Bitcoin: 7 questions answered

Early in December the price of Bitcoin, the world’s most important cryptocurrency, hit a new record high of more than $100,000. The surge was driven by the election of Donald Trump, who has voiced support for the digital coin and advocated a ‘strategic reserve’ of Bitcoin along the lines of America’s gold holdings at Fort Knox.

The extraordinary rise in Bitcoin’s price this year will doubtless be prompting some private savers to consider investing in the digital currency for the first time. But it’s vital to understand the currency first. The following Q&A aims to tell you all you need to know.

1. What is Bitcoin?

Bitcoin is a currency that exists only in digital form, so there are no banknotes or coins. Instead, ownership of Bitcoin is recorded electronically, rather as a bank account is, with some key differences: no bank or other organisation is involved; instead the information about who owns what is recorded in numerous places online. This massively duplicated storeroom of data is called the ‘blockchain’.

Although Bitcoin is described as a digital currency, its primary use is as a financial asset or a store of value – or, some say, as a medium of financial speculation.

2. How does Bitcoin work?

When someone buys Bitcoin, proof of ownership is recorded on the blockchain. The information is public, which aims to ensure transparency and security, although ownership is anonymous.

Each cryptocurrency transaction is individually recorded on to the blockchain by a huge network of participants who verify its authenticity using the complex computer programs that determine everything about how Bitcoin functions. One of these participants is rewarded in Bitcoin for the validation. This process of creating new Bitcoin is known as ‘mining’ by analogy with the extraction of gold.

3. Why was Bitcoin created?

Bitcoin was created by Satoshi Nakamoto, a pseudonym for a person or group whose true identity remains unknown.

Nakamoto’s intention was to create a ‘new electronic cash system that’s fully peer-to-peer, with no trusted third party’, such as a bank. The first Bitcoin block, also known as the ‘genesis block’, was mined on 3 January 2009.

Bitcoin was created in such a way that there is a limit on how much can ever be created: around 21 million Bitcoins. Of that total, almost 20 million are already in circulation. Making an asset scarce in this way should, according to conventional economics, support its value.

Some argue that this makes Bitcoin similar to gold, another asset whose supply is finite. Traditional currencies such as the pound or dollar, by contrast, can be created in unlimited amounts at will: if a central bank chooses to, it can print more money, as we saw when ‘quantitative easing’ was used to counter the effects of the global financial crisis and the pandemic.

4. What is a Bitcoin ‘halving’?

The most recent Bitcoin halving happened on 19 April 2024. As mentioned above, the validation of cryptocurrency transactions is rewarded with new Bitcoin. After a halving, the reward for each validation is cut by 50%. Regular halvings are the way in which the supply of Bitcoin is limited.

After a halving, the supply of new Bitcoin increases more slowly. All else being equal, this would be expected to support the price. Before a halving the price of Bitcoin has historically tended to fall, whereas following a halving it has typically risen. As with all financial assets, however, past performance is no guide to the future.

5. What risks are associated with Bitcoin?

Volatility is a key risk associated with Bitcoin: in its brief existence, the price has fluctuated wildly, as you can see from this chart.

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.