Already bigger than some sovereign currencies, the world’s most widely used alternative currency, Bitcoin, has broken the $1 billion in value mark recently. Bitcoin, a decentralized digital currency based on open-source, peer-to-peer protocol, was introduced in 2009 by a pseudonymous developer going by the name of Satoshi Nakamoto, and his since caught the attention of governments, banks, brokers and investors worldwide. The beauty of Bitcoin is that it is independent from world governments and centralized financial institutions, and is looked at by some as a refuge for those trying to protect themselves from economic crises and liquidity shortages, all while maintaining their financial transactions anonymous.
Bitcoin is digital currency, meaning it only exists on an electronic level. It does not exist in the physical world. While this idea scares some, the truth is that the vast majority of the entire monetary system today is already digital. Only a tiny percentage of the currency circulating globally uses physical notes or bills; the rest of the financial transactions are just a reshuffling of bank database entries. We have all heard the expression ‘that’s not worth the paper it’s printed on’, which is true – the dollar banknote is in itself next to worthless and is merely an extension of the barter system that currencies essentially replaced.
Bitcoin differs in that while the government or central banks can see every traditional transaction that you make, Bitcoin transactions stay private and coded, which has made it a favored method of transaction not only for expats looking for a way to hedge risk against traditional currency collapse, but also for people who want to elude attention. Advocates describeBitcoin as the foundation of a Utopian economy: no borders, no fees, no closing hours, and no one to tell you what you can and can’t do with your money.
Some say the recent banking crisis in Cyprus skyrocketed the popularity of the cybercurrency as depositors looked for new ways to move money. Some, for example in Argentina, favorbitcoins because they believe they will provide insulation from the country’s high inflation. Others, from Iranian musicians to Chinese artists to American auto dealers, use the currency to dodge international sanctions or to reach new markets.
How it works
Bitcoins can be exchanged by personal computer directly through a wallet file or a website without an intermediate financial institution.Bitcoins are sent and received through websites and apps called wallets. Wallets interface with bitcoins stored locally or with a service. They use a system of ECDSAdigital signatures to make and verify transactions.The money supply is automated, limited, divided and scheduled and given to servers or “bitcoin miners” (basically high-end computer users who supply the Bitcoin network with the processing power needed to maintain a running tally of all transactions, in exchange for some bitcoins for supporting the system)that verify bitcoin transactions and add them to an archived transaction log every 10 minutes. The log is authenticated by ECDSAdigital signatures and verified by the intense process of bruteforcingSHA256hash functions of varying difficulty by competing “miners.”
Users obtain new bitcoin addresses as necessary; these are stored in a wallet file with links to cryptographic passwords or “private keys” that enable access to and transfer of bitcoins. A file or “wallet” containing bitcoin addresses is usually encrypted with an additional password. Loose transactional privacy is accomplished in bitcoin by using many unique addresses for every wallet, making it difficult to associate bitcoin identities with real life identities, while at the same time publishing all transactions.
Bitcoins, even though they arevirtual, were developed to be constrained by scarcity. While a bitcoin has no actual material shape, the algorithm that generates it has been designed to replicate the competitive production of a scarce good, and production will decrease over time and will be subject to decreasing returns. Entry in the business of producing bitcoins is open to anybody, although the production process is capital and labor intensive.
Where to use it
No currency is worth much if one cannot use it to pay for goods or services. In the last couple of years, thousands of places have begun to accept bitcoins for payment, including websites, individuals, even rental car companies and restaurants. BitPayhandles Bitcoin transactions for some 4,500 companies, taking payments in bitcoins and then forwarding the cash equivalent to the vendor involved, which means that clients are insulated from the volatility. In March 2013, BitPay’s vendors had done a record of $5.2 million in bitcoin sales, and sales have been increasing every month. Bitmit, an online Ebay-like service, allows users to trade goods and services for bitcoin. Bitcoin is also an accepted currency for internet services such as Reddit, WordPress and Mega, and some businesses offer web domain management and web hosting for bitcoins. A large majority of VPNs—virtual private network services—accept bitcoin to offer increased financial privacy and anonymity for their customers. Bitcoin shares are currently traded through the Exante Hedge Fund Marketplace platform and authorized and regulated by the Malta Financial Services Authority (which as of March 2013, Exante holds $3.2 million in bitcoin assets).
Because Bitcoin is a currency whose value is based on the psychology of human beings, it is subject to booms and busts. Seemingly overnight, people all over the world, especially Europeans andAsians, have been funneling speculative money into the system, hoping to get a windfall as the currency continues to rise. Bitcoin has now become a speculative bubble driven by greed and risk as opposed to focusing on its utilitarian value.
If (when?) the Bitcoin crash comes, many predict that it will be an incredibly accelerated crash, and the entire system may unravel in just a few hours. How? Unlike the US stock market, in which trading can be halted if stock prices plummet too quickly, there is absolutely no limit in how quickly the Bitcoin process can fall. One of the positives of Bitcoin is that there are no governmental controls whatsoever, but in the case of a crash, well, there are still no controls. The full fury of the free market will be felt. Forward-thinking investors are building automatic stop sell orders that will sell off their bitcoins once prices drop to a certain level.
In addition, another weakness is that it is truly based in the virtual world, and therefore is subject to viruses, hijackers, and hackers. For example, a Trojan virus recently spread via Skype which hijacked computers and forced them to mine for Bitcoins (essentially cracking code to create new Bitcoins). Recently, the MTGox exchange, which deals with the majority of Bitcoin trades, came under attack from hackers who were focused on unsettling the Bitcoin market into a state of a panic-selling frenzy in order to reduce its value, making it possible for the hackers to sell high and buy low.
There are also many theories floating around that certain centralized banks are buying bitcoins in order to crash the system with a massive selloff, which would then discredit the system and scare people away from using alternative currencies. This makes sense, as anyone who believes that the governments of the world are going to sit back and just allow a digital currency that they have to control over to become the future of money, jeopardizing their monopoly over money creation, is very, very naïve. Wars have been started over much less. Also, taxation rules are murky in regards to Bitcoin and other cryptocurrencies. If Bitcoin was just a domestic currency, for example traded only in the US, the US government would have made huger attempts to shut it down long ago. But the fact that it is a decentralized, international currency makes things more difficult. That is not to say that they are not trying. The Treasury Department’s Financial Crimes Enforcement Network has claimed that money laundering rules will apply to Bitcoin, meaning that companies that trade in the cybercurrency would have to report high-value transactions and would have to keep and show more detailed records, such as companies like Western Union have to do. In May 2013, The Department of Homeland Security obtained a warrant to seize an account tied to Mt. Gox, a Tokyo-based exchange that says it handles 80% of all Bitcoin trading. The warrant alleges the company and a subsidiary were conducting transactions “as part of an unlicensed money service business.” And across the border, the Royal Bank of Canada has shut down the accounts of people known to be Bitcoin dealers. In more positive news, French financial authorities recently gave the Bitcoin Central payment processor approval to operate as a bank in France.
Bitcoin has gathered strong opponents and strong proponents alike. Its enthusiasts make comparisons to peer-to-peer movie swappers who challenged the entertainment industry’s business model in the 2000’s, and see Bitcoin as shaking up the financial world in the same way, although the large and rapidly changing fluctuation in the value of a Bitcoinhas evoked criticism of its economic suitability as a respectable currency. While some see Bitcoin as the answer to large centralized banks and their overshadowing power over the market, others would never in a million years dream of trusting their life savings nor business model to some mysterious computer algorithm made by some pseudonym called Satoshi Nakamoto that no one knows anything about. One thing is certain, and that is while no one can entirely predict the future of this cryptocurrency, in a few short months it has managed to turn the financial world upside down and has demanded attention.
What are your thoughts on cybercurrency?Do you see it as a good thing or a disaster waiting to happen? Do you hold some of your money in Bitcoins? I would love to hear your thoughts and experiences! Leave a comment below.