Bitcoin: More than Money

The digital protocol promises to change more than just the future of currency, despite government attempts to rein it in.

On August 6, Judge Magistrate Amos Maazant of U.S. District Court for the Eastern District of Texas made many a headline when he became the first known United States government official to declare that Bitcoin-the non-government and non-bank currency, payments network, and anarchic digital phenomenon-is indeed money. In a ruling rejecting a defense argument that a certain Ponzi scheme was not in fact a Ponzi scheme because its shares were sold in Bitcoins, instead of "real" money, Maazant made this declaration: "Bitcoin is a currency or form of money, and investors wishing to invest in [the scheme] provided an investment of money."

The following week, the German Ministry of Finance also formally recognized Bitcoins as a private money. Germans can now use Bitcoins to buy bratwurst, sell lederhosen, or invest in Volkswagen. The government is developing rules to ensure Bitcoin transactions are taxed, just like those in euros.

So governments are slowly acknowledging the obvious: Bitcoins are money. But bureaucrats, like many observers since the digital currency burst on the scene in January 2009, are likely missing the larger implications. Bitcoin is much, much more than just money.

At its core, Bitcoin is a completely decentralized ledger system. It can be thought of as a massive online version of an accountant's book in which transactions are recorded by deducting from one account and adding to another. An accountant's ledger can be used to keep track not just of dollars, but also cows or bushels of corn or anything else, and Bitcoin is just as flexible. That means it can serve as the backbone for any online transaction that relies on a ledger, such as property registration, futures swapping, and bonded contracts. Because Bitcoin is decentralized, these applications can exist largely outside regulators' reach. And because Bitcoin is growing in popularity, financial regulators are beginning to make plans for dealing with it, much to the chagrin of those who see the private currency as a revolutionary force inherently unmanageable by statist forces.

The Mysterious Rise of Bitcoin

The Bitcoin concept was introduced in a remarkable academic paper published online in late 2008 by someone calling himself Satoshi Nakamoto. (So far, Nakamoto's true identity remains a mystery despite the attempts of several investigative reporters to uncover it.) The paper described a cryptographic breakthrough that for the first time made possible "a purely peer-to-peer version of electronic cash [allowing] online payments to be sent directly from one party to another without going through a financial institution."

In early 2009, Nakamoto released open-source software implementing the concept and launching the Bitcoin peer-to-peer network. After the launch, volunteer programmers from around the world began to work with Nakamoto to further develop the underlying software protocol, collaborating via email, forums, and chats. Nakamoto remained an active participant through mid-2010, when he turned over control of the project to a contributor named Gavin Andresen. In April 2011, when asked by a developer to explain his declining involvement, Nakamoto said that he had "moved on to other things." He hasn't been heard from since.

The mystery of Bitcoin's designer is fascinating, but the fact that we don't really know where Bitcoin came from does not undermine its security or stability. The Bitcoin protocol and software are completely open-source, open to inspection by anyone. Hundreds of programmers and cryptographers have pored over the code's thousands of lines, and volunteers are continuously adding innovations. By now most Bitcoin code has been written by people other than Nakamoto.

At first, Bitcoin attracted interest mostly from a small group of cryptographers and technology enthusiasts who casually traded the currency back and forth and even gave some away to attract new users. The currency's early value was commonly in the pennies. The first known Bitcoin purchase took place in May 2010, when one user paid another 10,000 Bitcoins for two pizzas. That sum would be worth around $1.2 million at today's exchange rate.

Merchants ranging from bars and restaurants to online specialty retailers began to accept Bitcoin for payment in 2010. Now businesses as big as WordPress, Reddit, and OKCupid accept the stuff. The most popular use of Bitcoin today is in online gambling at sites such as SatoshiDice.com.

As demand grew and the marketplace expanded, so did the exchange rate. Before settling at a relatively stable price of about $120 per Bitcoin over the last few months, Bitcoin experienced several bubbles and crashes. It reached an all-time high of $266 in April 2013-an increase of more than 1,000 percent over the previous three months-and then dropped to $105 before turning back up. Each bubble has largely been driven by media attention, which attracts new users and thus new demand. At some point in these cycles of publicity, a critical mass of speculators cashes out, sending the currency tumbling.

Such volatility is not surprising. The total value of all outstanding Bitcoins is still relatively low-about $1.5 billion. This means even a small increase in interest in Bitcoin can send prices soaring. Additionally, a large portion of existing Bitcoins are for the moment being held as a long-term investment, so the market is not very liquid. As more and more people begin to use them for everyday purchases, the exchange rate will likely increase.

The How of Bitcoin

Until the invention of Bitcoin, online digital payments had to rely on trusted third parties, such as PayPal or Visa, to keep a ledger of account-holder balances, or a record of who owns what. For example, if I send you $100 via PayPal, PayPal will deduct the amount from my account and add it to yours.

Without such ledgers, digital money could be spent twice. Imagine that digital cash is simply a computer file, just as digital documents such as spreadsheets or photos are computer files. I could send you $100 by attaching a "money file" to a message. But just as with email, sending you an attachment does not delete that file from my computer. I could send the same $100 file to a second person, essentially spending the same money twice. In computer science, this is known as the "double spending" problem. Until Bitcoin it could only be solved by employing a trusted, ledger-keeping third party.

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  • Eduard van Haalen||

    Ooh, I can't wait for the AM links for this one.

    "Was the Gettysburg Address a Mistake?

    "Lincoln was far too kind to the South. And we still are.

    "...Over the succeeding century and a half, the Dixie pathos that Lincoln and [Thaddeus] Stevens sought to destroy instead morphed into the scoliotic backbone of American politics that burdens us today—a vendetta against Washington, D.C., so besotted with ancient grudges and hidebound demagogic exaggeration that it renders productive discourse and open exchange of ideas a virtual impossibility.

    "The game of division practiced by conservative reactionaries today—mostly southern, though the obstructionist contagion has spread to all 50 states—is the same as the fathomlessly fraudulent politics that split the country in 1861. Think the Dixie-fried Tea Party and health care fight represent something new? The impulse behind them is the same one that gave us Jim Crow, brought the National Guard to Little Rock High School and led Hank Williams, Jr. to record, “If the South woulda won, we woulda had it made.”"

    http://www.politico.com/magazi.....z2l5tPFOxp

  • crazyfingers||

    Not going to read that tripe but the Gettysburg Address accomplished exactly what it was intended to -- changing the subject.

  • wareagle||

    so everyone outside of the South loves DC? That must be it.

  • RBS||

    Apparently. Nevermind that millions of people in the South love DC.

  • sarcasmic||

    Translation: All opposition to D.C. is racist!

  • Heroic Mulatto||

  • crazyfingers||

    BTC is in the midst of a major correction after all of the gains the last few weeks. This is a great time to buy imo, if one can find it for sale anywhere.

  • waffles||

    Well-written article capturing why I am excited about bitcoin. There's tons of potential combined with a stubborn resistance to governmental strangling. However, it is nearly impossible to glean a "true value" of bitcoin as the early adoption is a speculation-driven rollercoaster.

  • Heroic Mulatto||

    But what would one do if the government decides to turn off the Internet? Currently a far-fetched scenario here (though I believe it is on the mind of many a bitcoin user trapped in despotic countries), but if bitcoin grew to threaten the post-Bretton Woods currency monopoly then it could be a reality.

  • SweatingGin||

    I have to think they couldn't get to that stage -- it would be, what, 50% or more drop in GDP immediately? And would just let someone else take over as the leading spot.

    I can't see anyone being able to make that happen. Far too huge of a loss.

    Longer term, at that point, you probably end up with an underground network (peer to peer, mesh net, etc.)

  • ||

    Bitcoin transactions are pretty onerous already on the power-hungry, custom-made, GPU-rich network that runs it now. Further, the hardware is relatively unique relative to other computing applications. If a government wanted to shut Bitcoin down it would have little trouble in doing so.

    You *might* have alternative crypto-currencies pop up. But I think envisioning some low-energy p2p crypto-currency popping up under the thumb of an oppressive regime is like expecting a rose bush to grow out of a random pile of manure.

    I think the better role of Bitcoin is as an example of modern low-overhead currency. Not a sign that the Fed and fiscal policy are unnecessary but certainly obsolete.

  • SweatingGin||

    Government would have an extremely hard time shutting Bitcoin down. They haven't managed to shutdown BitTorrent. It's peer-to-peer.

    The biggest thing, though, is that it is international. It's taking off in China, and it'll take off in India and South America, too. Even if the US government tries to nail it, it's still running in all the other places, and people will still want to get on board.

    GPUs are disappearing from the network at this point, replaced by ASIC. The amount of power that actually goes into securing the network will keep declining as GPUs get shut down and replaced with ASIC, and ASIC hardware only gets more efficient, as well. The scare stories about the amount of power that goes into securing the network are rather overblown.

  • waffles||

    If the government is at a point where turning off the internet seems like a good idea I would be worrying about food, water, and bullets, not bitcoins.

    If you were in Egypt when they tried to shut down the internet you would still have your bitcoins.

  • Jquip||

    Hm, if you and I agree to barter with one another for pigs and softwood, then which of the two objects of the transaction are money?

    What 'is money' versus 'what is said to work like money by people ignorant of barter' is whether or not it has a legally fixed 'true value.' Either by diktat or for paying taxes.

  • nybble41||

    The difference between barter and trading with money is whether the exchange is direct or indirect. It has nothing to do with "fixed 'true value'" or taxes. If one person wants pigs and the other wants softwood, for their own use, then neither is being used as money. If the only reason to accept one of those goods is so that it can be traded for something else later, then that goods is being used as money in that transaction. If a good is commonly used *as* money, then it *is* money.

    Bitcoin has no direct use; it exists only to facilitate indirect exchange. It would be unreasonable to consider it anything but money.

  • ||

    Because Bitcoin is decentralized, these applications can exist largely outside regulators' reach.

    Since when has decentralization been a barrier to bureaucracy? Especially one born from an ready-made network? If memory serves correctly bureaucrats were able to, pretty quickly, reach the Veins of California in the middle 1800s and whether it's the Deserts of the Gulf or the Tar Sands of Canada, if the wealth isn't flowing fast enough for them, they build a pipeline.

    Bitcoin is the tech-boom equivalent of beanie babies. There are pretty obvious indicators that plainly display that it is not a medium of exchange as much as a medium of hoarding and fetish. Indeed several alternative cryptocurrencies have shown faults in Bitcoin which the creators and network are unwilling or incapable of correcting.

  • cdschofield||

    The use of a type of Bitcoin protocol for different uses is already happening with the open source Ripple protocol. Currently it can transfer any world currency between parties including Bitcoins and it's own currency, Ripples. Essentially it's a protocol to facilitate any transaction without the need for a third party.
    https://ripple.com/

  • Christophe||

    Ripple doesn't get to call itself decentralized until it releases its server source code, and someone other than OpenCoin is running validators.

    Until then it is not decentralized, and not safe from regulatory crackdown.

    Go spam somewhere else.

  • reardensteel||

    Seems to me the secret to success of any currency is acceptance.

    Humans create value of their own work. That means anyone can enter the market by simply creating something of value to others.
    So let's say I knit a sweater. Someone else then agrees to pay me a certain number of Bitcoins for the sweater. Voila! I now have Bitcoins w/o having used any gov't currency (aside from what I spent to get the yarn). In other words, I didn't just "buy" the Bitcoins. So that's how we get new people into the market. But then what? Why would anyone want to enter the market?

    The only good reason to want Bitcoins is to buy other things with them, right? That's how money works. So it's critical that there be a large and diverse marketplace that accepts them. I must be able to buy stuff I want and need, real stuff, like food and clothing. If I can't buy most of the things I want with Bitcoins, they're really just a novelty.

    This has two major implications. First, Bitcoin will never truly work until it is widely accepted as payment for most things most people want. Second, gov't could seriously hurt the system by punishing businesses that accept Bitcoins.

    How can both of these hurdles be overcome?

  • Christophe||

    The black market needs something other than cash to function.
    This means even if completely illegal, Bitcoin can continue to grow (albeit slower).
    Adoption has been growing exponentially for the last few years. I'm not worried it'll just stop.

  • MarkinLA||

    The black market is also full of crooks who will gladly steal and there is an infinite supply of them.

  • MarkinLA||

    You also left out the possibility of it collapsing like any pyramid scam.

  • janet101||

    Google is paying 75$/hour! Just work for few hours & spend more time with friends and family. On sunday I bought themselves a Alfa Romeo from having made $5637 this month. its the best-job Ive ever had.It sounds unbelievable but you wont forgive yourself if you don’t check it out www.Buzz95.com

  • ibcbet||

    can produce more money.. great post

  • Jull||

    For me the idea of Bitcoin is rather interesting at present, but still I have rather a vague idea of it. Also I doubt that the Government will allow more money to appear and to be out of its regulation.

  • Tort||

    There is already a bitcoin prediction market replacing the now shutdown Intrade: Predictious http://www.predictious.com
    It launched back in July, and they have predictions on Sport, Politics, Entertainement, Economics.

  • Market Rats||

    The article about virtual money is worth reading, if you want to know more about this new thing in our world.

  • cobalt187me||

    If anyone is unsatisfied with their Bitcoin, just send it to me! I'll send my three daughters to college with it someday. 1MboYtUypfEKuDg1iwgBf4TWh5uUjDNRqu

  • dgahaha||

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  • Danhayes||

    Now those algorithms are appearing in contexts that hint at how cryptocurrency is only one possible application for such math, and how other applications may be even more powerful and socially useful.For info installment lender please visit.

  • Antone Shestak||

    Exactly Jerry, In the current online gambling market Bitcoin can be used as a currency, but it is much more than currency. I think it's cousin posture like litecoin, peercoin, and even doge coin are the core algorithms that power it.

  • crazydaisy||

    Bitcoin is an interesting company. cpa firm las vegas

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