Bitcoin

Bitcoin is a peer-to-peer payment system and digital currency introduced as open source software in 2009.

Bitcoin is intended to be digital cash/currency, based on cryptography and peer-to-peer networks, rather than trust. As Nakamoto explains:

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The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts.

 

 

 

btcpileThrough various exchanges, bitcoins are bought and sold at a variable price against the value of other currencies.

is a cryptocurrency, so-called because it uses cryptography to control the creation and transfer of money.

Users send payments by broadcasting digitally signed messages to the network. Participants known as miners verify and timestamp transactions into a shared public database called the block chain, for which they are rewarded with transaction fees and newly minted bitcoins.

Conventionally “Bitcoin” capitalized refers to the technology and network whereas “bitcoins” lowercase refers to the currency itself.

Bitcoins can be obtained by mining or in exchange for products, services, or other currencies.

Bitcoin has been a subject of scrutiny due to ties with illicit activity. In 2013 the FBI shut down the Silk Road online black market and seized 144,000 bitcoins worth US$28.5 million at the time.

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The United States, however, is currently considered to be Bitcoin friendly compared to other governments.

In China, new rules restricted bitcoin exchange for local currency, and the European Banking Authority has warned that Bitcoin lacks consumer protections. Bitcoins can be stolen, and chargebacks are impossible.

Commercial use of Bitcoin, illicit or otherwise, is currently small compared to its use by speculators, which has fueled price volatility.

Bitcoin as a form of payment for products and services has seen growth, however, and merchants have an incentive to accept the currency because transaction fees are lower than the 2–3% typically imposed by credit card processors.

 

Users send and  receive payments using client software on a personal computer, mobile device or web application.

Transactions do not explicitly identify the payer and payee by name. Instead, a transaction transfers ownership from one Bitcoin address to another.

Approximately every ten minutes, a block of transactions is confirmed to a shared public record called the block chain.

 

 

Electrum – A Bitcoin client

Bitcoin client software, or simply Bitcoin clients, allow a user to transact bitcoins. The first  it was released in 2009 by Satoshi Nakamoto as open source code.

This so-called Satoshi client, Bitcoin-Qt, has since been maintained and enhanced by a group of core developers and other contributors. Bitcoin-Qt can be used as a desktop client for regular payments or as a server utility for merchants and other payment services.

Historically, Bitcoin-Qt also supported mining, but this feature was removed because specialized mining clients are more efficient.

Bitcoin-Qt is sometimes referred to as the reference client because it serves to define the Bitcoin protocol and acts as a standard for other implementations.

Bitcoin clients have been implemented in several programming languages for personal computers, mobile devices, and as web applications. At the most basic a client generates and stores private keys and communicates with peers on the Bitcoin network.

When making a purchase with a mobile device, the use of QR codes to simplify transactions is ubiquitous. There are also now several server software implementations of the Bitcoin protocol.

So-called “full client” nodes on the network validate transactions and blocks they receive and relay them to connected peers.

 

Bitcoin uses public-key cryptography, in which pairs of cryptographic keys, one public and one private, are generated.

A collection of keys is called a wallet. Note that sometimes this term is used to mean client software in the sense of digital wallet.

A Bitcoin transaction transfers ownership to a new address, an alphanumeric string of the form 1FfmbHfnpaZjKFvyi1okTjJJusN455paPH derived from public keys by application of a hash function and encoding scheme.

 

The corresponding private keys act as a safeguard; a valid payment message from an address must contain the associated public key and a digital signature proving possession of the associated private key.

Because anyone with a private key can spend all of the bitcoins sent to the corresponding address, the essence of Bitcoin security is protection of private keys.

Theft of bitcoins has occurred on numerous occasions

The practical day-to-day security of Bitcoin wallets remains an on-going concern.

Risk of theft can be reduced by generating keys offline on an  uncompromised computer and saving them on external storage or paper printouts.

Various vendors produce physical bitcoins, collectables that store a private key on paper, metal,  wood  or plastic. Images of physical bitcoins are ubiquitous in media coverage of Bitcoin.

 

Block chain

Integral to Bitcoin is a public database and sequential record of all transactions, known as the block chain, that records current bitcoin ownership as well as at all points in the past. By keeping a record of all transactions, the block chain prevents double-spending.

Those that maintain the block chain are called miners and are rewarded with newly created bitcoins as well as transaction fees. Payment processing work done by miners verifies each transaction as valid and adds it to the block chain.

Bitcoin payment processing fees are optional and generally substantially lower than those of credit cards or money transfers.

Currently, doing the work of payment processing is rewarded with newly created bitcoins, 25 per block. The block reward will be halved to 12.5 bitcoins in 2017 and again approximately every four years thereafter. By 2140 there will be approximately 21 million bitcoins in existence and transaction processing will be solely incentivized by transaction fees.

Today, transactions that pay a fee may be processed more quickly.

 

Through various exchanges, bitcoins are bought and sold at a variable price against the value of other currencies.

While there may be a seemingly large number, exchanges regularly fail, taking client bitcoins with them.

A published research study showed that of 40 Bitcoin exchange markets studied, 18 ended up closing over a period of 3 years.

Bitcoin prices are fragmented and vary widely across exchanges.

 

Nakomoto cites as conventional currency’s root problem: “all the trust that’s required to make it work.” But Bitcoin requires us to replace trust in legal systems, institutions and procedures, with a system where we must:

Trust the willingness of counterparties to accept Bitcoin as currency for payment — a huge leap of faith. Purchasing Bitcoins means participation in a 100 percent trust-based system, without any legal mechanism to compel their acceptance. Conventional currencies rely not just on trust, but also on the force of law. For example, in America the “Legal Tender Statute” (31 USC Sec. 5103) specifies that: “United States coins and currency … are legal tender for all debts, public charges, taxes, and dues.” No country issues Bitcoins, and no government legally compels anyone to accept them as payment.

Trust unregulated institutions with your personal bank information just to purchase Bitcoins. As described in Mother Jones:

… if you … have qualms about handing over all of your bank information to an anonymous internet stranger, then you might want to just give up now. The major Bitcoin exchanges don’t accept credit cards …

Trust a cryptographic, peer-to-peer network computer technology most Bitcoin users don’t understand.

Trust that Bitcoin (really, a beta) won’t be replaced by a superior digital currency system, rendering original Bitcoins obsolete and worthless.

Trust that the Bitcoin Foundation/other participants won’t create additional Bitcoin series, thereby diluting the value of the original Bitcoins.

Trust that governments won’t intervene to render Bitcoins  worthless (e.g., if Bitcoins facilitate too much drug-dealing or money laundering, the U.S. government could make their possession illegal).

Trust an anonymous creator (Nakamoto) who’s mysteriously “moved on to other projects” and disappeared.

Trust that Bitcoin markets will be available to provide prices in real currencies — as recent events demonstrate, also a leap of faith.

Trust that your Bitcoins are stored in a secure location. Precisely because Bitcoin transactions are anonymous and non-reversible, they’re highly vulnerable to theft. If your Bitcoins are stolen, they’re pretty much untraceable.

Lack of anonymity

The block chain is a public ledger of every bitcoin transaction that does provide a certain level of anonymity; it identifies transactions by Bitcoin address not individuals names. Tracking the flow of bitcoins through transactions can give clues as to who the owner is, however.

And while Bitcoin uses cryptography, it does not do so to protect the identities of its users. In addition, Bitcoin intermediaries such as exchanges are required by law in many jurisdictions to collect personal customer data.

History

 

Main article: History of Bitcoin

First mentioned in a 2008 paper published under the pseudonym “Satoshi Nakamoto”, Bitcoin became operational in early 2009 with the release of the first open source Bitcoin client and the issuance of the first bitcoins.

The currency had early technical problems such as a 2009 exploit that allowed the creation of unlimited bitcoins.

It is widely believed that the first bitcoin trade for goods or services took place on May 21 2010 when Laszlo Hanyecz, a programmer living in Florida, sent 10,000 bitcoins to a volunteer in England who ordered two pizzas for Hanyecz at a cost of US$25.

By May 2011 interest in Bitcoin was growing, as were concerns. A report by Jason Calacanis included statements such as “Bitcoin may be the most dangerous technological project since the internet itself.”

The price of bitcoins has fluctuated wildly since its inception, going through various cycles of appreciation, which have been referred to as “Bubbles”.

In 2011 the value of one bitcoin rapidly rose from about US$0.30 to US$32, reached parity with the USD for the first time in February 2011 before falling back down to US$2.

 

Following increased media attention in the latter half of 2012 and the 2012-2013 Cypriot Financial Crisis, the bitcoin price began to rise again in early 2013 reaching a peak of US$266 on April 10 before crashing to around US$50

In March 2013 a technical glitch caused a fork in the block chain with one half of the network adding blocks to one version of the chain, and the other half adding to another other. For six hours there were effectively two Bitcoin networks operating at the same time, each with its own version of the transaction history. The core developers called for a temporary halt to transactions, sparking a sharp sell-off. Normality was restored when the majority of the network downgraded to version 0.7 of the Bitcoin software from the flawed version 0.8.

In 2013 some mainstream services began accepting it as a form of payment.

Certain non-profit or advocacy groups also began accepting bitcoins.

2013 also saw the first interventions by law enforcement. Assets belonging to the Mt.Gox exchange were seized, and the Silk Road drugs trading website was shut down.

During November 2013, the China-based Bitcoin exchange BTC China overtook Japan-based Mt.Gox and Europe-based Bitstamp to become the largest Bitcoin trading exchange by trade volume.  On 19 November 2013, the value a bitcoin on the Mt.Gox exchange soared to a peak of US$900 following a United States Senate committee hearing, at which the committee was informed that virtual currencies were a legitimate financial service. On the same day, one bitcoin traded for over RMB¥6780 (US$1100) in China.  With roughly 12 million bitcoins in existence as of November 2013, the new price increased the market cap for Bitcoin to at least US$7.2 billion.

By November 23, 2013 the total market capitalisation of all bitcoins in existence exceeded US$10 billion for the first time.

On 5 December 2013, the People’s Bank of China announced it was prohibiting Chinese financial institutions from using bitcoins.[11] Following the introduction of these new rules, the value of bitcoin dropped[51] and Chinese internet giant Baidu reversed its policy of accepting bitcoins for certain services.[52] Starting in October 2013, Baidu had been allowing clients of website security services to pay with bitcoins.  Buying real-world goods with any virtual currency has been illegal in China since at least 2009.

Economics

 

Bitcoin’s money supply is predefined by the Bitcoin protocol. Currently there are over twelve million bitcoins in circulation, with a creation rate of 25 bitcoins approximately every ten minutes. Since the money supply is fixed, bitcoin advocates argue that it is inflation-proof.[citation needed] At present the exchange price of a bitcoin is extremely volatile, which has led to some questions about its ability to function as a currency.[55] Others contend, however, that this is a necessary “growing pain” in such a new technology, and that Bitcoin needs to grow to achieve stability.[58]

Volatility has little effect on Bitcoin’s utility as a payment processing system since merchants need not price their goods in bitcoin and can immediately exchange bitcoin payments for local currency.  Processing fees are also substantially lower than those of credit cards or money transfers.

Some feel that Bitcoin may be especially well suited to facilitating cheap cross-border money transfers.

Currently Bitcoin does see use as a currency and by November 2013 there were about 1,000 brick and mortar businesses willing to accept payment in bitcoins, and more than thirty thousand merchants online.

 

Alternative to national currencies

Some have suggested that Bitcoin is gaining popularity in countries with problem-plagued national currencies, as it can be used to circumvent inflation, capital controls, and international sanctions. Bitcoins are used by some Argentinians as an alternative to the official currency, which is stymied by inflation and strict capital controls.

In addition, some Iranians use bitcoins to evade currency sanctions.

 

Financial journalists and analysts have suggested that there was a link between higher Bitcoin usage in Spain and the 2012-2013 Cypriot financial crisis.

 

Intrinsic value

Bitcoins have been described as lacking intrinsic value because their value is not backed by hard assets or full faith and credit of a sovereign government but their value depends only on the belief that bitcoins have achieved significant acceptance and lasting permanence.

 

Velasco and Medina counter this argument by noting the abstract work involving in minting a bitcoin: while the use value of a bitcoin is not universally agreed upon, its labour value is firmly established.

Austrian economists refute the notion of “intrinsic value”. Their subjective theory of value suggests that for bitcoins to have value it suffices if “rational expectations of the potential utility of bitcoin for the potential buyers exceed the price demanded”,  Konrad S. Graf  and Nick Szabo seeing a possible source of exchange value in bitcoins being used as collectibles.

Speculation

Bitcoins are often traded as an investment by speculators who expect the currency to increase in value as its popularity widens.

The European Banking Authority has warned that the risks of engaging in such speculation go beyond the possibility that the value of Bitcoin drops.

Their vulnerability to hacking and theft also makes their use as an investment more questionable.

Derivatives of bitcoins are thinly available. One organization offers futures contracts against multiple currencies.

Bitcoins have attracted the attention of some Wall Street types with Peter Thiel’s Founders Fund investing US$3 million and the Winklevoss twins making a US$1.5 million personal investment as well as making an attempt to launch a Bitcoin ETF. On January 7, 2014 it was reported that the IRS were studying how bitcoins might be taxed.

Forbes suggested that a motivation behind the review may have come as a result of attempts by the Winklevoss twins to create an exchange traded fund.

 

 

 

 

Economists have had a mixed reaction to Bitcoin. Some have responded positively to Bitcoin, including François R. Velde, senior economist of the Federal Reserve in Chicago who described it as “an elegant solution to the problem of creating a digital currency.”

Other economists commenting on Bitcoin have been critical. Nobel laureate Paul Krugman has suggested that the structure of the currency incentivizes hoarding and that its value derives only from the expectation that others will accept it as payment further dismissing Bitcoin as being essentially worthless since it has “no clear use”  and commenting on price volatility stated that “The economic significance of this roller coaster was basically nil”.

In November 2013 Richard Branson announced that Virgin Galactic would accept Bitcoin as payment, saying that he had invested in Bitcoin and found it “fascinating how a whole new global currency has been created”, encouraging others to also invest in Bitcoin.

PayPal President David A. Marcus has said he thinks that Bitcoin is a “great place to put assets” but that it won’t be a currency until its price volatility reduces.

 

Legal issues and status

 

Criminal activity linked to Bitcoin has largely centered around theft of the currency, the use of botnets for mining, and the fact that some will accept bitcoins in exchange for illegal items or services. Certain nation states may feel that its use in circumventing capital controls and for gambling are also undesirable. While some governments have taken a hands-off approach, others have moved to regulate Bitcoin and similar, private currencies. This may stem from a perceived association with criminal activity, the ability of Bitcoin to evade capital controls, and the fact that the currency lacks consumer protections.[citation needed]

Black markets

Several news outlets have asserted that the popularity of Bitcoin hinges on the ability to use them to purchase illegal substances.

In 2013 The Guardian reported that the currency was primarily used to purchase illegal drugs and for online gambling,  and The Huffington Post stated that “online gambling accounts for a huge portion of Bitcoin activity.”  C. 2013 legitimate transactions were thought to be far less than the number involved in the purchase of drugs,  and roughly one half of all transactions made using Bitcoin were bets placed at a single online gaming website.

In 2012, an academic from the Carnegie Mellon CyLab and the Information Networking Institute estimated that 4.5 to 9% of all bitcoins transacted were for purchases of drugs at a single online market, Silk Road.

As the majority of the Bitcoin transactions were at this time speculative in nature, this academic asserted that drugs constituted a much larger percentage of the products and services bought using the currency, however.  The Huffington Post stated in 2013 that online gun dealers use Bitcoin to sell arms without background checks.

 

Criminal activity

Bitcoin’s association with criminal activities has historically hindered the currency from attaining widespread, mainstream use and has attracted the attention of financial regulators, legislative bodies, and law enforcement.

The Washington Post had labeled it “the currency of choice for seedy online activities,” and CNN has called Bitcoin a “shady online currency [that is] starting to gain legitimacy in certain parts of the world.”

Its links to criminal activities have prompted scrutiny from the FBI, US Senate, and the State of New York. The FBI stated in a 2012 report that “bitcoins will likely continue to attract cyber-criminals who view it as a means to move or steal funds”.

Steven Strauss, a Harvard public policy professor, has suggested that due to its close association with illegal purchases, governments could outlaw Bitcoin, which was also mentioned in 2013 SEC filing made by a Bitcoin investment vehicle.

Bitcoins are not currently illegal in the US, however. FBI Special Agent Christopher Tarbell has stated that “bitcoins are not illegal in and of themselves and have known legitimate uses.”

Legal status

Main article: Legal status of Bitcoin

Many governments have made announcements regarding Bitcoin, and these decisions also likely affect treatment of other cryptocurrencies as well.

Some, including Australia, Canada, Finland, and Germany have simply stated that normal earned income rules apply to Bitcoin.

Other states reject the label of currency but will collect taxes on Bitcoin transactions such as Norway.

(Germany may technically fall into this latter category as it refers to Bitcoin as a unit of account,  which is one of several roles fully fledged currencies play.)

Still more have issued statements that assert Bitcoin is not regulated in their jurisdictions, such as Singapore and Poland.[citation needed] Denmark is among those that, as of 2013, have stated future regulations may be imposed.

In the United States, the Financial Crimes Enforcement Network has established regulatory guidelines for currencies such as Bitcoin, classifying certain firms engaged in the exchange and mining of Bitcoins as money services businesses.

New York state has considered the possibility of regulating Bitcoin.

 

Money laundering

Some regulatory and law enforcement authorities, including the European Banking Authority, feel Bitcoin may be used for money laundering.

A 2012 report by the FBI acknowledged such fears but stated that there were no known instances of this occurring.

Some say one obstacle to bitcoins becoming widely used to launder money is that all transactions are public.

During a US Senate hearing in 2013, Jennifer Shasky Calvery, director of the Treasury Department’s Financial Crimes Enforcement Network stated, “cash is probably still the best medium for money laundering.”

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