December of 2017 brought the rise of bitcoin’s price up to $19,000, grabbing the attention of national news outlets. It also brought many predictions about where the price is heading. Some have been predicting its downfall and others have been predicting a rise in price up to $100,000.
But what exactly is bitcoin and why is it important?
Bitcoin is a virtual currency, also referred to as a cryptocurrency, because of the way the currency is created. Bitcoin and other cryptocurrencies are important to understand because they are a medium of exchange not regulated by any government or central authority.
Bitcoin uses the blockchain technology developed by Satoshi Nakamoto, which is a pseudonym for the individual (or group of people) who wrote the white-paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System.”
What is blockchain technology and why is it valuable?
A blockchain is a shared ledger of transactions between parties. Transactions are stored on a network of peer-to-peer systems, called nodes, and each new block of transactions is verified by consensus on the network to confirm that the transactions are legitimate. However, private uses of the same technology, called permissioned distributed ledgers, can be used with preauthorized terms and only invited members. The technology is valuable because it enforces trust.
Here is an example of a bitcoin transaction:
Joe wants to buy a book from Bill. Bill provides Joe with an address to his bitcoin wallet, called a public key. Joe sends Bill a fractional bitcoin equal to the value of the book using the address. The transaction takes place and is viewable in both wallets almost immediately, but validation of the transaction takes about 10 minutes. Bill receives confirmation that the bitcoin is in his wallet. Bill then sends the book to Joe.
The main positive to this transaction is that Bill doesn’t need to trust Joe to send him a check or pay him in cash. He doesn’t need to have a credit card processing account. He can receive money directly to his wallet. A blockchain is a network where trust and verification are built in.
What does this transaction look like behind the scenes?
Joe logs into his virtual wallet at an exchange like Coinbase or the hard wallet on his computer and enters the amount of money that he wants to send. If he is performing the transaction on his phone, he could take a picture of the QR code that represents the public key provided by Bill. When Joe requests the transfer, he has the option of picking the priority of the transfer by selecting the fee level he wants to pay.
bitcoin and blockchain
In the above example, a fraction of Joe’s bitcoin #12221 is sent to Bill’s private key 1234ghk17.
At this point, the transaction is posted to the bitcoin network where network peers, or nodes, can elect to process the transaction based on the fee. The transaction is processed by multiple pools and/or nodes until one of the miners gets the correct hash. A hash is like a puzzle that must be solved to form a new block in the blockchain. A miner is a special computer whose only function is to calculate hashes. This process takes about 10 minutes. Once the transaction is confirmed, Bill has his bitcoin.
bitcoin and blockchain 2
Miner/ Mining rig
What prevents someone from counterfeiting bitcoin?
The blockchain is a record of all of the transactions that have been processed. Each block in the blockchain must have the hash of the transaction prior to it. If the hash is not correct, then the next transaction will not be able to be processed. So a counterfeit transaction is discovered quickly.
So bitcoin is a digital currency, but how can the blockchain technology be used for other types of transfers?
A private blockchain set up between a supplier and its customers eliminates the current need for purchase and sales orders. It eliminates the need for the vendor to create an invoice and the customer to enter an accounts payable invoice into their accounting system. It also eliminates the check or EFT payment.
Final Thoughts
When I first read about bitcoin and blockchain in a professional magazine about seven years ago, I thought that the whole concept was questionable and possibly a scam. I now see it as the future of economic exchanges and the potential replacement and simplification of many business processes.
If you would like to learn more about how bitcoin transactions are processed and other uses for blockchain technology, please consider attending my session at Scaling New Heights 2018 called “Blockchain 101: What are Blockchain and Bitcoin and How Can They Be Used?”
Author Bio: Nancy Orben is a CPA and Senior Manager at Blue & Co., a regional CPA firm. She is a Certified Bitcoin professional and is the accountant and business advisor for a cryptocurrency mining operation. She recently attended D4C – Day for Crypto, a symposium of international ICO experts. Nancy specializes in accounting software and related consulting. She is advanced certified and/or certified in all QuickBooks software. She has attended all 9 SNH conferences and was Insightful Accountant’s 2017 QuickBooks Desktop ProAdvisor of the year.