Bitcoin — and cryptocurrency in general — is somewhat of a nebulous concept, it may initially be unclear what happens to your real-world cash when topping up or offloading the coins in your wallet. It’s easy to view this chain of events as an overly complex system, governed by higher powers that are not for the mere mortal to understand.
But that’s not true. While the price of bitcoin may be somewhat volatile, it also adheres to a logical, fairly simple set of guidelines. Bitcoin, after all, is a commodity — and it acts accordingly.
A simple example
Say, for example, you buy a sweater at a retail store. In exchange for ownership of said sweater, you offer a stated amount of currency to the sweater’s previous owner. Look back far enough, and you can follow ownership of that sweater all the way up the supply chain, up until its manufacture. If you wanted to get really meta, you could go back even further, tracing the materials sourced and used to create the sweater. The point is, when you are making a bitcoin purchase, just as when you buy a sweater, or a computer, or a car, you are not the first owner. All bitcoin that exists was first mined, then distributed among the blockchain through purchases and sales.
Exchanges: buy and sell
When buying bitcoin, it is common to do so from a bitcoin exchange. Our users in the United States can currently do this directly through their wallet, thanks to our partnership with Kraken and its Kraken Direct brokerage service. Using real-world currency, you will purchase a set amount of bitcoin. Obviously the amount of bitcoin you receive will vary, depending on how much money you exchange, as well as the price of bitcoin. After making the purchase, the bitcoin is transferred to your wallet. Then you own the bitcoin.
Selling bitcoin can also be accomplished through an exchange. In this case, the transaction works oppositely of the way it did when you bought bitcoin. The exchange provides the funds, while you provide the bitcoin. In this way, exchanges essentially act as banks. Although with bitcoin you, the user, have much more control over your funds than you do with fiat currency.
Transaction fees
To be counted as official, a free bitcoin mining transaction must be included on the blockchain. To be included on the blockchain in a timely manner, those transacting should pay a transaction fee to bitcoin miners. Miners prioritize transactions that pay them higher fees. If your transaction is prioritized, it will be recorded on the blockchain more quickly, which means you will have access to your funds sooner than if you opted to pay a lower fee.
The wallet automatically uses a dynamic fee strategy to determine the optimal fee for your particular transaction. You can also always opt for the lowest possible fee. It’s also important to remember that transaction fees paid via a wallet transaction are never paid to itself, but rather the miners that will include the transaction on the blockchain.Find out more about transaction fees in our in-depth blog post on the topic.
Trading bitcoin
In this case, exchanges will have a bit more control over your funds. We refrain from offering any sort of advice when it comes to trading and instead focuses on the facts. Trading, however, is not without its risks and should be approached with caution, knowledge, and experience (if not yours, then with the help of someone else’s).
When trading, the bitcoin exchanges act as the middleman between buyer and seller. Each exchange operates what is known as an “order book.” Here, buyers are able to place orders for bitcoin purchases, stating how much bitcoin they would like and for what price. Sellers are able to see these orders, and either match that price or wait it out, in hopes that they will be able to offload their bitcoin for a potentially better deal.
Trading bitcoin is a bit like playing the stock market. Because currency values are constantly shifting, shrewd traders are able to ride the waves of currency (both real and digital), buying and selling at just the right time in order to maximize their profits. But beware—for every winner, there is also a loser.
Often, bitcoin traders’ funds sit with an exchange rather than in a wallet. This means they are not in control of their bitcoin until after they have withdrawn, received, and stored it safely in a bitcoin wallet. Trading bitcoin requires a lot of trusts, so make sure that when you are ready to trade you are doing so with a reputable exchange. Money can be made trading, and it can be lost just as easily.
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