In May 2010, on a sunny day in Florida, computer programmer Laszlo Hanyecz bought two pizzas online for the equivalent of $US30. If he was to have performed the same transaction in, say, mid-2021, the meal would have cost him nearly $US600 million.

That’s because Hanyecz paid for his dinner in Bitcoin – 10,000 of them. Hanyecz’s pizza purchase is now a part of the Bitcoin story, widely regarded as the first commercial transaction using the mysterious cryptocurrency and one that helped catapult it into the mainstream.

In 2010, the only places you might have heard of Bitcoin or other cryptocurrencies would have been in the dark depths of an internet message board used by nerdy teens looking for discreet ways to purchase drugs (or pizza).

The digital currency’s roots are closely linked with anti-establishment or libertarian movements, and early adopters touted its independence from banking institutions and freedom from government oversight as major benefits.

Today, Bitcoin and other cryptocurrencies are storming the world, offering a new asset class and catching the eye of investors everywhere, including one of the world’s richest men, entrepreneur Elon Musk (who has a habit of changing his mind).

Every day, Bitcoin changes hands hundreds of thousands of times all over the globe. It is often referred to as “digital gold”. But it is also extremely volatile and entirely unregulated, with no help desk if you get into trouble.

So, what’s the attraction of Bitcoin? And how does it work?

What is bitcoin, and how is it made?

In 2008 – two years before the storied pizza delivery – an anonymous person or group of people known only as Satoshi Nakamoto released an explanatory paper titled Bitcoin: A Peer-to-Peer Electronic Cash System. It set out Nakamoto’s idea for an electronic version of cash that would be secure, stable, trusted and trackable, all without the need for a central financial institution.

In essence, Nakamoto’s original vision for bitcoin still holds true today. It is a cryptocurrency: a digital currency that’s encrypted, which means it’s programmed to make it incredibly difficult to counterfeit.

You won’t find the local Bitcoin headquarters in a CBD, nor will you hear about the exploits of Bitcoin’s chief executive. You won’t be able to put any shiny Bitcoins in your back pocket, nor call up the Bitcoin hotline when you’ve got an issue with your Bitcoin credit card.

None of these things exist. There’s not even a central server nor system that runs Bitcoin. Instead, the network exists on a web of millions of computers across the globe, each linked to one another and tasked with verifying, cross-referencing and processing transactions on the network.

Huh?

Let’s say you decide to send your mum a Bitcoin – or a fraction of a Bitcoin, which is all that most people could afford these days – as a birthday present. You and your mum would each need to have a Bitcoin wallet (which is like an account), you’d need to find an online exchange (there are plenty), you’d set up an account linked to your bank account then buy the Bitcoins and send them to her wallet.

When you hit send, computers, called nodes, would all independently check that your transaction was above board – that you were good for it. If a majority agreed, your transaction would be chronologically added to a long public list – or chain – of every Bitcoin transaction in existence and the sale would go through.

Where does ‘blockchain’ technology fit in?

Every 10 minutes, the computers managing the network package all the transactions received during that time as a “block”, which is linked to the preceding block. Why 10 minutes? That’s just the time coded into the design when this system was first made. The point is, these blocks are unable to be modified or changed and can be traced all the way back to January 2009 when the network was first switched on.

It is these blocks that form the “blockchain” technology upon which almost all cryptocurrencies are based. There are now hundreds of cryptos similar to Bitcoin. There are even cryptos made as jokes (albeit that have value) such as Dogecoin, based on an internet meme about a sheepish-looking Japanese dog and created as a kind of satirical jibe at cryptos.

The reasons for running currencies using blockchain technology are numerous. For example, if one computer processing a transaction crashes, millions of others can step in and pick up the slack. Similarly, if someone was to try to dupe the system with a fraudulent transaction, every other node could reference it with its own copy of the blockchain, see that it was invalid and refuse to verify it.

Blockchain technology also creates a transparent ledger visible to anyone who cares to look, on which nothing can be changed, modified or hacked. The transaction itself is recorded but it doesn’t show the identities of people or companies involved, so anonymity is ensured, which can be good or bad, depending on how you look at it.

But this transparency and immutability is attractive to many Bitcoin fanatics, and to a growing number of investors generally, who decry what they see as the murky operations of many financial institutions. Bitcoin, remember, was rolled out in 2008, in the midst of the global financial crisis of 2007-2009.

Blockchain technology has other uses too – it’s not all about cryptos. For example, it has been used to develop “digital collectibles” known as non-fungible tokens, or NFTs. These assets, which tend to take the form of a piece of art or a short video clip, are essentially a computer link that their owner can click on to look at them, placed within the blockchain.

They’re like any collectible in the sense that they’re limited-edition and able to be transacted among people. The owner of an NFT has their exclusive ownership registered on the blockchain, unable to be altered or changed even if the NFT can be copied. It attracts the kudos of owning an original work of art. Some NFTs fetched millions of dollars at auctions in 2021.

And many companies make products using blockchain that have nothing to do with cryptocurrency or NFTs. For example, Sydney-based startup Lumachain is using blockchain to tackle transparency in global supply chains because the unalterable ledger is a record of an item’s provenance.

What does mining have to do with Bitcoin?

Making money is, of course, the driver of the Bitcoin boom – and not just for individual punters at home. Every day there are an estimated 400,000 Bitcoin transactions – anything from people moving their own Bitcoin between wallets, as you might do with bank accounts, or buying and selling Bitcoin or using Bitcoin to buy other cryptocurrencies. The process of verifying and recording these moves requires incredible computing power – and network operators can hardly be expected to keep the computers running on pure altruism. Instead, these operators get rich from “mining” Bitcoin. Mining is the crux of how the self-generating Bitcoin sausage is made.

Every 10 minutes, the first computer (or group of computers) to announce to the rest of the network that it has successfully verified all the transactions in a block is rewarded with 6.25 Bitcoin, worth about $US375,000 (at the time of writing – it goes up and down, sometimes rapidly). This is called a block reward, from which miners make a tidy profit, by selling it into the wider Bitcoin market through a cryptocurrency exchange, which acts like a highly decentralised mini stockmarket.

Think of bearded prospectors chipping away very fast at a rock face, searching for a reward.

Mining could once be done on any old laptop. Back in 2010, those same nerds in internet chatrooms could have landed Bitcoins in mere seconds. There was actually a website called the Bitcoin Tap where users could receive five Bitcoins just by entering in their wallet (account) details. But another crucial ingredient in the Bitcoin sausage is this: reserves are finite. Bitcoin was programmed in such a way that there will only ever be 21 million coins in existence. With about 18.6 million coins already in circulation, the computational difficulty of verifying transactions will continue to get exponentially harder – so hard that the rate of release will slow and Bitcoin’s supply won’t be depleted for another 120 years.

This is why mining Bitcoin requires serious processing power and a bit of luck, the luck coming from whoever gets over the line first to verify a block. Think of bearded prospectors chipping away very fast at a rock face, searching for a reward.

It’s no surprise then, that Bitcoin mining has become a business in itself. Massive companies, from Reykjavik to Siberia to Amsterdam, are tasked with overseeing warehouses full of computers dedicated entirely to mining Bitcoin. One miner, based in the Chinese city of Dalian, mines about 750 Bitcoins ($US44.6 million) a month. Around the world, miners pocket tens of millions of dollars a day in block rewards. Miners also pocket fees paid by Bitcoin users for each transaction that occurs within a block. If you simply wanted to transfer your Bitcoin between two wallets (accounts), in May 2021 this would have cost you around $US15, although the ever-fluctuating price of Bitcoin means this has been as high as $US60.

Running these computers is also a power-hungry process – we’re talking about warehouses stacked full of processors plugged into the grid. Unlike other warehouses full of internet servers, these Bitcoin miners aren’t providing a great deal of public utility. And yet the Bitcoin Power Index, run by news site Digiconomist, estimates the Bitcoin network has an annual carbon footprint comparable to that of Peru (population 32 million). The electricity consumed in just one Bitcoin transaction – with all those computers crunching tough equations – could power an average US household for more than 23 days.

As many of the largest miners are based in China, the electricity used isn’t particularly clean either, with the country producing about 57 per cent of its power from burning coal in 2020. This is why many sustainability advocates prefer cryptocurrencies such as Ethereum, which have far cheaper running costs and don’t use as much energy. It’s likely that as long as Bitcoin and other cryptocurrencies require immense amounts of processing power to operate, the green credentials of cryptocurrencies will continue to be an issue.

How did Bitcoin catch on?

Bitcoin’s value can be a tricky thing to understand. Why should something with no product or commodity tied to its value, and that generates no cash flow of its own, be worth, say, $US60,000 apiece? Isn’t it all just ones and zeroes floating around on the internet?

Well, yes. These are valid points and ones often raised by Bitcoin’s detractors, who have frequently denounced the asset as a scam comparable to a Ponzi scheme, believing the coins maintain value only as long as there’s a steady stream of greater fools willing to buy in.

But others call Bitcoin “digital gold” insofar as both gold and Bitcoin are finite – you can’t simply create more of them – and they take considerable effort to extract. And the economic context factors into its appeal. Bitcoin became increasingly attractive for investors in 2020 as central banks around the world pumped their economies, printing money at a rapid clip in response to the COVID-19 pandemic, sending interest rates to record lows.

Having money in the bank has been generating measly returns, meaning investors have been looking further afield for assets that may appreciate faster. Major international funds such as BlackRock have begun to invest in Bitcoin, alongside Wall Street legends such as Stanley Druckenmiller and Paul Tudor Jones. And for good reason: the price of Bitcoin over the first half of 2021 rose 58 per cent, far greater than the ASX200’s 5.6 per cent gain.

Bitcoin’s price is in part driven by its devout, almost religious, followers who extol the currency’s freedom from governments and banks …

Then there’s the influence of fame. In February 2021, Elon Musk announced that his automotive company, Tesla, had invested $US1.5 billion in Bitcoin and would begin to accept the cryptocurrency as a payment option for its electric cars. Following the news, the price of Bitcoin spiked nearly 20 per cent to a record high of $US72,800 as investors flocked to emulate Musk’s surprise purchase. However, Bitcoin’s price later fell more than 20 per cent as Musk walked back his decision that Tesla would accept the currency as payment.

Still, Musk has long been an advocate for cryptocurrencies and many prospective Tesla owners are young and male, intersecting with the core demographic of Bitcoin investors. The company also signalled it could look to invest further in cryptocurrencies, noting it may “acquire and hold digital assets from time to time or long-term”.

And there is a social factor at work. Bitcoin’s price is in part driven by its devout, almost religious, followers who extol the currency’s freedom from governments and banks and believe it will be a leading global currency in years to come.

Asher Tan was working as an economist on Melbourne’s Collins Street in 2011 when he first caught wind of Bitcoin. He recalls reading distinguished US economist Paul Krugman’s haranguing of the then-obscure currency. “I read his stuff on it enough times and thought, maybe he’s my idol but maybe he’s wrong.”

Tan now runs one of Australia’s most prominent crypto exchanges, CoinJar, but back in 2011 he says the idea of a social movement driven by the internet and the democratisation of finance was quite novel – and polarising. “At its core, it’s a message of old versus new, bottom-up versus top-down, and Bitcoin is the medium through which a lot of people choose to express this,” he says. “Bitcoin means different things to different people but the most important thing is that it’s still here now. Whatever your take, it’s still meaningful and relevant.”

Are you a Bitcoin type of investor?

Remember those pizzas in Florida? In Hanyecz’s day, buying Bitcoin required proficiency in the dark arts of the internet, as exchanges were often difficult to access. Today, exchanges have become far easier to find, requiring a mere Google search and a brief sign-up process followed by an identity check. Or you can do it all on your phone: apps such as Coinbase are popular for buying small amounts of Bitcoin or other cryptocurrencies.

But, while it might be easy to make a purchase, be warned: the potential for screwing up a Bitcoin transaction is quite high. If you’re someone who forgets passwords easily, for example, it might be best to stick to more traditional investment choices. Here’s why.

After buying Bitcoin (or another cryptocurrency) from an exchange, the coins are usually stored and managed by the platform itself. This acts much like a trading account with a broker, with your exchange account linked to your bank account to make it easy to buy and sell – cash in your Bitcoin and the money simply drops into your account.

For small amounts of money, keeping your money locked up on an exchange is generally pretty safe. But if your purchases start to stretch into the tens of thousands, it might be time to buy your own personal crypto wallet. These devices look closer to a USB stick than your parent’s leather bi-fold and connect via software on your computer, which allows you to transfer your coins across. Wallets can store any number of different cryptocurrencies and are a key part of trading crypto. As of May 2021, there were around 64 million active Bitcoin wallets. Only you can access your wallet.

When setting up a personal wallet for the first time, you are presented with two crucial pieces of information. Firstly, each wallet has a ‘public key’, which is a string of numbers and letters that allows you to receive coins into your wallet, much like a BSB number and bank account. If your mum wanted to send back that birthday gift you gave her, she’d need this number.

Secondly – and far more importantly – each wallet includes a private key, which is a secret number that grants full access to your stored coins. These often come in the form of a 12- or 24-word recovery phrase, comprising a string of random words that translate into your private key. This phrase is the master key to your Bitcoin and should be protected with your life. It’s important to note your Bitcoins are not actually stored in these wallets. The key gives you only the right to access your Bitcoin, which is stored on the blockchain, and wallets just serve to store and protect your private key – if you lose your wallet, your private key will still allow you to access your coins so long as you’ve noted it somewhere. If you lose your wallet and you lose your private key, your coins will be lost forever. Around $US140 billion in Bitcoin is currently lost or inaccessible.

Some investors even set alarms to be notified of major price swings in the middle of the night.

The cryptocurrency world also remains almost unregulated for now, which is both a blessing and a curse. The lack of regulation goes to the heart of what many Bitcoin fanatics enjoy about the currency, with it being largely outside of government control, but this also means an exchange you use to buy and sell crypto could disappear overnight – with your funds. In Australia, the government will usually have your back if a bank or financial institution you invest with collapses, but there are no such protections in the world of crypto.

Cryptocurrencies are immensely volatile. Crypto markets are also often dominated by “whales”: investors with massive amounts of cryptocurrency who have the ability to move markets on a whim. If they sell even a small portion of their holdings, they have the potential to send prices crashing.

Investing in Bitcoin is not for the faint-hearted. Expect a wild ride. They are 24-hour markets, which makes them impossible for traders (who need some sleep) to monitor constantly. Some investors even set alarms to be notified of major price swings in the middle of the night. In fact, in the time it takes to make a cup of tea, Bitcoin’s price could fluctuate by $1000. So don’t be surprised if that $US60,000 Bitcoin you just bought is worth $30,000 the next day. Just be thankful it’s not two warm pizzas.

An earlier version of this explainer was published in February 2021.