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What are Bitcoins?

The concept of digital money is not new. But one of the most recent incarnations, Bitcoin, is gaining widespread appeal.

Launched in 2009, it is a type of crypto-currency which exists as computer code and is not tied to any physical currency or commodity.

The system has no central bank or issuer and no disputes service, and once a transaction is completed it cannot be undone.

Users of Bitcoins can remain anonymous, making the currency popular for trade in illicit drugs, weapons and other illegal activity.

There is also no public face to the currency, which is run and administered entirely by the online community.

In New Zealand, a Customs officer charged with drug offences was caught earlier this year using a hidden website called Silk Road, which allows users to buy illegal drugs using Bitcoins.

But it is also touted as an alternative to the government- and corporate-controlled world of banking for people who just want to buy everyday things.

One of the currency's early adopters used his Bitcoins to buy pizza.

Nearly five million transactions using the currency have taken place so far this year, more than double the number processed in 2011.

But the system has been the victim of hackers who have stolen hundreds of thousands of dollars worth of Bitcoins over the past year.

The Bitcoin Foundation was recently established to rebuild their reputation and distance the system from the dodgy, underworld-type business it is associated with.

But can it survive? Is it secure enough? And does it have the potential for mainstream appeal?

What are Bitcoins?
The term Bitcoin is a bit of a misnomer because it is not a coin it all as it has no physical properties.

It is a string of computer code which represents a specific amount of the currency.

Bitcoins are generated by computers belonging to a network of its users' computers.

An algorithm releases 50 new Bitcoins into the network every 10 minutes, with the pace halving in increments until about 2140, when the number of Bitcoins will reach the pre-determined limit of 21 million.

Computers which generate Bitcoins are called "miners".

They "mine" Bitcoins by cracking increasingly difficult puzzles, which require enormous computer power.

This limits the number of people, and computers, which can issue Bitcoins and prevents the market being flooded with them – this would apparently cause hyperinflation.

Bitcoins can be bought through online exchanges such as Mt. Gox, whose listed exchange rate as this story was published was $US11.90 per Bitcoin.

Bitcoins can be stored in digital "wallets" on users' computers, on portable media such as flash drives or on cloud storage systems.

Buying something using Bitcoins is as simple as sending an email.

The price a user pays for Bitcoins depends on the market value of them on any given day, much like any other currency market.

What are Bitcoins used for?

Just like physical money, Bitcoins are used for a range of legitimate and illicit purposes.

WikiLeaks, for example, used Bitcoins as a way to receive donations after major credit companies such as Visa and MasterCard refused to process its transactions in December 2010.

The major advantage of using them is anonymity.

Users of the hidden website Silk Road use Bitcoins to buy all kinds of illegal and legal drugs. The goods are then posted internationally with fake return addresses.

When the New Zealand customs officer was caught using the site this year he denied it was to buy drugs.

A Dunedin university student was also caught using it to get 165 Ecstasy pills mailed from the Netherlands.

Mainstream use

The key to growth is to get mainstream merchants on board, and according to Scientific American this seems to be happening.

Tony Gallippi's company Bitpay provides mobile checkout services to companies which accept Bitcoins.

He says they had 100 merchants in November 2011, which has grown to about 1100 now.

Stores selling anything from clothing, musical instruments, and alpacas accept the currency.

Last year, Manhattan eatery Meze Grill famously accepted bitcoins as payment for food.

It is becoming easier for people to buy them through exchanges such as Mt. Gox, and retailers like it because it makes fraud all but impossible.

A Bitcoin transaction can never be reversed because of the complicated way the network's ledger is edited, so a retailer never has to be concerned about charging a stolen credit card, for example.

Fluctuating value

Eighteen months ago Bitcoins were relatively unknown. Media coverage by companies such as Forbes helped raise awareness, which in turn raised their value.

From April to May 2011, the going rate rose from US86 cents to $US8.89, but then skyrocketed to about $US27 by June after technology website Gawker published a story about it.

A Tennessee man, known as KnightMB, who held 371,000 Bitcoins, suddenly was worth more than $US10 million, becoming the richest man in the Bitcoin community.

Florida programmer Laszlo Hanyecz used 10,000 Bitcoins to buy two pizzas back when they were worth just a few cents.

If he'd held on to them, they would have been worth $US272,329 after the June 2011 boom.

But he was philosophical about it, according to Wired. "I don't feel bad about it," he said. "The pizza was really good."

Cleaning up the image

The Bitcoin network, while gaining in popularity, has become tarnished after several large thefts by hackers.

In the past few months, Bitcoin exchange Bitcoinica lost $US400,000 worth of the currency.

Another exchange, Bitfloor, had to close after having $US250,000 worth of bitcoins stolen.

That is why the group of Bitcoin loyalists set up The Bitcoin Foundation.

It is modelled on the Linux Foundation, a non-profit group designed to promote the popular open-source operating system.

Whether the Bitcoin's underworld image can be revived, however, remains to be seen.

To many, it is seen as a scam – a Ponzi scheme. Others view it as a way to buy illegal goods without being caught.

To most, however, it is likely to remain a mysterious and complicated initiative, inaccessible to people with limited knowledge of the internet and computer coding.

Bitcoins, argue some, were introduced because of problems associated with traditional currency, such as fraud and traceability.

But those problems are unlikely to be so insurmountable as to bring Bitcoins into the mainstream.

For most people, a dollar works just fine. 

callison@nbr.co.nz

More by Caleb Allison

Comments and questions
24

> For most people, a dollar works just fine.

Bitcoins have gained in buying power exponentially. The dollar is losing value by the week.

I converted many of my dollars to bitcoins, waited for the price to rise, traded my now valuable bitcoins for relatively cheap silver:

http://coinabul.com

When goldbugs are trading their metal for a currency, the currency is here to stay.

I now have more silver, bitcoins and slowly eroding dollars than I had when I started with just dollars.

I'm doing better than anyone dealing in just dollars alone. The dollar's days are numbered as the currency of choice.

"They "mine" Bitcoins by cracking increasingly difficult puzzles, which require enormous computer power."

The purpose of "mining" is more than just metering bitcoins. The purpuse of mining is to hash sign the next block in the block chain, making transactions irreversible and preventing double spending by making forgery impossible. The winning miner is rewarded for this by collecting the transaction fees (tips) and (currently) a new issuance of 50 bitcoins.

I think that something that wasn't really emphasized by this article that is very important, is that no one, and I mean no one (not even the original creator) can debase Bitcoin by making more of them..
The US continually prints more money to help pay the bills. It's an invisible tax that just shows up as inflation. This is money being taken right out of the pocket of people holding US dollars, and many of them are not even aware of it. People freak out about how much tax they have to pay, but pay no attention to the 50% tax they were given (in addition to their actual tax bill) by the fed doubling the supply of money. The fed has just recently announced a QE (quantitative easing = "printing" more money) initiative that will introduce 40 billion dollars of funny money to the US economy *EACH MONTH* in order to try to stimulate the economy.
I know that there is less concern about the US dollar in NZ, but as the world's reserve currency, it affects everyone. In some regards I'm relieved to think that at least the invisible tax is coming out of more than just the US economy, or I fear our economy would have completely collapsed already.
This situation is will never occur in Bitcoin. There will never be even as many as 21 million bitcoins. Production will stop just short of that (I think in the year 2140 if I recall correctly), and considering that some bitcoins will be lost forever through backup failures, forgotten passwords and lost keys there will really be some number considerably less than that. I myself lost 280 of them due to a raid array failure about a year and a half ago.
Bitcoin is about trusted money from a trusted source, and about making sure that everyone has to play by the same financial rules. The creator's message in the genesis block made it clear that the current financial system abuses were a major motivation for creating this system.

BitCoin is a ingenius Currency that has the ability to change the world and it will do exactly that. BTC is more of a "sound" Currency then the US or Canadian Dollars , because its just like gold . I personally am selling gold to buy bitcoins . Its a freedom currency with oppertunities to make alot of Fiat USD . On Ajex Jones today Lindsy Williams breaks down how the Globalists Are making Huge deals and trade deals an are not including the usd in those equations . Trillions of USDs will become worthless and Bitcoins will reflect in the market . Everythings for sale here , im turning every dollar into a BTC .

Id rather have a pile of BtC then a pile of worthless paper .

God Bless You All ,

Ps. LONG LIVE BITCOIN!!!

Bitcoin works great in countries that have implemented currency controls, take for example Argentina where even Paypal has been forced to block certain transactions.

In a world where the United States FATCA law will force banks and governments around the world to implement reporting schemes many people will just opt-out of the traditional banking system.

Bitcoin can not be shutdown, but it can be outlawed and then only criminals will have financial freedom.

it appears hard encryption beats monetary history and government restrictions.

Bitcoin seems like it might be a great investment for kiwis since we do not have capital gains tax. It might even become preferable to invest in bitcoin before property when Labour brings in the investment property taxes.

NZ could even become a center for this kind of business activity if it plays its cards right. We have the IT know-how and relatively free enterprise business model. NZ already has a bitcoin exchange market

https://bitnz.com/

I kind of resent the "murky world" slur in the title. The public ledger of all transactions actually makes it more transparent than current monetary systems while affording privacy to those who choose it. This IS the knowledge wave NZ wants to catch, the others were head fakes.

If you're not excited by Bitcoin and don't think it's one of the most important (and disruptive) revolutionary new technologies since the invention of the Internet, you don't understand it. If you think it's "fake Internet money" because it's not "backed by anything," you REALLY don't understand it. If your initial inclination is to dismiss it as a "scam" or a "fad," that's understandable, but if you follow through on that impulse without at least a little due diligence, you could be making a very big (and very costly) mistake.

The vast majority of currency transactions today are made by appending the transaction details to electronic journals kept by a trusted authority such as a bank. Bitcoin differs only in that the trusted authority is the bitcoin network, and the electronic journal is duplicated at every node of the network.

The so-called mining nodes are actually the voting members of the network. They all compete to create the next block of the shared journal, which contains the details of the newest transactions.

one of which awards (currently) 50 bitcoins to the winner. Each nodeOften, the race is won decisively and the winning block is seen by all nodes before any other node finds a an alternate winning block. Then all nodes stop working

My dog pressed the submit button too soon...

The vast majority of currency transactions today are made by appending the transaction details to electronic journals kept by a trusted authority such as a bank. Bitcoin differs only in that the trusted authority is the bitcoin network, and the electronic journal (called the "block chain") is duplicated at every node of the network.

The so-called mining nodes are actually the voting members of the network. They all race to create the next block-chain block, which contains the results of the election for the previous block, and details of the newest transactions. The first item in the new block is a hash which uniquely identifies the previous block. Other items are transactions which specify one or more source accounts, one or more destination accounts, the amount of the transaction fee, and a transaction which specifies creation of (currently) 50 bitcoins. The last item of a block is an arbitrary number called the nonce. The "difficult mathematical puzzle" is to pick a value for the nonce so that the hash of the whole block is a small number. A block is a potential winner if its hash is less than the target. All nodes agree on a new target every few weeks so that a winning block will be found about every ten minutes.

Each voting node (miner) prepares its own version of the next block, awarding all of the fees to whatever account it chooses, and arbitrarily including or rejecting transactions it knows of. It cannot modify submitted transactions to increase the transaction fees, but it can reject transactions for any reason including the size of the fee. No sane node will include an invalid transaction, such as one that overdraws an account, because such a block can never win the race. Having chosen a previous block and a set of transactions, the node races to find a winning nonce. Should it find one, it broadcasts its winner to all nodes. Anytime a potential winning block is received, the node checks it. If this block is valid, the node starts over, voting for the newly received block and choosing a new set of transactions after removing any transactions which were posted in the newly received block.

The non-voting nodes belong to merchants and customers. They receive all of the broadcasts of potential winning blocks, and maintain their own copy of the block chain. A customer will submit a transaction to the network specifying one or more accounts to draw on and one or more to pay, and cryptographic proof of ownership of the drawn upon accounts. The merchant will wait until this transaction has been included in the blockchain and until the block containing his payment has been listed as previous block by a confirming block, and that confirming block has itself been confirmed, etc,, until the merchant is satisfied that the transaction will stay on the block chain. This takes about ten minutes per confirmation. Then the merchant will release the goods to the.customer.

In person low value transactions may be accepted as soon as the merchant receives a copy of the transaction from the network, since this transaction will be accepted unless the customer has very recently spent the balance of the account he draws on. This would almost never happen by accident. High value transactions either take an hour or more to complete or must be guaranteed by some enforceable contract.

The author grants license to everyone to use this text anyway they please without restriction.

The basic rules of bitcoin can be changed by a majority of the voting nodes simply by modifying the software to change the definition of a valid transaction. For example, if well over half of the nodes agree that the bitcoins stolen from bitfloor cannot be spent, then transactions spending them accepted by minority nodes will not stay on the blockchain, and the node which accepted the transaction will lose the transaction fees and the 50 bitcoin bonus. So the minority nodes will quickly join the majority.

Or if all of the governments and all of the banks decide to join forces and spend whatever it takes, they can become the majority and change the rules.

Those who dont like the rules imposed by the majority of mining nodes can fork their own bitcoin block chain and keep going under the rules they like. The market will decide which 'coin' becomes dominant. Also there is no such thing as a stolen bitcoin. Only bitcoin that was donated by accident. There is no jurisdiction able to determine that bitcoins have been stolen and any assertions of stolen bitcoins are just heresay. Assume all "stolen bitcoins" are an inside job and you dont have to worry about silly unworkable ideas like trying to prevent people from spending bitcoins that some non-agreeing subset of bitcoin users might happen to think could be stolen.

If the MAJORITY of node operators agree that the bitcoins were stolen then they were stolen. End of story. The majority can give them to whomever they agree should get them. The minority who think they are not stolen will have to do the fork.

Those who think the current operators will remain in the majority underestimate the power and reach and wealth of the international trade organizations. Bitcoin will have 1% to 3% per year inflation (value halves in 23 to 69 years) and a transaction tax divided among soverign states, and the existing exchanges will go along or lose most of their business. Income and sales and property taxes could be eliminated in favor of percapita distribution of the transaction tax to local government.

Operators who like it as it is now can create an underground blockchain and try to keep their forkcoins useful enough to hold their value. Forkcoins might be initially created by paying bitcoins to an unredeemable address and then presenting before the deadline a forkcoin address that hashes to the bitcoin address. After that, a distributed bitcoin / forkcoin exchange would allow people with access to the forked network to buy forkcoins, spend then on blackmarket goods and service, or sell blackmarket items for forkcoins, and convert forkcoins to bitcoins in order to transact legal businesses. The transaction tax is evaded when blackmarket items are traded for forkcoins.

The value of forkcoins would derive from the continued loyalty of blackmarket merchants who accept only forkcoins and neither double-fork coins nor bitcoins. The limited supply (none created after the initial destruction of bitcoins coupled to creation of forkcoins) only matters if blackmarket operators continue to find it in their interest to remain loyal.

Everyone keeps talking about the "Murky" side of Bitcoin. Did you know that 99.999% of criminal activities use fiat currencies?

Thanks for the informative comments. Very interesting. As soon as it becomes a threat to political and economic powers they will look for excise and means to shut it down though.

Its not at all clear they will want to shut it down. That would entail destroying a number of legitimate businesses and abandoning a useful tool. They will just find a way to tax it, and will drive its competitors underground. And taxing it is easy as soon as they control a supermajority of processing power, which simply means throwing enough money at the problem.

Excise should have been excuse.

A toy for geeks. Its laughable to here users say its foolproof, which is exactly what experts say about the derivatives market until its uncovered that the trillion dollar market has been corrupted by banks fiddling LIBOR.

It would be safer investing and purchasing in third world currencies which carry less volatility you geeky nitwits.

This is not supposed to be a safe investment. It is a payment system and a way of sending amounts around $100,000 overseas and converting to another major currency at the same time. It also works for regular transfers of small amounts once everything is set up.

Buy and hold now is obviously a high risk speculation and not at all foolproof.

im a kiwi, put $40k into bitcoin when it was at $4.40, now my stake has a market value of ~$100k. i am holding long term. I don't need the money, and I think there are bright things in the future for bitcoin.

Bitcoins are not an investment. They are a way to speculate in currency, but without any protection from formal market regulation.
A bit like investing in phone cards (remember them?)

Basically all the people that have mentioned bitcoin as a long term investment want other people to invest so the value of their investment goes up.

This is an interesting concept, sure, but I not that some of the statements above (especially in the comments) are arguable. Indeed it is trite to refer to the issuance of new money by central banks as a "tax" on existing currency holders, but such new money issuance is not done lightly and has as its ultimate purpose the stability of the monetary system. That is where there are some significant questionmarks over bitcoins (or any other similar type of settlement system). The cap on the number of bitcoins creates a certain artificiality regarding their value, the more so if more people hold them based on assumptions of capital gain and don't actually use them. This creates an environment where trading values would be expected to be highly volatile (unless there is some form of manipulation that is not obvious). For a "currency" system like bitcoins I would have thought that value stability would be critical for sellers of goods and services to adopt, just as the ability to then use them.
The other question that should be asked is how to manage compliance with the AML-CFT Act since if bitcoins are being used by fraudsters or people seeking illicit goods it must seem obvious that there will be a huge attraction to use bitcoins for these types of activities (sorry, that's anti money laundering and counter financing of terrorism for those unfamiliar with the legislation). This Act (and its overseas equivalents) set up protocols for reporting and tracking suspicious transactions. Unless such mechanisms are possible with bitcoins, it is worth checking if larger bitcoin transactions may even be legal once the Act is fully in force next year.