Introduction: What is Bitcoin?

Bitcoin is the world’s first digitally traded open source currency. The use of Bitcoins have grown slowly and steadily since the program was first released in early 2009. The creator of Bitcoin uses the pseudonym Satoshi Nakamoto to avoid publicity and has allowed international project leaders to control the expansion and public image of the project. The official operational staff is small and the entire Bitcoin enterprise is currently valued at approximately $3 million dollars.

The concept of Bitcoins (BTC’s) is simple. Bitcoins are merely digital units of currency. Conceptually, they operate exactly the same as any physical form of money. Users can trade Bitcoins over the Internet for goods and services; some sites even exchange Bitcoins for their equivalent in various currencies (and vice versa). Bitcoins are owned completely by users and are stored on personal devices; this eliminates the need for banks or intermediary credit institutions. BTC’s are kept in “wallets” on the owner’s computer or personal electronic advice. These wallets keep track of transactions and facilitate the management and housing of Bitcoin assets. Newcomers to the Bitcoin program are given a small percentage of a Bitcoin as a welcome gift.

BTC’s operate on a micro-scale of distribution. Owners can trade BTC’s as whole parts (1.0 BTC) or as percentages of a whole (0.001 BTC). Bitcoin programming currently allows users to trade BTC’s that have been divided to the 8th decimal place. Users have labeled even the most miniscule BTC divisions to make references easier when discussing prices on a micro-scale (centibitcoin, millibitcoin, microbitcoin, and the smallest denomination – “satoshi”). The minute subdivision of BTC’s prevents aggressive deflation given the relatively small amount of BTC’s currently in existence.

There are several methods of acquiring more Bitcoins. Just like physical currencies, Bitcoins can be traded for legitimate products and services – there is a restaurant in New York City that accepts Bitcoins as payment. Bitcoins can also be “mined” by tech-savvy users with the computing power to handle complex functions. Mining is highly technical and requires an extensive knowledge of computers and the Bitcoin generation process. Similar to entering other currency markets, new users can easily trade physical monies (dollars, euros, yen) for their equivalent worth in Bitcoins; this is perhaps the easiest entry method for potential Bitcoin users.

No central issuing authority regulates the generation and dispersal of new Bitcoins. Bitcoins are created through users “mining” on a peer-to-peer network. Specific mining entities (nodes) solve mathematical problems on the network and are awarded with the creation BTC’s. The solving of a mathematical problem creates what is called a “block,” which functions practically as a proof of work for the mining node. Completing a block automatically creates a new one and this explains how the periodic generation of BTC’s is self-regulatory. The amount awarded to each node for solving a new block is adjusted based on the strength of the network. Additionally, the difficulty of solving blocks is automatically adjusted based on the frequency of their completion. Blocks will proportionately increase in difficulty to the strength of mining attempts. Block turnover frequency is estimated at about once every ten minutes.

Interestingly, the Bitcoin program is set to continually diminish the number of mined BTC’s at fifty-percent over every four-year period. So, in the first four years of existence, approximately 10, 500,000 BTC’s will be created. Over the subsequent four-year period only 5,250,000 BTC’s will be created. This process is repeated over four-year intervals until the total number of created BTC’s is capped at 20,000,000. It is important to note that the relative coin value for each block solved decreases at a rate exactly parallel to the number of BTC’s created over every four-year period. Essentially, the total value of each block solved will decrease by fifty-percent in conjunction with the number of BTC’s that can be created.

Bitcoin’s Purpose

Current project leaders like Gavin Andresen maintain that Bitcoin is intended to democratize currency and protect the consumer. Government meddling and predatory credit institutions have no power over the worth or distribution of BTC’s. Consumers maintain complete control over the purchasing power of BTC’s. BTC’s do not rely on the dollar for trade purposes and operate completely independently. Supposedly, this freedom of trade will emancipate BTC participants from unnecessary arbitrary financial constraints. Furthermore, consumers are the sole and complete owners of their BTC assets.

Removing the influence of banks and federal monetary institutions allows users to decide the trade value of BTC’s outside of any intermediary control. Without carefully controlled federal limits, BTC users control the flow of the digital currency and the total value of its purchasing power. The worth of BTC’s is entirely democratic and decided directly among users. BTC’s do not derive value from a physical substance like gold or silver. For many years, the value of the USD was tied directly to gold. Now, the USD is backed by the good faith and credit of the US government. Users trust the credit of the US government and this allows the USD to maintain its worth. BTC’s rely entirely on the good faith of its users in each other. BTC’s only maintain their value as long as users trust that other people will honor the democratically decided worth of one BTC.

The Good, The Bad, and The Bitcoin

BTC’s offer several advantages to the consumer. The controlled release and capped supply of BTC’s prevents a sudden and dramatic flooding of the market with devalued currency. The generation and dispersal of the currency is controlled by algorithmic gates that hedge against inflation. Accordingly, consumers can steadily predict the rate of output and total number of produced BTC’s in preparation for market adjustments. Dependability and stable value render BTC’s an advantageous solution over fickle currencies. Assuredly, algorithm protected networks cannot predict human emotions like fear, greed and anger. But, simple benefits like relative value predictability will affect and quell the more volatile influences on currency.

Digitalized currency is easy to trade and provides ample security measures to assure legitimacy. Unwieldy greenbacks and clunky change are slowly retiring under pressure from plastic. Credit cards and online banking are increasingly popular methods of payment because they are simple, economical, and environmentally friendly. BTC’s, which never materialize in the physical world, are perfect for users who are comfortable with online transactions and cyber currency storage. Additionally, each BTC is given a unique identifying address to ensure its authenticity. Personal wallets will check any received BTC’s for their addresses and this protects against counterfeiting. Although each BTC has an identifier, this does not eliminate the anonymity of BTC’s. A BTC’s authenticity can be checked, but is destination and origin can be hidden – just like cash.

Most of BTC’s major advantages stem from their avoidance of third-party transaction interference. BTC’s are not taxed. Furthermore, the foundational structure of the BTC network denies viable taxation methods. The peer-to-peer system setup by Satoshi makes it virtually impossible to tax holdings or transaction using BTC’s. Similarly, transactions cannot be charged. There is no cost for sharing BTC’s, nor could anyone intercept transactions and charge for their completion. This prevents unnecessary costs and protects the financial information of each party involved in the transaction. BTC’s are not subject to seizure by any outside intruder. All BTC assets are owned completely by each individual user and personalized security features disallow seizure of assets by any bank or government. These features are especially attractive users who have turned to BTC’s out of distrust of government regulated monetary systems or necessity due to criminal activity.

Unfortunately, most of Bitcoin’s pros are also cons. First, BTC’s are non-intuitive for many Internet users. The concept of non-physical money being transferred over the Internet and stored on computers is difficult for some users to grasp. Many are deflected from BTC’s on the simple premise that they are not backed by any larger body or physical material. There is no guarantee that money invested in BTC’s will not quickly lose value. BTC value depends on the democratic network of users; perhaps ironically, this turns many away from the cyber cash.

BTC’s instantly alienate a majority of Internet users who distrust the web or do not understand its basic structure and functions. Using BTC’s is a practice reserved for tech-savvy individuals who have the knowledge, time, and means to participate in this digital advent. This explains current approximations that only about 10,000 people currently use Bitcoin – a miniscule number of total Internet users. Some BTC users also have trouble understanding the conversion process between physical currencies and BTC’s. Various hitches and nuances tend to frustrate less fluent Internet users.

The anonymity and easy instant transferal of BTC’s have garnered a fair amount of criminal applications. Internet black markets accept BTC’s as payment for all types of illicit products and services. Cyber criminals have colluded on a number of illegal markets and BTC’s hold significant value in exchange for drugs, weapons, and services. BTC’s only hold value because users trust that other illegal vendors will also accept them as payment. Zero regulation allows BTC’s to flow back and forth between various accounts with virtually no outside knowledge.

A lack of regulatory bodies over BTC distribution means that one single individual or a small group of individuals could amass a majority of available BTC’s. This power could be leveraged to manipulate BTC markets however the owner(s) desires. Serious BTC users doubt that this will happen, but it is a possibility. Similarly, eliminating credit institutions prevents users from taking a line of credit on BTC’s. All such transactions (the use of collateral or equity for credit) would take place between individual BTC users. Again, these unmonitored agreements open the door to any number of financial crimes. Without any oversight, BTC “creditors” could quickly become nothing more than mafia-type debt collectors with the potential to inflict permanent financial or physical harm.

Another worry is that BTC’s could become severely deflated. It is possible for Bitcoins to be lost or destroyed. As BTC’s disappear the value of those remaining will rise to unsustainable levels. Since no more BTC’s can be created beyond the predetermined 21,000,000, it is impossible for an increase in currency production to counteract excessive deflation. However, the BTC website offers a simple solution were this to occur. By dividing a single BTC beyond eight decimal places, users would self adjust to the deflation through further subdivision of individual units, an answer true to the founding principle of the currency.

Analysis

The Bitcoin endeavor is intriguing but, ultimately, unpractical. It is reasonable to expect that BTC usage will increase a moderate amount, especially among experienced Internet users. It is not, however, reasonable to assume that large amounts of people will suddenly or even slowly change from a tangible currency to a digital one. The Internet is already too nebulous a notion for many among older generations. Adding a micro-sized currency with no physical verification of value to the Internet does not equate to a viable financial system for a good portion of the population.

Even experienced computer users have found difficulty in grasping the idea of BTC’s and how they are used. The theoretical economic implications of an un-backed currency frighten potential investors. There are simply too many unknowns about what will happen to the currency.

Conceptual barriers aside, it is unlikely that the government will continue to allow BTC’s to operate on networks that facilitate the trade of illicit materials. Cyber is the emerging realm; it is largely untested and growing quickly. The government has already taken an interest in Bitcoins and this interest is expected to increase in the coming months. Criminal applications of protected BTC networks fall directly under national security concerns and will justify action from the government. Analysts expect that the government will either force some form of regulation on BTC or attempt to shut it down.

Conclusion

BTC will continue as a unique Internet phenomenon but its longevity is uncertain. For now, traditional monies still have the trust and familiarity that BTC would have to earn in order to supplant them. Assuredly, BTC’s have introduced a popular concept and done a good job in addressing evolving currency solutions. Nonetheless, it is doubtful that BTC’s will prompt any quick or permanent changes in mass currency usage.