A Bitcoin lives as code inside a computer. It’s intangible but works like cash. Decoding Bitcoin

Chances are you have never used a Bitcoin, but you’ve probably heard of it.

The virtual currency is popping up more and more in the news and the government has been showing an increased interest in the subject.


For instance, the top Democrat and Republican on the Senate’s Homeland Security and Governmental Affairs Committee this week told federal financial regulators and law enforcement officials to explain how they are keeping tabs on “virtual” currencies, including the $1.2 billion market for Bitcoins.

So what, errr, is a Bitcoin?

What follows is guide to understanding the currency, why it’s used and why the government is paying attention.

What is a Bitcoin?

At its most basic level a Bitcoin is a form of money that can be used to pay for products or services just like the dollar bills that sit in your wallet.

A Bitcoin lives as code inside a computer. It’s intangible, but it works in many ways like cold, hard cash.

To acquire a Bitcoin, you need to buy it with another currency or have someone send it to you in a transaction. To hold a Bitcoin, you need to keep it in a digital “wallet,” a piece of software, on your local computer or you can you can allow a company to hold your “wallet” on their servers.

Bitcoin payments are made by transferring the digital currency between two users’ “wallets.” The fees for these transfers are lower than for more traditional forms of payments, like using a credit card or a bank transfer, because they are not backed by the safeguards and intermediary services provided by companies like Visa or Bank of America.

( Also on POLITICO: Bitcoin: Tax haven of the future)

This means Bitcoin payments can usually be made more quickly and cheaply but they lack safety nets that come with using a more established system, such as deposit insurance and being able to contest a credit card charge.

“For your average person, there’s no good reason to have large sums of money in Bitcoin,” said Jerry Brito, a senior research fellow at George Mason University’s Mercatus Center. “You want to buy Bitcoin when you want to use it for something.”

A retailer and merchant has to be willing to accept Bitcoins as a payment and right now not many do.

The dating site OkCupid and WordPress.com are among the businesses that have started to accept Bitcoin.

Bitcoin is “decentralized” meaning that it’s created and maintained by a network, rather than controlled by an institution like the Federal Reserve. The monetary policy of Bitcoin has already been established in a sense, with a cap of 21 million Bitcoins being able to enter circulation to reduce the risk of inflation.

Right now the price of a Bitcoin is around $100.

You might have heard that Bitcoin transactions are anonymous. That’s not entirely true and reflects only part of the utility of the currency. Bitcoin backers stress that it is really semi-anonymous, meaning that all transactions are publicly recorded on a so-called “block chain,” a sort of ledger, but that you have control over how much identifying information to provide.

“What Bitcoin offers to the average user is a way to make cash-like transactions on the Internet, where by transferring ownership you have transferred that actual asset, as opposed to just transferring a debt,” said Adam Levine, editor-in-chief of the podcast Let’s Talk Bitcoin!

Why is the government interested?

Bitcoin and other virtual currencies are increasingly drawing the attention of federal and state officials, though many have yet to formally express their views.

The chief worries have been whether they can be used by criminals to launder money, sell drugs, fleece unsuspecting consumers or evade taxes.

The Treasury Department and state governments have taken steps to require some Bitcoin businesses to register and meet certain requirements because of concerns around money laundering and consumer protection.

The Securities and Exchange Commission is pursuing a case against an alleged Bitcoin Ponzi scheme and the Government Accountability Office has recommended that the IRS issue guidance for taxpayers on the reporting requirements for Bitcoins and other digital currencies.

( Also on POLITICO: Congress starts looking into Bitcoin)

Meanwhile, New York state financial regulators have subpoenaed Bitcoin businesses and raised the possibility of “new regulatory guidelines.”

The Senate Homeland Security Committee is quizzing these agencies about what they are doing to oversee these markets and to make sure there is a coordinated approach.

Bitcoin supporters are already worried about too many government tentacles in the market.

“Bitcoin today is poised to be that kind of success potentially but right now if you want to start a Bitcoin business before day one, before you can open your doors you have to get licensing from 48 different states,” Brito said. “I hope we can get policymakers to address their concerns while not being an impediment to its potential innovation.”

Who uses it?

Brito, who next week will publish a Bitcoin primer for policymakers, estimates there are hundreds of thousands of people using the cryptocurrency and that they fall into three main groups: tech early adopters, entrepreneurs, venture capitalists and speculators, and politically motivated types who like the fact it is not controlled by a government.

“Like the Internet of the 1980s, the ecosystem is both young and highly technical,”said Charles Hoskinson, Director of the Bitcoin Education Project. “The users currently are mostly from Western European and North American countries and under 40. Most have college degrees or some university education. And most are fairly comfortable with using computers and the Internet. Over time we expect to see enormous growth in countries with unstable economies and poor financial services sectors such as Zimbabwe.”

Tyler and Cameron Winklevoss of Facebook fame made headlines this year by proposing the Winklevoss Bitcoin Trust, which would sell shares to investors who would not own Bitcoins but who want to speculate in whether their value will go up or down.

“For merchants, they do not have to pay the steep fees credit card gateways charge nor do they experience chargebacks,” Hoskinson said. “For entrepreneurs, there are enormous opportunities in developing companies that make Bitcoin easier to use for both businesses and consumers.”

Who created it?

Bitcoin is only four years old, but its origins are somewhat mysterious.

Someone working under the pseudonym Satoshi Nakamoto is credited as the creator of Bitcoin, thanks to his 2008 whitepaper “Bitcoin: A Peer-to-Peer Electronic Cash System.”

Following Satoshi’s disapperance, Bitcoin has since become a kind of open-source project similar to the Linux operating system, meaning that it is maintained by a community of developers, including those that are a part of the Bitcoin Foundation.