Bitcoins: Currency of the Geeks

From Business Week:

Mike Caldwell, the founder of a small company in Salt Lake City that makes timekeeping software, considers himself financially conservative. He's also a geek, and couldn't help but get excited late last year when he heard about bitcoin, a new virtual currency. In February, on one of the handful of online exchanges that have appeared over the past year, he bought about $20,000 worth at less than a dollar per bitcoin. "I felt that maybe I would get a 20 or 50 percent return," says Caldwell, 33. By early June, when he sold the last of his stake, a bitcoin was worth around $30. Caldwell says his total return was well over 1,000 percent. "That magnitude was totally unexpected," he says.

For those who got in early, it's a gold rush. In the last few months this online cash has exploded in usage, notoriety, and value. Like dollars or yen, a bitcoin's worth fluctuates with demand, but in its short history it's gone mostly up. About $130 million worth of bitcoins are now in existence, and the value of that stash has grown more than 6,000 percent this year. Bitcoin partisans are breathless: "This is the biggest invention since the Internet," says Bruce Wagner, an entrepreneur who hosts a monthly bitcoin meet-up group in Manhattan.

The project was started in 2009 by an enigmatic programmer known as Satoshi Nakamoto. He always communicated electronically, never answered personal questions, and disappeared from online forums in December. The conspiracy-minded speculate that Nakamoto was actually a group of people, or a government cryptographer, or a pseudonym for Gavin Andresen, the Amherst (Mass.) programmer who took over the project after Nakamoto vanished. "I spoke to one guy who thought aliens might have come to earth to bring us this technology, it's so perfect," says Wagner.

Digital transactions normally require a trusted intermediary such as PayPal to credit and debit accounts properly and prevent cheating. With bitcoins, "there is no middleman, says Andresen or," more accurately, there's a distributed middleman. Individual transactions are encrypted, logged by a decentralized network running on thousands of home computers, and recorded in a public ledger. The system works similarly to peer-to-peer music-sharing networks in that files are shared among swarms of users, rather than downloaded from a central server.

Suppose you're in the market for alpaca socks, one of the few consumer items you can buy with bitcoins. Step one: Get some BTC—that's the symbol—at a currency exchange site such as Mt.Gox. Then download a desktop app from bitcoin.org, which will store your lucre (some use an online service such as Instawallet.org instead) and connect you to the decentralized bitcoin network. Next, find the alpaca farms bitcoin address, a string of characters also known as a public key. Click the send coins button.

The purchase is unconfirmed until a miner certifies it. Miners are power users who crunch numbers on behalf of the network, and some have racks of computers dedicated to the task. They're called miners because, just as gold miners increase the supply of gold, they create new bitcoins, at an algorithmically controlled rate. The greater their computing power, the more they generate for themselves. Once a miner's computer has processed a transaction, the alpaca farm gets bitcoins and you get socks. It's complex but fast: The bitcoin network has handled as many as 87 quadrillion calculations per second, 35 times more than the top supercomputer.

Bitcoins have all the advantages of cash—free to use, very hard to trace—as well as its disadvantages. That digital wallet is a file on a hard drive or online, and if it's lost or stolen there's no recourse. The currency is backed only by the faith and credit of its participants and outside the scope of any banker, politician, or the Federal Reserve. To a certain breed of libertarian nerd who grew up on cyberpunk, it's the Digital Rapture.

Full article can be found here.

Speed Bumps on the Road to Virtual Cash

From the New York Times:

MONEY is accumulated, traded and transferred online every day, but can there be a form of currency that exists only online and yet has real-world value?

That is the premise of Bitcoin, an open-source virtual currency system that since 2009 has grown to a market worth more than $100 million.

But the past few weeks have shown that a virtual currency can be just as vulnerable as the paper kind. Bitcoin accounts have been subject to hacking and theft; the currency itself experienced a bubble and a crash. And at least one group that was collecting donations in Bitcoins has decided against using them because of possible legal entanglements.

Gavin Andresen, who is the lead developer of the open-source software that operates the currency, said in an interview from his home in Amherst, Mass.: “I expected it to have lots of speed bumps along the way — but I didn’t expect there to be so many speed bumps in a row.”

There are several appeals to the idea of an online currency. The standard way to ensure the validity of online transactions, according to Jerry Brito, a technology expert at George Mason University, is “to have an intermediary to keep the ledger,” that is, a service like PayPal or a credit card company that takes a percentage of the transaction.

A virtual currency would not need an intermediary. It would also make it harder for authorities to track transactions (particularly appealing for gambling sites or other quasi-legal activities).

Bitcoin began as a kind of thought experiment. In 2009, an anonymous programmer published a paper proposing a virtual currency that would elegantly solve many of the problems surrounding currency that exists only on the Internet, including the main one, that the money would simply be copied like, say, music files, and plummet in value.

Another part of the challenge was to create a currency without having to resort to a central bank to issue the currency and track the transactions. In other words, the transactions would be genuinely “peer-to-peer” rather than pass though a virtual bank.

The solution of the Bitcoin programmer, who wrote under the name Satoshi Nakamoto, was to ensure that each “coin” was its own certificate of authenticity — that the coin, in essence, would be nothing more than that certificate.

In the Bitcoin system, a new coin is produced whenever a computer can calculate an answer to a difficult problem, and then attaches that answer to a digital record of every transaction of every Bitcoin ever traded — a breathtakingly large amount of information to carry around in order to buy a pack of gum, but in a time when information can zip around the Internet, not too much to ask. Anyone would be free to create a new coin, within proscribed supply limits, by having a computer do the work needed to prove that it was in fact a valid Bitcoin.

“The incentives are right, they are a check that everyone is following the rules,” said Mr. Andresen. “Early adopters want it to succeed, because they already own the currency. And if you generate Bitcoins no one thinks is valid, you have wasted a lot of computer time.”

In fact, Bitcoin is a rarity for a currency in that it is neither a so-called fiat currency — one like dollars, which are valuable because the government says they are — nor is it a specie currency, one that gets its value because it can be converted into a precious metal like silver or gold.

But why would a Bitcoin have value if it is only a stream of numbers, unsupported by government fiat or by some underlying asset?

“Why does any tool have value?” Mr. Andresen asked. “It is valuable because it is useful.”

Starting almost as soon as the coins were introduced, they have been traded for dollars at online exchanges, serving as a crude measure of the currency’s popularity and health (and also giving a market where owners can trade in Bitcoins for real dollars).

After two years, there are seven million of these “coins” in circulation and the rate of increase — currently 50 coins are added every 10 minutes — will slow each year until the number tops out at 21 million coins around 2025. The coins, which trade for about $17 each at online exchanges, have a cumulative value of about $100 million. “I do think of it as the market cap of Bitcoin,” said Mr. Andresen. Today, a list of businesses that accept Bitcoin currency is a motley collection of companies on the fringe of the computer world, groups that conduct gambling or the like, and, notably, the antisecrecy group WikiLeaks, which accepts contributions in Bitcoins. You certainly can’t stock the pantry or furnish your home with Bitcoins.

Full article can be found here.