Bitcoin Explained In Simple Terms

Often called the democratic currency, electronic cash or cryptocurrency, Bitcoin is a virtual currency that economists believe could threat any government and dictate the rules of economy for the coming years.

“In developing countries, such as those in Africa, there is much promise for something like this because you don’t need a financial institution and infrastructure to allow people and businesses to transact money,” said Aaron Lowen, Associate Professor of Economics at Seidman College of Bussiness.

“All you would need is internet and a mobile phone.”

So, what is bitcoin?

Money, a way to exchange value, can take lots of different forms, whether it be just a way for people to account value, to trade or store over time. Nowadays, the most common form of money is notes and coins because it is an incredibly convenient form.

Apples, for example, are a terrible store of value because they rot. Therefore, gold has been used as money. Silver has been used as money. Stone has been used as money. Cigarettes have been used as money. All sorts of strange things over the years have been used as money.

The current dominant form of money in the world is the US dollar, but the US dollar has no value, it is just a piece of paper. The only reason it has been given any value is because the US government stands behind it. This means that the only reason people value paper money is because they know everyone else values it.

Bitcoins are just another form of currency. They are no less strange than gold, paper money, pieces of rocks or metal as used before. As the US government stands behind the US dollar, the same way people running the software and using bitcoins stand behind it.

Bitcoin is a software protocol that computers run to deal with internet transfers, also called online currency. First mentioned in a research paper published under the fake name Satoshi Nakamoto, Bitcoin became operational in 2009.

“It’s hard to explain the process in plain English, because it’s so complicated,” said GVSU MBA student Paul Jabaay, who has researched the subject in-depth.

To put it in other words, bitcoins are nothing more than a piece of data, with a certain electronic address attributed to them. The term for the use of the computer processor to run the calculations is called mining. The outcome of mining would be finding a block and the reward for decrypting that block are bitcoins. Bitcoins are increasing in value because of their convenience which makes people want them, so they pay money for them. No one can duplicate a bitcoin or a transaction and as a result fraud is excluded.

What is a block?

“If I have bitcoins and I send a bitcoin to someone else, that bitcoin is encrypted and the transaction is placed inside a block,” said Mr. Jabaay.

Nowadays, a new block is generated about every 10,5 minutes.

“To verify that I send him that bicoin, the computers from the system run a mathematical equation to decrypt it in order to verify that the transaction was real. As a reward for their work of the processing power they are contributing, they receive a new bitcoin.”

The transfer of bitcoins is digital, therefore there is the need to ensure that the transaction is real. This is what essentially the Bitcoin software does. Bitcoin software looks at people who are trading and bundles those transactions, forcing other computers to verify if the certain transaction is true. In this way the system reinforces itself. As a result, bitcoins are accepted because other people verified the transaction by decrypting the blocks. The algorithm is set up so that after a certain point the reward for solving and mining a block is halved.

“I believe the next halving is going to happen in 2016, when it’s going to half the current rate, which is 25, down to 12,5,” said Prof. Lowen.

“So instead of getting 25 bicoins per solved block we will get 12,5 bitcoins per block.”

Elaborate computers and systems are built with the sole purpose of finding these blocks through the Bitcoin network, which is just like the internet: an open-source software, where everyone downloads the same protocol, and they all run the same mathematical equations to find these blocks.

When it started early in 2009, the difficulty of finding these blocks was very low, but over time the difficulty increased, making it harder to find these blocks. This means that one has to contribute mine processing power to it, as well as to invest more resources. The original algorithm is programmed to produce bitcoins until they reach the limit of 21 million. However this can be changed. This is possible due to the nature of the software, an open-source one, which means that the network and those who are doing the mining can accept a change in the block chain and modify the amount of bitcoins that can be generated.

How can somebody store bitcoins?

“You create a wallet on the computer and you store the codes associate with each coin, because each coin has its own identifier,” said Prof. Lowen.

“The user can keep bitcoins digitally in the computer all the time, or on paper, if you are afraid the computer may be stolen or hacked.”

Bitcoins are traceable money, so if one has the wallet address he or she can trace the entire transaction until the very first bitcoin was created, by searching on the block chain. When the user downloads the Bitcoin software, the protocol, he or she also downloads the entire block chain history, so it is known where every bitcoin has ever been.

What is Litecoin and how does it differentiate from Bitcoin?

Litecoin is an alternative to Bitcoin, which uses a different computer system, allowing a faster verification of the transaction, in about two minutes, compared to the 10 minutes required by the Bitcoin system.

The main difference consists in the required computer resources. Litecoin uses memory script to verify the transaction, while Bitcoin uses processing power. These two competing currencies affect each other, reacting in a tandem. If Bitcoin drops, Litecoin will drop too. Even if they have different value, they rise and fall together. Litecoin is still yet to be used for large exchanges. However, the implementation of it for major exchanges is anticipated for the next year.

“We expect that if people really value the value of cryptocurrency, the value of Bitcoin and Litecoin will proportionally increase,” said Mr. Jabaay.

What is the currency reciprocity?

For any stock or commodity there are people that are selling and there are people who are buying. When the buyer and the seller match up on the price they are going to pay, the transaction is made. It is a zero-sum game, for every buyer there is a seller and for every seller there is a buyer.

“What is the price if a Coca-Cola stock? Well, its worth whatever the market says it is worth,” explained Prof. Lowen.

“It people have no confidence in Coca-Cola’s earning power, the price of the stock will drop; if they think it will be more successful next year, they buy more stock.”

The difference between Bitcoin and stock however is that many stocks pay dividends, a share of profits received by a stockholder or by a policyholder in a mutual insurance society. This means that there is always a worry about what would be the stream of dividends over time. Bitcoin, however, does not have that. It works like a supply-demand stock market.

Will it make a difference?

Bitcoins at the moment do not have a great impact on First World countries because of the well-developed financial infrastructure system setup that allows people to transact easily, through the internet, visas or banks.