Federal Bureau of Investigation (FBI) can decipher. This opens up possibilities of governments or federal authorities tracking the financial transactions of ordinary citizens.

Cryptocurrencies have become a popular tool with criminals for nefarious activities such as money laundering and illicit purchases. The case of Dread Pirate Roberts, who ran a marketplace to sell drugs on the dark web, is already well known. Cryptocurrencies have also become a favorite of hackers who use them for ransomware activities.

In theory, cryptocurrencies are meant to be decentralized, their wealth distributed between many parties on a blockchain. In reality, ownership is highly concentrated. For example, an MIT study found that just 11,000 investors held roughly 45% of Bitcoin's surging value.

One of the conceits of cryptocurrencies is that anyone can mine them using a computer with an Internet connection. However, mining popular cryptocurrencies requires considerable energy, sometimes as much energy as entire countries consume. The expensive energy costs coupled with the unpredictability of mining have concentrated mining among large firms whose revenues running into the billions of dollars. According to an MIT study, 10% of miners account for 90% of its mining capacity.

Though cryptocurrency blockchains are highly secure, other crypto repositories, such as exchanges and wallets, can be hacked. Many cryptocurrency exchanges and wallets have been hacked over the years, sometimes resulting in millions of dollars worth of "coins" stolen.

Cryptocurrencies traded in public markets suffer from price volatility. Bitcoin has experienced rapid surges and crashes in its value, climbing to as high as $17,738 in December 2017 before dropping to $7,575 in the following months.

 Some economists thus consider cryptocurrencies to be a short-lived fad or speculative bubble.

How Do You Buy Cryptocurrencies?

Any investor can purchase cryptocurrency from popular crypto exchanges such as Coinbase, apps such as Cash App, or through brokers. Another popular way to invest in cryptocurrencies is through financial derivatives, such as CME's Bitcoin futures, or through other instruments, such as Bitcoin trusts and Bitcoin ETFs.

What Is the Point of Cryptocurrency?

Cryptocurrencies are a new paradigm for money. Their promise is to streamline existing financial architecture to make it faster and cheaper. Their technology and architecture decentralize existing monetary systems and make it possible for transacting parties to exchange value and money independently of intermediary institutions such as banks.

Can You Generate Cryptocurrency?

Cryptocurrencies are generated by mining. For example, Bitcoin is generated using Bitcoin mining. The process involves downloading software that contains a partial or full history of transactions that have occurred in its network. Though anyone with a computer and an Internet connection can mine cryptocurrency, the energy- and resource-intensive nature of mining means that large firms dominate the industry.

What Are the Most Popular Cryptocurrencies?

Bitcoin is by far the most popular cryptocurrency followed by other cryptocurrencies such as Ethereum, Binance Coin, Solana, and Cardano.

Are Cryptocurrencies Securities?

In the past, the SEC has said that Bitcoin and Ethereum, the top two cryptocurrencies by market cap, were not securities. In September 2022, SEC Chair Gary Gensler stated he believes cryptocurrencies are securities and has asked SEC staff to begin working with crypto developers to register their crypto. However, he also clarified that he did not speak on behalf of the SEC; he was only speaking for himself. He encouraged those starting in the crypto space to register their crypto in the spirit of getting ahead because "It's far less costly to do so from the outset."

The Bottom Line

Cryptocurrencies are digital assets that are secured by cryptography. As a relatively new technology, they are highly speculative, and it is important to understand the risks involved before making an investment.

Investing in cryptocurrencies and other initial coin offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Because each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein.

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Bitcoin (BTC) is a cryptocurrency, a virtual currency designed to act as money and a form of payment outside the control of any one person, group, or entity, and thus removing the need for third-party involvement in financial transactions. It is rewarded to blockchain miners for the work done to verify transactions and can be purchased on several exchanges.

Bitcoin was introduced to the public in 2009 by an anonymous developer or group of developers using the name Satoshi Nakamoto.

It has since become the most well-known cryptocurrency in the world. Its popularity has inspired the development of many other cryptocurrencies. These competitors either attempt to replace it as a payment system or are used as utility or security tokens in other blockchains and emerging financial technologies.

Understanding Bitcoin

In August 2008, the domain name Bitcoin.org was registered.

Today, at least, this domain is WhoisGuard Protected, meaning the identity of the person who registered it is not public information.

In October 2008, a person or group using the false name Satoshi Nakamoto announced the Cryptography Mailing List at metzdowd.com: "I've been working on a new electronic cash system that's fully peer-to-peer, with no trusted third party." This now-famous white paper published on Bitcoin.org, entitled "Bitcoin: A Peer-to-Peer Electronic Cash System," would become the Magna Carta for how Bitcoin operates today.

On Jan. 3, 2009, the first Bitcoin block was mined—Block 0. This is also known as the "genesis block" and contains the text: "The Times 03/Jan/2009 Chancellor on brink of second bailout for banks," perhaps proof that the block was mined on or after that date, and maybe also as relevant political commentary.

Bitcoin rewards are halved every 210,000 blocks. For example, the block reward was 50 new bitcoins in 2009. On May 11, 2020, the third halving occurred, bringing the reward for each block discovery down to 6.25 bitcoins.

One bitcoin is divisible to eight decimal places (100 millionths of one bitcoin), and this smallest unit is referred to as a satoshi. If necessary, and if the participating miners accept the change, Bitcoin could eventually be made divisible to even more decimal places.

Bitcoin, as a form of digital currency, isn't too complicated to understand. For example, if you own a bitcoin, you can use your cryptocurrency wallet to send smaller portions of that bitcoin as payment for goods or services. However, it becomes very complex when you try to understand how it works.

Bitcoin's Blockchain Technology

Cryptocurrencies are part of a blockchain and the network required to power it. A blockchain is a distributed ledger, a shared database that stores data. Data within the blockchain are secured by encryption methods. When a transaction takes place on the blockchain, information from the previous block is copied to a new block with the new data, encrypted, and the transaction is verified by validators—called miners—in the network. When a transaction is verified, a new block is opened, and a Bitcoin is created and given as a reward to the miner(s) who verified the data within the block—they are then free to use it, hold it, or sell it.

Bitcoin uses the SHA-256 hashing algorithm to encrypt the data stored in the blocks on the blockchain. Simply put, transaction data stored in a block is encrypted into a 256-bit hexadecimal number. That number contains all of the transaction data and information linked to the blocks before that block.

Transactions are placed into a queue to be validated by miners within the network. Miners in the Bitcoin blockchain network all attempt to verify the same transaction simultaneously. The mining software and hardware work to solve the nonce, a four-byte number included in the block header that miners are attempting to solve. The block header is hashed, or randomly regenerated by a miner repeatedly until it meets a target number specified by the blockchain. The block header is "solved," and a new block is created for more transactions to be encrypted and verified.

How to Mine Bitcoin

A variety of hardware and software can be used to mine Bitcoin. When Bitcoin was first released, it was possible to mine it competitively on a personal computer. However, as it became more popular, more miners joined the network, which lowered the chances of being the one to solve the hash. You can still use your personal computer as a miner if it has newer hardware, but the chances of solving a hash are individually are minuscule.

This is because you're competing with a network of miners that generate around 220 quintillion hashes (220 exa hashes) per second.

 Machines, called Application Specific Integrated Circuits (ASICs), have been built specifically for mining—can generate around 255 trillion hashes per second. In contrast, a computer with the latest hardware hashes around 100 mega hashes per second (100 million).

To successfully become a Bitcoin miner, you have several options. You can use your existing personal computer to use mining software compatible with Bitcoin and join a mining pool. Mining pools are groups of miners that combine their computational power to compete with the large ASIC mining farms.

If you have the financial means, you could also purchase an ASIC miner. You can generally find a new one for around $20,000, but used ones are also sold by miners as they upgrade their systems. There are some significant costs such as electricity and cooling to consider if you purchase one or more ASICs.

There are several mining programs to choose from and many pools you can join. Two of the most well-known programs are CGMiner and BFGMiner. When choosing a pool, it's important to make sure you find out how they pay out rewards, what any fees might be, and read some mining pool reviews.

How Do You Buy Bitcoin?

If you don't want to mine bitcoin, it can be bought using a cryptocurrency exchange. Most people will not be able to purchase an entire BTC because of its price, but you can buy portions of BTC on these exchanges in fiat currency like U.S. dollars. For example, you can buy bitcoin on Coinbase by creating an account and funding it. You can fund your account using your bank account, credit card, or debit card. 

How Is Bitcoin Used?

Bitcoin was initially designed and released as a peer-to-peer payment method. However, its use cases are growing due to its increasing value and competition from other blockchains and cryptocurrencies.

Payment

To use your Bitcoin, you need to have a cryptocurrency wallet. Wallets hold the private keys to the bitcoin you own, which need to be entered when you're conducting a transaction. Bitcoin is accepted as a means of payment for goods and services at many merchants, retailers, and stores.

Brick-and-mortar stores that accept cryptocurrencies will generally display a sign that says “Bitcoin Accepted Here”; the transactions can be handled with the requisite hardware terminal or wallet address through QR codes and touchscreen apps. An online business can easily accept Bitcoin by adding this payment option to its other online payment options: credit cards, PayPal, etc.

Investing and Speculating

Investors and speculators became interested in Bitcoin as it grew in popularity. Between 2009 and 2017, cryptocurrency exchanges emerged that facilitated bitcoin sales and purchases. Prices began to rise, and demand slowly grew until 2017, when its price broke $1,000. Many people believed Bitcoin prices would keep climbing and began buying them to hold. Traders began using cryptocurrency exchanges to make short-term trades, and the market took off.

Risks of Investing in Bitcoin

Speculative investors have been drawn to Bitcoin after its rapid price appreciation in recent years. Bitcoin had a price of $7,167.52 on Dec. 31, 2019, and a year later, it had appreciated more than 300% to $28,984.98. It continued to surge in the first half of 2021, trading at a record high of over $69,000 in November 2021—it then fell over the next few months to hover around $40,000.

Thus, many people purchase Bitcoin for its investment value rather than its ability to act as a medium of exchange. However, the lack of guaranteed value and its digital nature means its purchase and use carry several inherent risks. For example, many investor alerts have been issued by the Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA), and the Consumer Financial Protection Bureau (CFPB) regarding Bitcoin investing.

Regulatory risk: The lack of uniform regulations about Bitcoin (and other virtual currencies) raises questions over their longevity, liquidity, and universality.

Security risk: Most individuals who own and use Bitcoin have not acquired their tokens through mining operations. Rather, they buy and sell Bitcoin and other digital currencies on popular online markets, known as cryptocurrency exchanges. Bitcoin exchanges are entirely digital and—as with any virtual system—are at risk from hackers, malware, and operational glitches.

Insurance risk: Bitcoin and cryptocurrencies are not insured through the Securities Investor Protection Corporation (SIPC) or the Federal Deposit Insurance Corporation (FDIC). Some exchanges provide insurance through third parties. In 2019, prime dealer and trading platform SFOX announced it would be able to offer Bitcoin investors with FDIC insurance, but only for the portion of transactions involving cash.

Fraud risk: Even with the security measures inherent within a blockchain, there are still opportunities for fraudulent activity. For instance, in July 2013, the SEC brought legal action against an operator of a Bitcoin-related Ponzi scheme.

Market risk: As with any investment, Bitcoin values can fluctuate. Indeed, the value of the currency has seen wild swings in price over its short existence. Subject to high volume buying and selling on exchanges, it is highly sensitive to any newsworthy events. According to the CFPB, the price of Bitcoin fell by 61% in a single day in 2013, while the one-day price drop record in 2014 was as big as 80%.

How Long Does It Take to Mine 1 Bitcoin?

It takes an average of 10 minutes for the mining network to validate a block and create the reward. The Bitcoin reward is 6.25 BTC per block. This works out to be about 100 seconds for 1 BTC to be mined.

Is Bitcoin a Good Investment?

Bitcoin has a short investing history filled with very volatile prices. Whether it is a good investment depends on your financial profile, investing portfolio, risk tolerance, and investing goals. You should always consult a financial professional for advice before investing in cryptocurrency to ensure it is right for your circumstances.

How Does Bitcoin Make Money?

The Bitcoin network of miners make money from Bitcoin by successfully validating blocks and being rewarded. Bitcoins are exchangeable for fiat currency via cryptocurrency exchanges and can be used to make purchases from merchants and retailers that accept them. Investors and speculators can make money from buying and selling bitcoins.