Thursday, July 17, 2014

Bitcoin may be the biggest thing since the Internet. Here's what you need to know about the digital currency.

What is Bitcoin?

Bitcoin is an open-sourced software-based payment system.  It’s also commonly called digital currency, or crypto-currency.  Basically, it’s a new form of currency – not money – that’s based on digital technology.  The key point of Bitcoin is that it’s exchange and operates peer-to-peer, without the regulation or involvement of any central bank or government.  http://www.bitcoin.com.

How does it work?

Bitcoin is the name for the currency that can be used to buy goods or services, or transferred to other users.  There are websites that allow you to store and transfer Bitcoins, and plenty of websites and even brick and mortar merchants who are accepting Bitcoin.  To oversimplify, think of it as PayPal with Monopoly money.  Instead of printed or minted money, Bitcoin currency is stored in the form of encrypted codes in digital files.  The user then has a private key, printed on paper, metal, wood, or plastic, used to essentially access or unlock that code, and then can do what they wish with the value of the Bitcoin.

Instead of using a central bank or institution to regulate and document transactions, Bitcoin payments and transfers are recorded in a public ledger.  Therefore, it truly a peer-to-peer system that offers complete anonymity and ultimate flexibility. 

What are the advantages over paper money?

There are several benefits to using Bitcoin above and beyond normal currency.  Because it’s not tied to any government or central bank, it can easily facilitate commerce without the slow and clumsy process of wiring money.  For that same reason, transactions are anonymous and unregulated, or easy to tax.  In an increasingly digital age, Bitcoin is not money but a representative currency with value that adheres to the ultimate notion of capitalism – not expected to replace our money but as a complement.  But in large part, the world is still trying to figure out how to best use Bitcoin.  Two things are clear – it’s different, and it’s powerful.

Who accepts it?

Like we mentioned, Bitcoin is accepted peer-to-peer.  However, it’s also gaining popularity and acceptance among legitimate vendors.  Just this year, companies like Overstock.com, Targetdirect.com, Wordpress announced they will take Bitcoins, which are some of the world’s largest vendors.  That adds to the list of other merchants like Atomic Mall, Clearly Canadian, Dish Network, the Sacramento Kings NBA basketball team, Tiger Direct, Zynga, Reddit, Etsy, PayPal, eBay, OkCupid, and Newegg to accept it.  The new-age airline/space travel company Virgin Galactic even accepts Bitcoins if you want to pay for a ride to outer space!  In late 2013, the University of Nicosia became the first of its kind to accept Bitcoins to pay for higher education.   Many brick and mortar merchants are also taking Bitcoin as payment – by using a digital scanner that’s interfaced with a QR code on your smart phone or iPad. 

Who started Bitcoin?

This is where it gets insanely interesting.  First introduced in 2008 and gaining legitimacy in 2009, Bitcoin’s creator seems to be a man named Satoshi Nakamoto.  However, no one’s ever seen him.  Consistent with the anonymous, cryptic nature of Bitcoin, Nakamoto never showed his face in public nor shared any personal details.  For a while he interacted on online forums but never revealed his identity.  His last known communication was in 2011, and then he just disappeared.  But before he did, a successor was informally named to look after Bitcoin, a programmer named Gavin Andressen who now serves as the system’s lead developer.

As Bitcoin rose to popularity, ravenous packs of curious journalists followed Nakamoto’s trail, trying to be the first one to uncover his identity.  They found more questions than answers.  A Newsweek reporter published a definitive account of finding Nakamoto, a man living in the Temple City area of Los Angeles with the real name Dorian Nakamoto.  But the conclusion was largely discredited after coming under intense scrutiny upon publication.  Others tracked the breadcrumbs to Hal Finney, a “paralyzed crypto genius,” who suffers from ALS.  Finney just happens to live in the same Temple City neighborhood, be the second person ever to use and buy Bitcoins, and attempted to create similar currencies in the past.  But due to his disease he’s largely uncommunicative, and no one knows if he is really Nakamoto and operating under an alias, friends with the real creator, or it’s just a coincidence.  Another study based on writing samples concluded that another man, Nick Szabo, an expert in law, finance, cryptography and computer science, is the real creator of Bitcoin.  Wild rumors fly around the internet (as they’re apt to do) that Bitcoin was even created by the NSA or some shadowy secret society to upset or control international banks.

In a brain-melting mystery reminiscent of Verbal Kint/ Keyser Söze in The Usual Suspects, we’re still trying to definitively prove the identity of the founder of Bitcoin, past speculation and innuendo.  But the unsolved case of Satoshi Nakamoto definitely adds to investor intrigue! 

What’s the value of Bitcoins?

The value of Bitcoins fluctuates, just like any stock, commodity, or the dollar.  Right now (as of this writing on July 17, 2014) the value of one Bitcoin is equivalent to $618.88 USD.  The value fluctuates wildly – in 2013, the value went from as low as $13 to over $1,100.  This year, prices have been as low as $344 and as are now on a yearlong high (based on recent news, which I’ll share later.)  It’s important to note that the value of Bitcoins has increased steadily since its inception in 2008, and initial valuing in 2011 at $0.30.

Is the value of Bitcoins stable?

No. The value or Bitcoins fluctuates wildly.  In fact, according to Mark T. Williams, a professor of economics at Boston University, the volatility of Bitcoin is over seven times that of gold and over eight times that of the S&P 500.  There are several reasons for that, but first it’s important to note that volatility doesn’t really matter as much as with traditional currency.  Remember that no one uses Bitcoins as an accounting method like US dollars, just currency.  So no one is taking out debts, mortgages, or gets paid wages in Bitcoins.  A future promise to pay (or be paid) would surely leave us stressed every time it lost value.  But since Bitcoins are used in real-time payments and dictate their own worth (aren’t tied to the dollar, Gold, any index, etc.) they essentially all rise and fall together. 

Still, the volatility can be alarming.  Between June and October of 2011, Bitcoin lost 90% of its value.  The Bitcoin Foundation’s retort is that volatility is due to insufficient liquidity – basically, that the more we use it and the more places that accept it, the smaller the margin for volatility will be. 

For the most part, speculators and venture capitalists have been the biggest investors in Bitcoins so far.  Earlier in 2014 the price dropped sharply after a third-party application site shut down and false reports that the Chinese government was banning Bitcoins.  

Like the early days of the Internet, they know Bitcoins is on to something big – they just aren’t sure how that will play out. 

How much is in circulation?


There are about 12 million Bitcoins in circulation, which means a money supply worth around $7 billion.  Bitcoins are “created” on a diminishing scale of halves every year, so the number of new Bitcoins is 50% each year until none are created.  That means there will never be more than 21 million Bitcoins in circulation, which “fixes” the currency amount and eliminates the potential for mass deflation.

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Look for part 2 of this blog soon, where we'll cover how Bitcoins can be bought, held, and stored, why they're gaining massive legitimacy, what governments and banks think of them, and how the criminal element is exploiting the phenomenon!

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