Unless you've been living under a rock for the last few weeks, you've probably heard the word Bitcoin thrown around in the news quite a bit. If you're a bit more web savvy, or an active Redditor, chances are you've known about it for a few years. But, do you really know what Bitcoin is, how it works, or where it comes from?
Given the recent uptick of interest in, and value of, Bitcoin, I decided to do a little digging to see what I could find out. Going into my investigation into the so-called virtual currency, I found myself pleasantly surprised about a number of things. Specifically, how it functions, how it's created, and the mystery surrounding its founding father.
Bitcoin is a "virtual currency," born on and carried over the internet. It is a virtual currency in so far as it is entirely web-based and does not derive its value from any hard substances like gold or silver. I find myself chuckling a bit when I hear it described as virtual, not that it isn't true, but because all money is an abstract perception of value. Our dollars aren't backed by any hard substance, they're simply a means to avoid bartering. And in the entire USD money supply, only around 3% of it is in paper form, approximately 97% of it exists digitally. On top of that, the supply of money is controlled by a Central Bank, inflating and deflating the money supply as they see fit and as a means of attempting to control business cycles (ha!)
With Bitcoin, there is no central bank. There is no central planner of the bitcoin supply. Why don't we have a look at how Bitcoin is created and distributed. Per a fantastic article in the New Yorker:
bitcoins function essentially like any other currency, and are accepted as payment by a growing number of merchants, both online and in the real world. But they are generated at a predetermined rate by an open-source computer program, which was set in motion in January of 2009. This program produced each one of the nearly eleven million bitcoins in circulation (with a total value just over a billion dollars at the current rate of exchange), and it runs on a massive peer-to-peer network of some twenty thousand independent nodes, which are generally very powerful (and expensive) G.P.U. or ASIC computer systems optimized to compete for new bitcoins.
Bitcoin releases a twenty-five-coin reward to the first node in the network that succeeds in solving a difficult mathematical problem requiring a certain amount of brute-force computation (known as a proof-of-work calculation.) The solution is then broadcast throughout the network, and competition for a new block and its twenty-five-coin reward begins.
In this way, bitcoins are mined like gold used to be, in quantities that are small relative to the total supply, so that the supply grows slowly. There is an upper limit of twenty-one million new coins built into the software; the last one is projected to be mined in 2140. After that, it is presumed that there will be enough traffic to keep rewards flowing in the form of transaction fees rather than mining new coins. For now, the bitcoins are initially issued to the miners, but are distributed when miners buy things with them or sell them to non-miners who desire an alternative currency. The chain of ownership of every bitcoin in circulation is verified and registered with a timestamp on all twenty thousand network nodes. This prevents double spending, since no coin can be exchanged without the authentication of some twenty thousand independent cyber-witnesses.
In a sense, the digital currency acts as a natural resource with a finite supply as opposed to amoney system that is open to manipulation by banks and governments. There will never be a flood of bitcoins into the market since its very nature ensures that it cannot be counterfeited. It's an ingenius way to create a tamper-free currency for the connected world.
Furthermore, bitcoin users can spend their currency with complete anonymity. This works because every single bitcoin transaction is piped through what is known as a blockchain. Per Bitcoin.org, a blockchain is a shared transaction log on which the entire Bitcoin network relies. All confirmed transactions are included in the blockchain with no exception. This way, new transactions can be verified to be spending bitcoins that are actually owned by the spender. The integrity and the chronological order of the blockchain are enforced with cryptography.
A transaction is the transfer of bitcoins between bitcoin addresses. In order to spend bitcoins, you must download a virtual bitcoin wallet which is given a unique bitcoin address for use in transactions. These wallets use cryptography, in the form of complex mathematical problems, that make it virtually impossible for someone to hack into them and steal bitcoins.
So, we now have an understanding as to what the currency is and how it comes into existence. Are there legitimate uses for it? You bet.
Per a recent article in TechCrunch, bitcoin-related companies are en vogue in select Silicon Valley accelerator programs. Boost VC, a Menlo Park based accelerator, announced that it would be focusing on bitcoin-related startups for its summer class of companies.
And it's not just investors that are interested. More and more notable companies are beginning to allow payment in the form of bitcoins. Select companies include Wordpress, Reddit, and NameCheap (a domain registrar.) What was previously thought of as a currency for use strictly in the darkest depths of the Deep Web is slowly, but surely, turning into a currency for conducting legitimate commerce.
Bitcoin is an open source project that is run similarly to Linux, the open source operating system platform. The community of software developers for the Bitcoin universe is comprised of serious software engineers. But, interestingly enough, the identity of the currency's initial creator is something of a mystery.
Someone known only as Satoshi Nakamoto is believed to be the father of Bitcoin. Only, no one has ever actually met or spoken to him. Known only through online writings on blogs, message boards, and forums, he (or she) remains a mystery. Some believe Satoshi is really a consortium of programmers, others believe he may be a Russian economist / mathematician. No one knows for sure. Personally, I like to believe that Satoshi is an Artificial Intelligence that emerged from the depths of the internet in the aftermath of the Financial Crisis of 2008. Obviously this isn't the case, but given the nature of Bitcoin, it's fun to imagine.
As Bitcoin continues to gain ground and legitimacy, it will inevitably face scrutiny from government entities. It has already begun in earnest and will almost certainly increase as time goes on. While central banks inflate away the value of the dollar and the euro and financial crises continue to spread throughout the Eurozone, Bitcoin will only grow in value and notoriety. I am fascinated to see where this leads.
What do you guys think? Anyone on WSO have a Bitcoin Wallet? Anybody have any experience buying things with bitcoins? What about the long run? Is Bitcoin here to stay or will major governments step in to crush it? Let me know in the comments.