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.

Crypto currencies 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.

Where can I buy Bitcoin?

Bitcoin 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, Coinfloor and Kraken.

• Find out more: the best and worst investment platforms

Is it safe invest in Bitcoin?

Bitcoin is an extremely risky investment 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 crypto, there are a few risks to consider first.

• Find out more: what is investment risk?

Price volatility

The value of cryptocurrencies, such as Bitcoin, 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) - or just leave digital currencies alone - Bitcoin 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.

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.

This means you may not get access to the Financial Ombudsman Service if you have a dispute with a provider, they are however required to register with the FCA, to comply with anti-money laundering and terrorist financing regulations.

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.

Crypto isn’t  protected by the Financial Services Compensation Scheme (FSCS).

If the provider of your cryptocurrency wallet went out of business and shut down, you wouldn't be eligible for compensation from the FSCS.

Ordinarily the FSCS will compensate you up to £85,000 worth of investments if you have received bad investment advice, or if a regulated investment firm goes out of business and cannot return your money.

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. This should 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 crypto involves heavy computer calculations to verify transactions.

Using large amounts of energy is a major contributor to air pollution and climate change.

According to a study by Cambridge University, Bitcoin alone uses more electricity than the whole of Argentina.

In addition, 65% of Bitcoin miners are located in China, a country that generates most of its energy from burning coal, a significant contributor to climate change due to the carbon dioxide it produces.

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