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Bitcoin – Currency of the Future?

Written by kevin

Imagine a currency that is entirely digital and online-based.

That is not controlled by any government or central bank.

And that you can even “mine” and create yourself.

Is there such a thing?

Indeed there is. It’s called Bitcoin.

Bitcoin is the name of the world’s first “decentralised open source digital currency”. It was launched in 2009 by a programmer called Satoshi Nakomoto (rumour is that may or may not be his – or her, real name).

Bitcoin is an Open Source Project and it isn’t managed by a centralized institution, bank or any other authority.

The Bitcoin currency isn’t pegged to any other currency in the world and nor is it backed by gold or promises of any central bank or reserve.

All this might sound alarming. But in fact, the open source and peer-to-peer nature of Bitcoin is it’s very strength.

Bitcoin is entirely outside the control and manipulation of financial institutions and politicians. The currency is bought and sold entirely online according to freely floating market exchange rates.

And being peer-to-peer means it operates and is managed in a manner similar to file-sharing services that we are familiar with such as BitTorrent.

Basically the system manages itself online through it’s pre-programmed peer-to-peer system which automatically exchanges information continually about the currency amongst all the participants in the system.

The interesting thing is that the economics and business magazine The Economist recently wrote an article praising the Bitcoin.

One of the great things about Bitcoin is that it runs itself without intervention, manipulation or interference of governments. This means politicians can’t get to fiddle with it for their own ends. So in that sense, it’s a very neutral currency.

So how are Bitcoins created?

Bitcoins come into existence through a digital encrypting process known as “mining”. This involves a complex and laborious computer processing procedure which serves to keep the creation of new Bitcoins to a slow trickle.

An algorithm has been built into the Bitcoin mining system to ensure that the supply of Bitcoins cannot suddenly be massively increased simply by the application of more and more powerful computing resources.

There is also a cap of 21 million Bitcoins maximum that can be created, At present only around 6 million are said to be in circulation.

Many people made fortunes very quickly by purchasing Bitcoins in the early days which then saw their value explode hundred fold in a short time which the exchange rate suddenly spiked. On launching, one Bitcoin was worth $0.003. In April 2011 they reached $1. In June 2011 climbed to $10. Then, just three weeks later, the exchange rate hit $22.

In other words, if you had bought a $100 worth of Bitcoin on launch date, your Bitcoin holding would at it’s June 2011 peak have been worth a staggering $732,600. That’s an incredible increase in value and I had to check my arithmetic twice (three times in fact) to be sure. But it’s correct.

Since then the exchange rate has come down sharply and has been falling slowly further since. Which also means that conversely, if you had bought Bitcoins at their June 2011 peak exchange rate and sold a month later, you would have lost half your money.

So there’s an element of boom-and-bust going on here. The Great Dutch Tulip Bulb Mania comes to mind. This was at a time in the 17th century when people went mad buying up tulip bulbs for no other reason than the fact that the price of tulip bulbs was accelerating out of control. Before it suddenly crashed, leaving large numbers of people out of pocket and ruined (and millions of tulip bulbs probably thrown on the compost heap).

However, once it settles down – and provided Bitcoin continues to gain acceptance and doesn’t suddenly wane and die, the value of Bitcoins seems likely set to rise in coming months as awareness and interest in this new currency takes off.

Where can I get hold of some Bitcoins?

Basically there are two ways you can obtain Bitcoins: you can purchase Bitcoins on a currency exchange which specializes in Bitcoins. Alternatively, you can “mine” Bitcoins using your own computer.

Mining your own Bitcoins might sound attractive, but in practice it’s a very time intensive process. It requires a great deal of computer processing power – and will mean a correspondingly high electricity bill as well. It will also slow down your computer, so if you are thinking of doing this, you should really only use a dedicated state-of-the-art PC.

A more practical way of becoming involved in the Bitcoin mining process is to take part in a “mining pool”. In this way, your computer – or preferably a spare computer if you have one available, becomes part of a virtual online Bitcoin mining network. The proceeds from the “mined” Bitcoins are then shared out amongst the participants.

But a much quicker and easier way of obtaining some Bitcoins is simply to purchase some via an online currency exchange. Right now the world’s biggest and most well-known is the US-based Mt. Gox exchange at www.mtgox.com.

Trades on Mt.Gox are however solely between US Dollars and Bitcoins, so if you are trading from a third-currency such as the Euro, it might be better to use an alternative such as BitMarket at www.bitmarket.eu.

Trades on these exchanges take place strictly between participants, not with the exchange itself. In other words, these online exchanges operate like a conventional currency or stock exchange, acting as a meeting place between buyers and sellers.

In both cases you first need to register (free of charge).

But before you do this, to take part in the Bitcoin system, you need to install a Bitcoin client on your computer. They are available for Windows, Mac and Linux. The client includes a digital wallet which is stored on your machine and holds all your Bitcoins. You carry out your Bitcoin transactions through your Bitcoin client.

Alternatively there are cloud providers who offer an online wallet service. This of course means you have to be willing to trust that provider with the contents of your Bitcoin wallet.

It’s especially important to make sure your Bitcoin wallet is secure. Backups are therefore extremely important.

Free Bitcoins!

There’s also another way to obtain Bitcoins. Some online traders offer free Bitcoins as a bonus when you purchase their products or services from them.

There’s also a free Bitcoin giveaway site run by Gavin Andresen, one of the key project members of Bitcoin, called Bitcoin Faucet at https://freebitcoins.appspot.com. The amount of Bitcoins the site issues per applicant is tiny (currently 0.001 Bitcoins) and it’s intended as a publicity vehicle for Bitcoin, to help generate interest in the currency.

To what extent is Bitcoin a “real” currency?

The most important aspects of a currency is that it holds it value over time, that people have confidence in it – in other words, they are willing to accept it as a means of exchange, and are willing to hold it as a means of saving, and finally, that it cannot be easily forged.

Because Bitcoins cannot be easily created, this also means it is practically impossible for the world to suddenly be swamped with Bitcoins. As a result, the value of the Bitcoin looks likely to rise in the future.

The complex nature of the cryptology built into the Bitcoin also makes counterfeiting Bitcoins pretty well impossible.

However, Bitcoin is a very new currency and as such it’s a high risk concept and activity to get involved in. We are entering unchartered waters here.

But on the other hand, conventional finance is itself often high risk.You only have to think Credit Crunch and the banking crisis of 2008. And who knows for sure what’s in store for the US Dollar and the Euro in future? I have to say I don’t feel especially confident about either of them right now.

There are concerns about Bitcoins being used by money launderers, drug dealers or terrorists. But this charge can also be made against established conventional currencies.

There is also uncertainty about how governments and financial authorities world wide will react to the Bitcoin. Bitcoin lies completely outside of their control – and governments and politicians like to be able to control and regulate things (and some would say, mess things up) – especially when it comes to currencies and financial systems.

So there are a number of unknowns right now concerning this new currency.

What can you do with Bitcoins?

There are a small but fast growing number of businesses – mostly online, who accept Bitcoins.

The growth in the popularity and power of smartphones will probably help to ease the acceptance of Bitcoins. Having a smartphone would give you instant access to your Bitcoin wallet at all times and will mean that you will be able to spend Bitcoins offline as well as online.

However the fact is that at the moment, the Bitcoin as a new currency has a momentum problem. Businesses will only start accepting Bitcoins when people hold Bitcoins and want to buy goods and services with Bitcoins. And people will only be able to spend Bitcoins when businesses start accepting Bitcoins…

Trading volumes in Bitcoin on the various exchanges are miniscule at present compared to conventional national currency exchanges. This in itself leads to high volatility in selling prices between trades.

I think the main reason most people are interested in obtaining and holding Bitcoins right now is solely for speculative purposes. And also as a safe haven. The Bitcoin can be used as a means of spreading risk against other conventional national currencies.

So to sum up, given the uncertainties at the moment surrounding the Bitcoin, I wouldn’t advise putting your life savings, nor either any substantial amount of money into Bitcoin that you can ill afford to risk.

But it might well be worth purchasing a nominal amount as a small flutter.

At any rate Bitcoin is a phenomena that will be interesting to keep a close eye on in the coming weeks and months.