Imagine there was a currency that wasn’t tied to any particular country or government. It could be accepted any place in the world, without having to be exchanged into local currency. It could provide both anonymity and security in transactions, and only the free market would decide how much it was worth.
While such a currency may sound like the stuff of science fiction, it’s the reality for Bitcoin, the peer-to-peer digital currency.
While Bitcoin started as the province of extreme techies, it’s recently gotten the attention of the mainstream financial world. Here’s what you need to know about this unusual currency.
The Origin of Bitcoin
In 2008, an anonymous designer (or designers) using the pseudonym Satoshi Nakamoto published a paper describing the potential for Bitcoin. A year later, Nakamoto launched the Bitcoin network. Bitcoin is self-sustaining, which means that whoever is behind the Nakamoto pseudonym doesn’t need to maintain involvement in the program in order for it to continue.
How Bitcoin Works
The inherent problem with a digital currency is ensuring that money isn’t double spent. That is, how do you keep people from simply using the same piece of currency over and over again if the currency isn’t physically tied to something?
Bitcoin avoids this problem in an ingenious way. Each Bitcoin actually represents a unique number, and every transaction using Bitcoin is recorded so that the same unique number can only be used once by the same user.
This public record of transactions is called the blockchain — and it is this that keeps Bitcoin from being purely anonymous. Users of Bitcoin are anonymous, but the Bitcoins themselves can be traced. (This would be like if the U.S. Treasury traced the movement of all cash by scanning serial numbers with every cash transaction, thus ensuring that no counterfeit money was introduced.)
Bitcoin is like any currency in that it only has value because people agree that it does. Now that more merchants are accepting Bitcoin as payment, and more individuals are interested in having their money in decentralized currency, Bitcoin has gained value. As of this writing, one Bitcoin is worth nearly $200. However, because this currency is decentralized, it’s also incredibly volatile.
How to Get Bitcoins
There are two ways to get into the Bitcoin economy. The first is to become a “miner.” Since the currency is really just a series of numbers, there are formulas for generating (or mining) new numbers. People can use free software to turn their computer into a Bitcoin miner. Bitcoin is set up so that there are a diminishing number of Bitcoins that can be mined each year, with a cap of 21 million Bitcoins. There are currently about 11 million Bitcoins in circulation, and final Bitcoins will be mined in the year 2140.
Mining isn’t free, however, since running your computer isn’t free; and any casual PC user will find that it isn’t worth the money to run the program in order to earn Bitcoins.
That’s why it’s also possible to purchase Bitcoins from other users with various traditional currencies, including dollars. The main Bitcoin exchange marketplace is a Japanese website called Mt. Gox.
Is Bitcoin the Future of Money?
There’s a lot to be excited about with Bitcoin. It allows for a true free market and can solve many current problems with centralized currencies, such as conversion costs for international transactions.
However, the anonymous nature of Bitcoin means that it’s also very attractive for illicit activities, from money laundering to illegal purchases.
In addition, the volatile and finite nature of Bitcoin means that users may be rewarded for hoarding, which could potentially lead to a deflationary spiral if Bitcoin became more universally accepted.
Altogether, Bitcoin is a smart adaptation to the issues of the global economy. It will be interesting to watch how this experiment plays out.
Have you ever used Bitcoins? After reading this article, are you more or less inclined to do so?