William Welte: Time to talk about bitcoin
An anonymous computer programmer. An online trading card exchange. A secure black market website. An asset capable of over 160 percent value appreciation over a few days. A pirate’s treasure. It all seems like something straight from a William Gibson novel.
It’s time to talk about bitcoin.
The financially conscious and technologically savvy of you have likely heard this term. If you fall into either of those categories and don’t know what I’m talking about, I wonder where you’ve been keeping your head.
I don’t say that to be flippant; I say it because the trials and tribulations of the fledgling currency have already been featured on NPR’s Planet Money, Financial Times, The Wall Street Journal, Forbes, The New Yorker, Wired, CNNMoney, Stossel, Time, Bloomberg, Yahoo, TechCrunch, Ars Technica, the New York Times and even in our own freepressonline.com.
Just because you’ve heard mention of this brave new “currency” doesn’t mean it’s easily understood, as Tom Sadowski pointed out in his recent Free Press article.
Bitcoin is meant to function as a new form of digital currency. Think of it like cash for the Internet. Beyond that, the reality is a little more confusing.
Bitcoin was introduced in a paper in 2008 by an anonymous author calling himself “Satoshi Nakamoto.” There is no way to know who Satoshi Nakamoto is. For all we know, "Satoshi Nakamoto" is a pseudonym for a group, possibly even a corporation or government. The paper’s abstract begins by laying out a simple goal: “A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.”
Bitcoin is a digital version of cash that can be transferred anytime, instantly, with no bank, no credit card fees, no wire transfer, and no antiquated ACH waiting period: free and instant. U.S. dollars, and a few other major currencies, can be converted to bitcoins through online exchanges. Like any currency, the bitcoin concept carries both economic and a political components. Unlike any established currency, however, it also features a cryptographic component.
A primary concern with the use of any digital currency is the possibility of double-spending: just like copying files to a thumb drive, digital currency can be copied, potentially allowing the same unit of currency to be spent twice. Bitcoin offers a cryptographic solution, to ensure that no illegitimate transactions are allowed.
Bitcoins are stored at a public address, similar to an email address, made up of a long alphanumeric string. Using this address, you can send bitcoins anywhere in the world.
Rather than deriving legitimacy from any central authority, as fiat currency (a currency backed and controlled by a government or other singular entity) does, bitcoin transactions are legitimized by consulting a decentralized record of all past transactions, called the block chain. The block chain files are stored on many different, independently-operating network nodes, each of which presumably has a stake in the integrity of the bitcoin protocol and validity of the transaction ledger. For bitcoin to work, all of the many nodes involved must agree to accept the most recent, valid version of the block chain. A single transaction is not considered truly legitimate until it has appeared repeatedly in the block chain.
When a new block is being added to the chain, an algorithm is applied to each block in order to derive a hash, a fixed length alphanumeric string representing the data in the block file, which will be included in the next block. Every subsequent block carries within it the DNA of the entire transactional legacy of bitcoin.
The decentralized nature of bitcoin implies that no government or corporate body can interfere with the inherent structure of the block chain or the code that governs it. No changes can be made to the bitcoin code unless all nodes on the overall bitcoin network agree to them. The essence of bitcoin is its reliance on peer-to-peer network authorization in place of fiat control.
For many, the lack of fiat control is part of the appeal of bitcoin. Like conventional fiat currency, bitcoins are not a physical store of value, like gold or silver. Where the U.S. dollar is backed by the authority of the Federal Reserve and the reputation of our government, bitcoin is backed by a combination of usefulness and the finitude built into the bitcoin code. An essential characteristic is that there can never be more than 21 million bitcoins in existence. Bitcoin has value because it is useful and it is in limited supply.
Some might argue that the relative rarity of bitcoin makes it more valuable than the U.S. dollar in the long term: bitcoin has been referred to as Gold 2.0. Even the U.S. Treasury plainly states that cash isn’t backed by anything: “The notes have no value for themselves, but for what they will buy. In another sense, because they are legal tender, Federal Reserve notes are ‘backed’ by all the goods and services in the economy.”
The Federal Reserve can order reserve notes to be printed as it sees fit, while the creation of bitcoin is self-regulated and limited.
Let me reiterate: bitcoin is a digital payment system that can transfer money seamlessly, instantly, anywhere, anytime, is impartial to any governmental entity (or any entity for that matter), resists regulation, and has built in protections against double-spending and code manipulation. In many ways it may be the financial product consumers and merchants alike have been waiting for.
While it's currently impossible to pay for groceries or purchases from Amazon with it, it does appear that bitcoin may be on its way to becoming the practical, preferred payment option for merchants. Small business owners and a handful of larger corporations are gradually embracing the technology. Bitcoin adoption can be viewed in real time by consulting the coin map. Payment platforms like Coinbase and Bitpay are making it easier than ever for merchants to start accepting bitcoin.
From all appearances, bitcoin is on the path to the mainstream. According to coindesk.com, bitcoin was featured prominently in a 2013 Consumer Protection and Compliance Conference presentation given by Western Union executives, which means the financial industry is paying attention.
The Winkelvoss twins, known for their lawsuit against Facebook and their portrayal in the 2010 film The Social Network, reportedly hold upwards of $10 million in bitcoins and are apparently hard at work developing a bitcoin exchange-traded fund to help bring bitcoin into the mainstream. In a New York Times article from April, they describe their belief in the bitcoin protocol as a message of faith: “We have elected to put our money and faith in a mathematical framework that is free of politics and human error.”
One major concern for bitcoin investors will be how governments react to what may be perceived as a threat to fiat currency. While the bitcoin protocol cannot be regulated itself, governments can still do everything in their power to hinder bitcoin use and mainstream acceptance.
Forbes has a nice summary on some of the federal attention bitcoin has been getting: The IRS has been encouraged to make sure people pay tax on it. The FBI realizes it’s useful as a currency for illicit activity. The SEC has argued that it is indeed money and that people should go to jail for using it in Ponzi schemes. And the Department of Treasury has issued guidance for Bitcoin money transmitters.
The FBI has been quoted directly acknowledging that bitcoin is in fact legal and has “legitimate uses.” The financial crimes enforcement network released guidance on bitcoin, clarifying how FinCEN regulations apply to the bitcoin community.
It is very difficult for me to make any sort of concrete argument for or against Bitcoins. I am not an economist, nor am I a computer scientist, and bitcoin is simply too new, and relies on far too many unknowns. I think cautious optimism and a healthy dose of skepticism are in order: too many people have too much invested for you to take what is said on online about bitcoin at face value.
That being said, these are exciting developments. If you have some money you wouldn't otherwise be missing, I do think it is worth buying a fraction of a bitcoin to better understand what may be a coming revolution in currency. Just this past weekend, bitcoin reached a new all time high of $395 per bitcoin, according to bitcoinwisdom.com.
Full disclosure: I own a small amount of bitcoins.
William J. Welte is a technical writer and entrepreneur currently living and writing in his hometown of Camden. He can be reached at wjwelte@gmail.com.
Event Date
Address
United States