Late last year, after WikiLeaks began releasing its trove of State Department cables, many individuals sought to show solidarity with the group by making a donation. They found, however, that many payment processors would not remit money to WikiLeaks, some say as a result of U.S. government pressure. PayPal even froze the group’s account so it couldn’t access funds already collected.

“Hey, Visa, Mastercard, Paypal: It’s MY money,” media critic Jeff Jarvis tweeted at the time. “How DARE you tell me where I can and can’t spend it?”

Intermediaries as Choke Points

Whether or not payment processors ought to be telling us how to spend our money online, the fact is they can. We rely on third parties to transact online, and when government wants to restrict how we can spend money online, it’s these intermediaries they turn to.

Online gambling and sports betting is perfectly legal in countries like the UK, Ireland and Australia, and a resident of the U.S. will have no problem reaching the websites of gaming sites from those countries. Placing a bet is another matter, however, because the Unlawful Internet Gambling Enforcement Act of 2006 requires payments systems to block transactions to online gambling sites.

Similarly, Congress is considering a law like the proposed Combating Online Infringement and Counterfeits Act (COICA), which would not only allow the Department of Justice to seize the domains of sites suspected of selling counterfeit and pirated goods, but would also require payment processors to block transactions to sites placed on a black list.

To transact online, you have to have an account with a third party like PayPal that you trust will follow your payment instructions. There’s been no such thing as “online cash,” no currency that could be exchanged untraceably between two persons without a third party intermediary–no such thing, that is, until now.

True Digital Cash

Bitcoin, an open-source project created in 2009 by Satoshi Nakamoto, is the world’s first distributed and anonymous digital currency. That’s a mouthful, but it’s not difficult to understand.

Since the web has been around, digital currencies have come and gone. Think of Facebook Credits, a digital currency that allows you to buy virtual goods on Facebook applications, or Microsoft Points, the currency of the Xbox Live Marketplace and Zune store. You exchange dollars for them just like you might exchange dollars for euros, then use them to buy stuff from sellers who’ll take them, say a patisserie in France, or FarmVille in Facebook.

The web has also seen all-purpose digital currencies, from defunct dot-com bubble start-ups Flooz and Beenz, to the slightly more successful e-gold. Unlike cash, however, digital currencies to date have had a third party intermediary monitoring transactions. That’s because digital cash is different from physical cash in one very important way: If I hand you a 100 euro bill, I no longer have it. You can’t be as sure of that, however, when the cash is just 1’s and 0’s. So it’s been necessary to have a trusted intermediary deduct the amount from the payer’s account, and add it to the payee’s.

Bitcoin is the first online currency to solve the so-called “double spending” problem without resorting to a third-party intermediary. The key is distributing the database of transactions across a peer-to-peer network. This allows a record to be kept of all transfers, so the same cash can’t be spent twice–because it’s distributed (a lot like BitTorrent), there’s no central authority. This makes digital bitcoins like cash dollars or euros: Hand them over directly to a payee, and you don’t have them anymore, all without the help of a third party.