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Bitcoin: from the beginning

How did the Bitcoin virtual money system get started? Dr Karl takes a bite out of history.

How did the Bitcoin virtual money system get started? Dr Karl takes a bite out of history.

Today, all modern societies use some kind of 'money' as a convenient way of exchanging goods and services.

Down through the ages, money has been through various physical incarnations — promises scratched into soft clay which was then fired, large wheels of limestone rock, metal coins, paper notes, credit cards and so on.

In each case, 'money' involved some kind of physical object. But now 'virtual money' is on the scene — and it's not physical.

And its first commercial use was to buy two pizzas — for the princely sum of 10,000 Bitcoins, which later turned out to be worth millions of dollars.

Back in 2008, many were getting disillusioned with 'conventional' finance, exemplified by the collapse of the investment bank, Lehman Brothers, the fourth largest investment bank in the USA, and the whole infamous global financial crisis. So for some people, the time was right for a virtual electronic currency that was independent of banks and governments, and in fact, did not need either banks or governments to be the 'trusted' clearing house.

The first workable digital money, Bitcoin, was created in 2008, by the still-anonymous programmer, Satoshi Nakamoto.

In a landmark paper, he described how to set up a decentralised and secure digital cash system. It uses peer-to-peer networking combined with encrypted signatures to both generate, and exchange, these Bitcoins.

A Bitcoin is not a physical thing — it is just an entry in an electronic ledger. Everybody can have a copy of this ledger. It's updated every 10 minutes, and contains every transaction of every Bitcoin.

Thanks to the brilliant mathematics behind it, this ledger has to be an honest record AND it can't be altered — but I'll talk more about that later.

The value of Bitcoins has been very volatile, ranging from US$0.03 to over US$1,200.

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Bitcoins for pizza

Laszlo Hanyecz, a Florida programmer, carried out the first real-world Bitcoin transaction. He had 'mined' 10,000 Bitcoins. (Later on, I'll talk about you can 'mine' Bitcoins out of thin air with your friendly local supercomputer).

Laszlo wanted to turn his 10,000 Bitcoins into a pizza. But the local pizza store did not accept Bitcoins. Of course it didn't — at that time, no commercial institution accepted Bitcoins. Back then, his Bitcoins were like Monopoly money.

So on 18 May, 2010, Laszlo posted a request on Bitcoin forum asking if anybody could use his 10,000 Bitcoins (then worth about US$41) to buy two large pizzas (then costing about US$25).

As Laszlo said, " … what I'm aiming for is getting food delivered in exchange for Bitcoins where I don't have to order or prepare it myself, kind of like ordering a 'breakfast platter' at a hotel or something, they just bring you something to eat and you're happy."

It was an experiment. As Laszlo said, "I just think it would be interesting if I could say that I paid for a pizza in Bitcoins."

After a few days, he was contacted by Jeremy Sturdivant, who was then 18 years old, and also living in the USA. After a bit of back-and-forth, the deal was finalised. Laszlo sent the 10,000 Bitcoins to Jeremy, who contacted a pizza store in Jackson, Florida, which delivered the two pizzas.

On May 22, 2010, Laszlo joyfully posted, "I just want to report that I successfully traded 10,000 Bitcoins for pizza."

By August 4 that year, the value of the Bitcoins had risen to US$600, and by 29 November had reached US$2,600. Laszlo said, "I don't feel bad about it. The pizza was really good." By November 2013, those 10,000 Bitcoins were worth US$12.4 million.

To commemorate that first commercial Bitcoin transaction, May 22 is now called Bitcoin Pizza Day.

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Volatile value

Even today, only some companies accept Bitcoin — but only in a half-hearted way. They will accept Bitcoin via a third party, but will then immediately convert it into their own trusted currency. The problem is that the value of Bitcoins is volatile - its price relative to other financial assets varies a lot. So, as an asset, a Bitcoin is risky to hold — without warning, its value might go up, or down.

Bitcoin is twice as volatile as gold, and three-to-four times as volatile as the major currencies.

But the brilliant thing about Bitcoin is what underlies it — the block chain, the unchangeable register of every Bitcoin transaction that has ever been carried out, and that anybody can have a copy of. So I'll talk more about that, next time.

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