Writing in Time, of all places, Jerry Brito discusses Bitcoin, the latest alternative currency to capture the digerati's imagination:
The web has also seen all-purpose digital currencies, from defunct dot-com bubble start-ups Flooz and Beenz, to the slightly more successful e-gold. Unlike cash, however, digital currencies to date have had a third party intermediary monitoring transactions. That's because digital cash is different from physical cash in one very important way: If I hand you a 100 euro bill, I no longer have it. You can't be as sure of that, however, when the cash is just 1's and 0's. So it's been necessary to have a trusted intermediary deduct the amount from the payer's account, and add it to the payee's.
Bitcoin is the first online currency to solve the so-called "double spending" problem without resorting to a third-party intermediary. The key is distributing the database of transactions across a peer-to-peer network. This allows a record to be kept of all transfers, so the same cash can't be spent twice–because it's distributed (a lot like BitTorrent), there's no central authority. This makes digital bitcoins like cash dollars or euros: Hand them over directly to a payee, and you don't have them anymore, all without the help of a third party.
The Bitcoin digital currency also works a lot like cash in that it's anonymous. When you go to a flea market and pay cash for an old Commodore 64, there's no record of the transaction. You don't have to know the seller's name, and the seller doesn't need to know yours. Digital currencies by contrast rely on accounts, and have to collect at least some information about you. Because Bitcoin employs no such accounts and instead relies on public key cryptography, there's no way to know, just looking at the database of transfers, who sent money to whom.
The downside, Brito writes, is that this makes it easier to facilitate activities that ought to be illegal, such as the trade in stolen credit card numbers. The upside is that it makes it easier to facilitate activities that shouldn't be illegal but are banned anyway: "Want to contribute to WikiLeaks or some other politically unpopular organization? No problem. Live under a repressive regime and want to buy a repressed book or movie? Here's how. No wonder the Electronic Frontier Foundation calls Bitcoin 'a censorship-resistant digital currency.'"
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