What is Bitcoin? Cryptocurrencies explained
What is Bitcoin and cryptocurrency?
Bitcoin and other cryptocurrencies (or ‘crypto’) are forms of currency that aren’t controlled by any country or central bank.
You can use cryptocurrency to buy or sell items from people or companies that accept those types of payments, though most don't.
Cryptocurrencies are stored in virtual wallets, which can be on a website, mobile or even physical paper wallets.
There are several types of cryptocurrency – Bitcoin is just the most well known – and they all have variations in value and purpose. Other popular cryptocurrencies include Ethereum and Tether.
Please note: the content contained in this article is for information purposes only and does not constitute financial or investment advice.
What are stablecoins?
Stablecoins are an alternative type of cryptocurrency that are tied to another asset, for example gold or a major global currency like the US dollar.
The company behind the stablecoin holds a reserve of the other asset to support its value.
This can make stablecoins less volatile than other types of cryptocurrency which have no intrinsic value, which means their worth only comes from how valuable investors think they are. As a result, stablecoins are more likely to be used for payments.
However, if investors lose confidence in the company behind a stablecoin - for instance, because they believe it doesn't hold enough of the related asset - the stablecoin's price can collapse.
And if the related asset's price is volatile, then the stablecoin's price is also likely to be volatile.
Where can I buy Bitcoin?
Bitcoin and other cryptocurrencies can be bought through online cryptocurrency exchanges.
A cryptocurrency exchange is a service for people to buy or sell their cryptocurrency.
These function in a similar way to investment platforms, and allow you to monitor how the cryptocurrencies in your 'wallet' are performing.
There are a number of exchanges available including Coinbase, CoinCorner and Kraken.
Unlike regulated investment platforms, if an exchange goes out of business, you're not protected by the Financial Services Compensation Scheme.
- Find out more: the best and worst investment platforms
Beware cryptocurrency scams
Scammers usually advertise on social media or search engines - often using celebrity images and slick websites to promote these types of investments.
The Financial Conduct Authority (FCA) says scam firms can:
- manipulate software to distort prices and investment returns
- scam people into buying non-existent cryptoassets
- suddenly close consumers' online accounts and refuse to transfer the funds to them or ask for more money before the funds can be transferred.
You should also watch out for initial coin offerings (ICOs), a digital way of raising funds from the public using a virtual currency like Bitcoin. Some issuers might not have the intention to use the funds raised in the way set out when the project was marketed.
You can find a list of unregistered cryptoasset businesses on the Financial Services Register. It shows UK businesses that appear to be carrying on cryptoasset activity without being registered with the FCA, and should hence be avoided.
If you suspect you've clicked on a fraudulent link or have been targeted by scammers it's important to contact Action Fraud as soon as possible.
Which? has launched a free email service revealing the latest scams.
Is it safe invest in Bitcoin and cryptocurrencies?
All cryptocurrencies are extremely risky investments and you should only consider investing if you can afford to lose the money you put into it.
It is true that where there's higher risk, there's potential for higher returns. But remember there's also more potential for losses.
Investing directly in shares or through investment funds is usually a less volatile way to take on investment risk.
If you're thinking about investing in Bitcoin or other cryptocurrencies, there are a few risks to consider first.
Price volatility
The value of cryptocurrencies can change significantly. It's common to see its price fluctuate by around 10% or more daily.
If consumers lose interest in Bitcoin and move to a new cryptocurrency (or vice versa), it will also lose value. The same goes for other cryptocurrencies.
Governments could also crack down on firms involved in cryptocurrencies, or make them impossible for businesses to accept as payment.
If you're investing with a specific goal in mind – buying a property, for instance – price swings could put your plans in jeopardy.
Given the risks, if you're going to invest in cryptocurrency, you should also invest in other assets, like stocks and shares and bonds, that can help to balance out variations in price.
- Find out more: how to balance your investment portfolio
Lack of regulation
Bitcoin and other cryptocurrencies aren't regulated by the Financial Conduct Authority (FCA) in the same way as investment platforms or banks.
Cryptocurrencies aren't protected by the Financial Services Compensation Scheme (FSCS), and you won't access to the Financial Ombudsman Service if you have a dispute with a provider.
Ordinarily, the FSCS would compensate you up to £85,000 worth of investments if you receive inappropriate investment advice, or if a regulated investment firm goes out of business and cannot return your money.
Cryptocurrency firms are however required to register with the FCA, to comply with anti-money laundering and terrorist financing regulations. They may also carry out regulated activities.
Cyber attacks
The blockchain system is very secure, making it difficult to break into people's crypto wallets.
However, there are still security risks. You should have the security of a transaction linked to an email address or mobile number. If a hacker can determine some of your non-Bitcoin personal information like this, they may be able to gain access to your digital wallets.
How does Bitcoin work?
Bitcoin works using a system called 'blockchain', as do many (but not all) other cryptocurrencies.
Blockchain is a network of computers that all have access to every transaction that takes place.
Each time a Bitcoin or other cryptocurrency transaction is completed, the entire network is updated with this information so it can be validated by users on the network to prevent counterfeiting or double spending.
The transaction information on the network is encoded using cryptography, which keeps the transaction data secure and prevents anyone from tracking who it belongs to.
Once validated, the transaction information is added to a chain of previously approved transactions.
Is Bitcoin bad for the environment?
Cryptocurrencies require large amounts of energy. This is because 'mining' for cryptocurrency involves heavy computer calculations to verify transactions.
One study by Cambridge University suggested Bitcoin alone uses more electricity than the whole of Argentina.
However, not all cryptocurrencies have significant environmental impacts. For example, some may use an alternative to blockchain which removes the need for miners.
- Find out more: ethical investing explained