On Bitcoins and the rise of digital currency

07.15.11

First appeared in Crikey on the 20th June, 2011.

As I write this, a single Bitcoin is buying $US19.65. A year ago they were worth half a cent each, meaning that in the past 12 months their value has increased by some 393 000% – a result considerably beyond the 27% increase posted in the same period by the Brazilian real, otherwise the global financial system’s best performing currency. Bitcoins are, in short, and by a significant margin, the most valuable currency on the planet.

But, of course, this all depends upon what we mean by “currency”. Or, perhaps more importantly, what we mean by “Bitcoins”.

As the name might suggest, the Bitcoin is a unit of money that exists solely in the online world. A wholly decentralised, encrypted peer-to-peer network utilising technology not entirely dissimilar to the BitTorrent protocol, Bitcoins operate by assigning every coin and every user on the network a particular code, and then using these to instantaneously add each transaction to the communally shared log file that is the currency’s entire history.

When a transaction occurs, it becomes attached to a computationally intensive proof-of-work problem that is circulated through the network until a computer manages to “solve” it. When this occurs,  the legitimacy of the transaction is confirmed and an a certain number of Bitcoins is produced for the computer that struck upon the correct solution. Thus the system becomes self-sustaining. Transactions cannot be validated without the input of computers attached to the network, and the only way of creating new Bitcoins is by “mining” them out of the proof-of-work problems created by the transactions of others. There are currently 6 559 650 Bitcoins in existence, each sub-divisible to eight decimal places. The algorithm running the system has an upper ceiling of 21 million Bitcoins – distributed at an exponentially decreasing rate – due to be reached in the 2030s.

Once you come into possession of a Bitcoin, whether through mining or through an exchange agency such as Mt Gox, it can be used as with any normal currency. You find something you want to buy, you input the user’s ID code into your digital wallet (the Bitcoin desktop client) and then you wire them the relevant amount of money… Well, uh, sort of like a normal currency.  However, having only been around for two years, the actual commercial applications of your average Bitcoin are fairly limited. They’re not being accepted at, say, Amazon. Or Crikey. Instead the currency is getting most play as a novelty investment property. At Mt Gox, people make offers in real world currency for a declared  number of Bitcoins and others can choose to sell if the price seems suitable – hence the existence of an exchange rate. And as the difficulty of the proof-of-work problems has increased – one professional “miner” reported having his house raided because his processor farm was sucking so much energy off the grid that police assumed he was growing hydroponic marijuana –  exchanges have become the primary mechanism by which most people accrue the currency.

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The ramifications of this set-up are enormous. Bitcoins are currency as pure data squirt, a form of money completely detached from any central banking institution or non-financial force. That is, the amount of currency possessed by a single person cannot be altered without the express consent of that person. And unlike all previous monetary systems, the absence of a central authority means the total amount of currency circulating through the system cannot be manipulated, nor for that matter can the currency be shut down. Moreover, because all users share the data on all transactions, and any particular transaction cannot be validated unless the honest code is shared by a majority of users, the currency is essentially incorruptible. Even the most sophisticated botnets imaginable would find it next to impossible to assume control of the 50% of linked users required to artificially alter the shared code. This is currency in its purest, most individualised form, a financial cloud where banks and governments are rendered, in essence, nugatory.

Bitcoins have been greeted with everything from derision to slightly terrified awe by those in the digital community. Sceptics point to its lack of commercial application, the high technological barrier of entry, the extreme volatility of its price – in the past month it has ranged from $US10 to $US32 – and the mandated upper ceiling as reasons for its likely demise. Critics also bring up the immense potential for abuse of the Bitcoin system. With the aid of simple anonymising software such as Tor, a Bitcoin user can make themselves entirely untrackable. As could probably be predicted, this has already led to the emergence of numerous websites devoted to the trafficking of contraband, including, most notoriously, the Silk Road, an open market for illicit drugs. One doesn’t have to venture too much farther to imagine the trafficking of humans, weapons and child pornography by similar means. If there is to be a proffered reason for an eventual government crackdown, it will almost certainly be this.

But, at the other end of the spectrum, you have those who think that Bitcoins could do for money what the internet has done to pretty much every other type of media: democratise it, equalise it and begin destroying the institutions that once upheld it. In the most extreme version of this narrative, Bitcoins are seen as capable of bringing the entire global financial system to its knees and refashioning it in a new mould, a mould where the actions of mighty and foolish fiscal monoliths are no longer capable of destroying the wealth of the people below them.

As with all things, the truth probably lies somewhere between each extreme. There are numerous technological and cultural barriers to overcome before the currency becomes in any way a practical proposition, but few of these seem insurmountable, given time. People point to the fact that it has taken close to ten years for BitTorrent technology to reach anywhere near popular acceptance. But, conversely, it is similarly hard to envisage a world where Bitcoin usage has advanced to such a stage that it begins to displace traditional currencies. If for no other reason than the fact that it’s hard to envisage any government allowing it to get to that point without first making the entire system illegal. They may come to dominate certain online transactions, but I have a sneaking suspicion that the banks will manage to weather the storm.

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So, what relevance do Bitcoins have to you? Well, in all likelihood, none. They could be an investment curiosity, but they’re probably not the most secure proposition to pump your life savings into. Something to throw a couple of hundred at, perhaps when the price eases. But, for me, whether or not I actually put any money into the system almost seems beside the point. My fascination certainly stretches beyond the prospect of financial gain or usability. And that’s because, in their complex simplicity and sheer unexpectedness, Bitcoins simply strike me as a fresh reminder of the internet’s continuing capacity to surprise and unsettle the things we thought we knew. They may be worthless tomorrow – hell, they’ll probably be worthless tomorrow ­– but right now Bitcoins are making us contemplate a world where the meaning of money is totally unfamiliar, and that strikes me as quite remarkable.