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Excerpt from the May 2012 Newsletter:
BITCOIN: THE BIT GENERATION OF MONEY OR WHAT?
The Bitcoin is a new digital currency which proponents herald as the future of money because it allows fast, inexpensive and anonymous internet-based financial transactions, while eliminating the need for intermediaries and supervisory authorities to manage its stability. Since its launch the Bitcoin system has been welcomed as an effective payment system that is autonomous from central banks and operates without transaction fees. On the other side, however, opponents see it as a dangerous payment system out of the control of financial authorities, providing an easy method to launder money, acting as a magic wand for illegal gamblers, terrorists, drug traffickers and child pornographers.
Bitcoin is the product of a group of cryptographers with an enormous influence on the digital world. In 1998, a cyberpunk named Wei Dai proposed a digital currency called “b-money” to facilitate commerce over the internet, that could not be traced or regulated by authorities. Ten years later, it is still not clear if a single programmer or a group of programmers, working under the pseudonym of Satoshi Nakamoto implemented Dai’s proposal and released the software for the Bitcoin system.
At first sight a Bitcoin account may seem to work just like any other ordinary on-line bank account: deposits are stored in the form of electronic book entries and payments consist of orders to credit one account at the expense of another. But upon deeper analysis we note crucial differences: the Bitcoin system relies on peer-to-peer networking which means that instead of being linked through a central server, each Bitcoin programme located on an individual’s PC is linked to other Bitcoin programmes, which in turn are linked to other Bitcoin programmes. Each PC contains a copy of the account book that registers transactions in the system. The cleared transactions are rapidly and automatically communicated to other Bitcoin programmes. This decentralization helps the system evade attacks by hackers and allows individuals to send money directly to one another without the intermediation of any banks or brokers.
The entire Bitcoin system is built around “mining”; the process that creates and distributes the Bitcoins. Anyone may try to create Bitcoins, in a way that is very similar to the mining of gold. While gold miners compete in finding, extracting and purifying gold, Bitcoin miners compete to solve an extraordinarily difficult formula six times per hour by using algorithm capacity. Each successful solution contains a copy of the most recent transactions made through the Bitcoin system and becomes part of the newly balanced book account that is distributed across the network.
Like success in mining gold, success in mining the Bitcoins is determined by a combination of luck and investment in the search process. Bitcoins miners invest in the computer power to mine the digital currency and manage to make a profit at it. This in a way gives a sense of fairness to the way the wealth embodied in new units of the digital currency is initially distributed. Mining also offers a solution to a problem that every ordinary monetary system has to face, ie: maintaining the credibility of the currency as a store of value by containing the rate at which the currency is created. The Bitcoin system solves the problem by building into the mining algorithm upper limits on both the rate at which the currency can be generated and the total amount that can ever be generated. To date, there are approx 7.5 million Bitcoins in existence, with approx 50 Bitcoins awarded every 10 minutes. It is estimated that by 2030, the number of Bitcoins will reach the absolute ma ximum, 21 million and, contrary to traditional currencies having legal course of action, no individual or management committee will have the power to change this.
Furthermore, the Bitcoins’ independence from any centralized system signifies that they cannot be artificially manipulated and, therefore, are less exposed to inflation or deflation, the typical risks of ordinary currency having legal course. The transactions are carried out of the international markets and, therefore are not subject to the economic crisis typically linked to the failure of certain state and financial systems. In practice, the Bitcoin accounts are pseudonymous, identifiable only by a long series of random letters and numbers such as "73SiMSaP00Yus44momSaH". This makes Bitcoins as private as cash.
No surprise that the Bitcoin was not used by anybody when it was first released in January 2009. Today instead, it seems to be supported by an interesting group of miners, programmers, account holders and service providers. Technophiles were the first users because they were intrigued by a high-tech project that combined peer-to-peer network technology and cryptography. In a way, they liked the idea of earning money by building specialized mining computers. To reduce the gambling-like nature of Bitcoin mining, some miners have then combined their computing power into mining pools. These pools win mining competitions more often and with more regularity than stand-alone miners, and pay out Bitcoins to members according to the computational power that they contributed.
The Bitcoin system has also caught the imagination of certain investors attracted by the anonymity of the Bitcoin transactions. Since mining is costly, time-consuming and technical, investors needed a way to buy Bitcoins rather than create them, while miners needed a market for selling their Bitcoins. Consequently, Bitcoin Exchanges where created to facilitate transactions in different currencies, such as Euro, USD, Yen just to name a few. As the demand for Bitcoins began to be higher than their offer, Bitcoin prices (ie: their market exchange value with traditional currencies) also rose dramatically. And this boom attracted ideological followers as well as day traders and speculators. To date, a Bitcoin has the value of approx 5 USD, which may be deemed a great success to think that back in 2010 to get two pizzas one needed 10.000 Bitcoins…
Actually, a significant part of the Bitcoin system consists of the online businesses that offer goods and services of all kinds. That withstanding, to date the customer base is still too small and none of the online stores is yet ready for prime time as the prices converted into USD are still much higher than those on non-Bitcoin merchant sites.
In the past there have been some other attempts to introduce virtual currencies, from CyberCash and DigiCash to credits linked to virtual commodities and services, like the ones provided by Facebook and SecondLife. Similar to those cases, it will be the value attributed to the Bitcoin by its users that will determine its success or not.
To succeed on the market Bitcoin must first overcome some problems linked to its production, a process that due to the limited and casual nature of its circulation, for the time being makes it a rather anti-economic payment system, and link it to security. Storing Bitcoins on a home-computer may actually be dangerous. If the encryption system protects the integrity of the Bitcoin network, it doesn’t prevent the theft of the information used to verify the identity of account owners from their own hard drives. This is also why several websites offer to store individuals’ Bitcoins in an “e-wallet” for protection against hackers. But the lack of sound regulation means that there is no assurance that these websites are trusted.
Notwithstanding the limited volume of the "BitCoin Economy", governments and traditional banking systems are rather worried about its totally anonymous character and the fact that, unlike other on-line payment systems, such as credit cards or Paypal, it does not leave any trace of the transactions made. Given its specifics, the Bitcoin system may also have less reputable users, attracted by the Bitcoin’s pseudonymity and ease of transfer. Actually, the illegal drug marketplace, online gambling sites, money launderers, terrorists and child pornographers could find the Bitcoin system very attractive and make wide easy use of it as the provider of the "service" can’t be forced to hand over the name of its client as the transaction is entirely anonymous.
The Bitcoin is probably not going to replace the dollar, euro or yen. However, it is clear that this virtual currency, acting in a complementary capacity and not as a complete alternative to ordinary currencies, holds the highest of ambitions. In a way, the Bitcoin system may be seen as the internet before certain technologies made it so useful and valuable for the entire world community. At the beginning of the internet era, it was quite hard to find anything interesting and of true value on the web. Companies that had web pages did so more to look trendy rather than for real business reasons. Now the Internet has become a crucial player in our society and economy. The potential for the Bitcoin system is very much the same… Most likely it will have to undergo some discussions with governments to become less feared, it will have to develop an effective study on anti-speculation systems to avoid dangerous bubbles and guarantee control over its value, as well as incr ease its security, but these may be peanuts, or better, only bits.