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PostA Bitcoin in Your Christmas Stocking? From Ric Mauricio (John Eipper, USA, 12/27/13 9:06 am)
In response to my request of 5 December, our reader Ric Mauricio sends the following primer on the Bitcoin phenomenon:
What is Bitcoin?
Bitcoin is a decentralized peer-to-peer payment network that is powered by its users with no central authority or middlemen. Bitcoin is considered an alternative currency. It uses a triple-entry bookkeeping system.
Who created Bitcoin?
Bitcoin's beginnings as "crypto-currency" can be attributed to Wei Dai on the cypherpunks mailing list in 1998, suggesting the idea of a new form of money that uses cryptography to control its creation and transactions, rather than a central authority. Alternately, the idea has been attributed to Nick Szabo, when he proposed the creation of Bit Gold. The first Bitcoin specification and proof of concept was published in 2009 in a cryptography mailing list by a Satoshi Nakamoto, a mystery person or persons. The network has grown exponentially, with many developers working on Bitcoin. Satoshi's anonymity often raised concerns, most likely due to a lack of understanding of the open-source nature of Bitcoin. The Bitcoin protocol and software are published openly and any developer around the world can review the code or make their own modified version of the Bitcoin software. Just as with current developers, Satoshi's influence was limited to the changes he made being adopted by others and therefore he did not control Bitcoin.
Bitcoins exist as software (although there are actual minted coins, currently not available) which contain the rules governing their supply. New bitcoins can be created only by solving complex problems embedded in the currency, keeping the total growth limited. Like any currency, bitcoin is designed to function as a means of exchange, a unit of account and a store of value. Satoshi addressed one of the biggest problems in online transactions: fraud. In the real world, it's the job of a centralized authority to prevent that from happening. But Satoshi figured out a workaround by cutting out that middleman: just make all transactions public, and have the entire community confirm that a transaction is legit. "We have proposed a system for electronic transactions without relying on trust," Satoshi wrote in his 2008 spec paper laying out the currency.
Who controls the Bitcoin Network?
Nobody owns the Bitcoin network. Bitcoin is controlled by all Bitcoin users around the world. While developers can improve the software, they can't force a change in the Bitcoin protocol because all users are free to choose what software and version they use. In order to stay compatible with each other, all users need to use software complying with the same rules. Bitcoin can only work correctly with a complete consensus among all users. Therefore, all users and developers have a strong incentive to protect this consensus.
How does Bitcoin Work?
Behind the scenes, the Bitcoin network is sharing a public ledger called the "block chain." This ledger contains every transaction ever processed, allowing a user's computer to verify the validity of each transaction. The authenticity of each transaction is protected by digital signatures corresponding to the sending addresses, allowing all users to have full control over sending bitcoins from their own Bitcoin addresses (wallets). In addition, anyone can process transactions using the computing power of specialized hardware and earn a reward in bitcoins for this service. This is often called "mining."
Is Bitcoin really used by people?
There is supposedly a growing number of businesses and individuals using Bitcoin. This includes brick-and-mortar businesses like restaurants, apartments, law firms, and popular online services such as Namecheap, WordPress, Reddit and Flattr. At the end of August 2013, the value of all bitcoins in circulation exceeded US$ 1.5 billion, with millions of dollars worth of bitcoins exchanged daily. It has been reported that 36 municipal government agencies now accept bitcoins, but I have been unable to confirm this. Now here is a question that I will throw out there regarding transactions using Bitcoins. Let us suppose you are a retailer. The cost of your product is $US 100. Normally, you will mark this up 100%, thus the retail selling price is $200. After your cost of goods sold and operational expenses, your profit is $US 50. If you are paid in Bitcoins the equivalent of $200 and the value of the Bitcoin decreases by 50% (as we have seen in the last few weeks), if you hadn't exchanged the Bitcoins back into US dollars, you would be losing money. And if this is happening on a daily basis, how can you control your business revenues? As far as I know, there are currently no Bitcoin hedging instruments available.
How does one acquire bitcoins?
1) From payments for goods and services; 2) By purchasing bitcoins at a Bitcoin exchange; 3) By exchanging Bitcoins with someone through a transaction; or 4) By earning Bitcoins through competitive mining.
Why is the price of bitcoins so volatile?
As with any item in the world, it is subject to human interaction, and thus subject to the same manic/depressive emotions that controls human transactions. It is no different than fiat currencies, commodities like gold or silver or oil, real estate, stock markets, tulip bulbs, cabbage patch dolls, or beanie babies. One can trade these items and make lots of money ... or lose lots of money. Here is my two bitcoins' bit of advise as taught by Sir John Templeton: "The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell." And remember, Bitcoins are created by anonymous computer geeks. Who's to say that one of these computer geeks or a hacker turns rogue? By all means, I wouldn't bet the farm or go all-in. Or, as Wall Street's Art Cashin would ask, "Can you say bubble?"
Szabo, Nick. "Bit Gold" Unenumerated. Blogspot. http://unenumerated.blogspot.com/2005/12/bit-gold.html
Dai, W (1998). "b-money." http://www.weidai.com/bmoney.txt
Nakamoto, Satoshi (1 Nov 2008). "Bitcoin: A Peer-to-Peer Electronic Cash System." http://bitcoin.org/bitcoin.pdf
Sawyer, Matt (26 February 2013). "The Beginners Guide To Bitcoin - Everything You Need To Know." Monetarism. http://www.monetarism.co.uk/the-beginners-guide-to-bitcoin-everything-you-need-to-know/
"How Does Bitcoin Work?" http://bitcoin.org/en/how-it-works
"Getting Started with Bitcoin" http://bitcoin.org/en/getting started
"Business accepting Bitcoins" http://usebitcoins.info/
Estes, Adam (28 March 2013). "Bitcoin Is Now A Billion Dollar Industry." http://www.thewire.com/business/2013/03/bitcoin-now-billion-dollar-industry/63667/
Ro, Sam (3 April 2013). "Art Cashin: The Bitcoin Bubble." http://www.businessinsider.com/art-cashin-the-bitcoin-bubble-2013-4
"BitBills Attempt to Patent Physical Bitcoins". Let's Talk Bitcoin! 30 June 2013. http://letstalkbitcoin.com/477/
"Triple Entry Bookkeeping System." http://financialcryptography.com/mt/archives/001325.html
JE comments: My thanks to Ric Mauricio for taking the time to compose this informative primer. I'm still in the dark about a few things Bitcoin: 1) What exactly is this mining, and more precisely, why was "mining" incorporated as part of the Bitcoin project? Does it serve as a community-based check on the honesty of transactions? Which leads to my second question: 2) If all the Bitcoin transactions are public, then what is the advantage? I thought the whole raison d'etre of Bitcoin was its de-centralized nature, which makes it an ideal medium for conducting business outside the reach of a given government or central authority. Put in another way: if you want to conduct shady dealings such as money laundering, isn't privacy your absolute first priority? And finally, question 3): if Bitcoin exists only as software, what is to prevent a brilliant computer geek from undermining the whole system--or at the very least, "minting" a few million Bitcoins for her or his own benefit?
Here's an interesting link, which gives the US dollar exchange rate for Bitcoin in real time. Note that the value per coin has risen to $740, about 50% higher than the last time we checked. This, Friends, is one volatile currency, which undermines the single greatest property we seek in our money: stability. For now, I'll pass. (But if you want to donate to WAIS in Bitcoins, let me know and I'll find a way to make it possible.)