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Bitcoin – Pirate’s Gold or new Global Currency?

Bitcoin is a “cryptographic currency” that was first proposed in 2008 by a programmer using the supposed alias Satoshi Nakamoto. There are currently around 63.6 million USD of Bitcoin in circulation.

by David Glance On August 29, 2011

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On July 19th this year, a Doctor Nefario arrived at Seattle airport and was asked if he had enough money to cover his stay in the US. He replied that he did, but it was in Bitcoin, an electronic cryptographic currency. Unfortunately, not only did the Customs and Border Protection Authority not know what Bitcoin was, they didn’t accept it as a valid currency and so refused him entry.

The Customs and Border Protection’s ignorance of Bitcoin is shared by many, even though there are currently around 63.6 million USD of Bitcoin in circulation.

This may seem trivial in comparison to the approximately $950 billion US dollars in circulation. However, “real” currencies sometimes end up being not worth much, as was the case with the Zimbabwean dollar, which had to be discontinued as the national currency in 2009 when it became essentially worthless. A $100 trillion dollar banknote at that time wouldn’t even buy a bus ticket.

What is Bitcoin?

Bitcoin is an example of a “cryptographic currency” that was first proposed in 2008  by a programmer using the supposed alias Satoshi Nakamoto. In early 2009, he released software that would implement the creation, sending and receiving Bitcoins over a peer-to-peer network. His main motivation was to avoid the need for “financial institutions serving as trusted third parties to process electronic payments”  such as a bank or PayPal. The scheme allowed the receiver to be sure that the Bitcoin received hadn’t been also sent elsewhere and so was genuine.

The other attribute of Bitcoins was that Nakamoto thought that they would be largely anonymous. Although theoretically possible, the exact nature of this anonymity is still being debated and it is clear that to achieve it, users need to take a series of precautions.

The Dark Side of Bitcoin?

It was the anonymity of Bitcoin and its relation to an illicit online market place called Silk Road that really brought Bitcoins to the public’s and US Government’s attention.

Silk Road can be used to buy and sell drugs and other contraband. This led two US Senators to demand that the Silk Road be shut down and Bitcoin to be investigated. They expressed a further concern that Bitcoins could be used for money-laundering although given the relatively illiquid nature of the currency, if there is money-laundering going on, it will be on a relatively small scale.

The fact that Bitcoin would be adopted by organisations like Wikileaks and LulzSec would not have surprised anyone given its decentralised and non-mediated attributes. However, this association has also coloured the US Government’s view of the currency. Whilst the US authorities could bring pressure to bear on financial institutions such as Visa, Mastercard or PayPal to stop payments going to Wikileaks, there is no central authority controlling Bitcoin, making it very much more difficult to control. Having said that, it is not clear how much funding Wikileaks receives in the form of Bitcoins.

How do you use Bitcoins?

You can get Bitcoins in two ways. The first, and most difficult way of getting Bitcoins is through what is called Bitcoin mining. For this, you use computers to perform some of the cryptographic operations involved in making the Bitcoin network work and if you are the first to solve the calculations, you are rewarded with a certain number of Bitcoins.

The simpler way of getting Bitcoins is to buy them through one of the many Bitcoin exchanges. One such exchange is Mt Gox, which allows you to buy Bitcoins using funds transfers of ordinary cash and e-Cash. Once you have added funds to your account, buying Bitcoins is like buying shares; you can place an order to buy at the market rate or at a preferred rate.

Once you have the Bitcoins, you can leave them in your account on the exchange or transfer them to a digital wallet on your computer or to an online e-wallet service.

You can then use your Bitcoins to buy goods and services ranging from books to web site development to legal services. However, it is clear that the majority of Bitcoin is being bought and sold for investment purposes. This is another underlying cause for some of the fluctuation in rates that have beset the currency, which has seen its value go from $1 USD to $30 USD at its peak and is currently about $8.6 USD.

How safe is Bitcoin?

Although the underlying system of transferring Bitcoin may be secure enough, Bitcoin suffers from a number of vulnerabilities that have led to widely publicised problems in the Bitcoin world. It is fair to say that all of the events so far have been down to the immature nature of the businesses and people involved and the fact that many of the exchanges are being run by individuals or small numbers of staff.

One of the first Bitcoin incidents occurred in June 2011 when Mt Gox was hacked and the user database of 61,000 users taken. The hackers used the usernames and passwords to then transfer 25,000 Bitcoins, approximately $225,000 USD to an account out of which they then tried to sell, succeeding in only removing about $1000 worth because of the daily limit imposed by Mt Gox. As a consequence of the hack, the exchange rate for Bitcoin on Mt Gox plummeted before climbing back to the pre-hack level.

This hack was not sufficient to shake the confidence of the Bitcoin community but did raise concerns about the risks involved in Bitcoin.

The second event was when another Bitcoin service, MyBitcoin.com, was hacked resulting in the site closing down along with all of the account holders’ Bitcoins. Approximately $2 million USD of Bitcoin (valuation at the time) was lost as a result of the hack with one account holder who helped promote the site to family and friends losing about $250,000. It appears now that not all of the Bitcoins were stolen and there is supposedly a claims process for users to retrieve a percentage of the remaining coins.

Following on from MyBitcoin.com came the failure of yet another Bitcoin site called Bitomat. Based in Poland, a technical error on the part of the operator caused the server to crash, losing access to the Bitcoins in the process. Mt Gox has recently taken over the accounts of Bitomat and offered to refund the lost coins to those users to help ensure the continuation of Bitcoin.

The Future of Bitcoin

It is clear that the “idea” of Bitcoin is one that has a resonance with certain groups of people. A electronic currency that is free from mediation and interference of governments and corporations and which can be anonymous are attributes that make it ideal for groups that are operating on the fringes of society – activists (cyber or otherwise), libertarians and yes, criminals.

Whether the implementation of Bitcoin as it currently stands survives or is ultimately replaced by a variant will depend on how many other things go wrong and also on the development of more robust and easy to use software.

Of the two aspects, the recent Bitcoin events are growing pains in comparison to the fall out of the Global Financial Crisis and what countries, companies and individuals have lost as a result of a largely self-regulated financial industry.

Ironically, Bitcoin may end up being more resistant to national and corporate manipulation and possibly more robust as a result.

On a personal note.

I decided to experiment with Bitcoins through Mt Gox and bought about $50 of them. Due to a glitch in the Mt Gox software, 5 Bitcoins (approximately $45) are sitting in cyberspace limbo with a support email to Mt Gox unanswered after 2 days. So, if you are going to use Bitcoins, do so carefully and with small amounts of money that you can afford to lose.

This post was originally published on David Glance’s blog, Tech Muse.

Photo Credits: Flickr CC keep_bitcoin_real and AForestFrolic

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