Bitcoin is an open source peer-to-peer (P2P) electronic cash system that's completelydecentralised, with no central server, trusted authorities or middle men. The availability of bitcoins can't be manipulated by governments or financial institutions. Bitcoin already has a number of exchanges for converting to and from other currencies; BitcoinFX, New Liberty Standard, Bitcoin Exchange and Bitcoin Market.
Bitcoin may last for years and become a popular global currency, or it could be just a flash in the pan, but either way I think this is an important sign of the times to come. This is one of the first truly decentralised currencies and has paved the way for hundreds more to compete together in the new arena of Cipherspace
over the coming years. This is one of the key factors in the transition of global society into the post-nation-state economy talked about in The Sovereign Individual
How it works
In a p2p computer network there are no servers, the entire network is composed of users running instances of the application on their computers. Each running instance offers a small amount of processing and storage resource to the network so that it can deliver the services it was designed for such as redundant storage, anonymity or voice-over-IP applications.
In the case of a p2p currency system, some of the services the network is designed to offer are privacy, verification, authentication, currency creation and transfer of ownership. To ensure a reliable and tamper-proof system requires a lot of resource, and that amount is proportional to the amount of coins in the network. The network is able to pay the users for the resource they offer by making the coin-creation process part of the network protocol itself instead of being handled by a central trusted authority. This creates a natural and incorruptible link between the supply of currency in the network and the demand for it.
Even aside from the ability to exchange bitcoins for other currencies, it still makes a very useful tool for independent organisations and groups because it allows them to trade and settle accounts amongst themselves independently and privately. It effectively gives them a "bank" that has a trustworthy system of accounts that can't be tampered with and requires no corruptible central authority to operate. See the Bitcoin Whitepaper for more detail about how it works.
To try Bitcoin, download the Bitcoin software, then once it's running, click 'Generate Coins' which will pay you bitcoins in exchange for your computer working to validate bitcoin transactions. Check the exchange rate to calculate how many bitcoins need to be sent. The payer can purchase additional bitcoins if needed. The payer's previously generated bitcoins allow for a lower out of pocket payment. The payer then sends the bitcoins to the receiver using the Bitcoin software. The receiver can then sell their bitcoins for dollars. The receiver's previously generated bitcoins allow a higher dollar payout.
Buying Bitcoins is more difficult than expected considering that there's so many people trying to buy them. The reason is because Bitcoins more closely resemble cash than they do credit. This is because the transactions are irreversible whereas credit cards, Paypal and many other electronic forms of credit can be reversed up to six months later. To make matters worse, PayPal and most credit card company's have reversed many Bitcoin transactions because they consider Bitcoin to be a fraudulent operation. So the bottom line is that buying Bitcoins needs to be done with a solid irreversible form of currency such as cash in person or posting a cheque.
The Bitcoin Wallet
Bitcoins are not simply an account balance stored somewhere like a Paypal or Amazon account balance, they're in the form of actual binary which you look after in a safe place on your own hard-drive, or delegate the responsibility to a third party like TradeHill or MtGox. It's therefore important to Ensure your wallet is secure in terms of being backed up in other physical locations, and in terms of privacy.
This is a problem because its actually very difficult for an average end-user to know how to keep information both physically distributed and safe from unwanted access. If people knew you had a lot of Bitcoins how confident are that it would be impervious to a dedicated hacker? We need to ensure that full control of our private information is in our own hands, but we also need to take advantage of distributed storage. Digital cash makes this issue all the more important, and it's only peer-to-peer network that really has the answer to these requirements.
Extending Bitcoin functionality
Bitcoin could become a multipurpose network by adding additional information to coin blocks, for example NameCoin extends the network to provide a distributed DNS alternative. Similar things could be done to provide distributed authentication and a distributed ontology for shared knowledge and organisation.
Bitcoin Set To Unleash Massive Tsunami Wave Of New Development With New Features
Bitcoin will be more than a currency if multi-transactional features are added to the core code. Right now the developers of theCryptocurrency are designing initial support for new types of transactions. What are multi-transactions? Multi-transactions allow the possibility of ‘contracts’. According the [Bitcoin Set To Unleash Massive Tsunami Wave Of New Development With New Features wiki], “A distributed contract is a method of using Bitcoin to form agreements with people via the block chain. Contracts don't make anything possible that was previously impossible, but rather they allow you to solve common problems in a way that minimizes trust.” This means services based on cryptographic trust are now possible that was previously only possible with paper, pen, and a line to sign. The new possible services that could be developed include escrow services, secured deposits, dispute mediation, assurance of goods, smart property, etc. These features would eliminate the need for paper contracts in many different industries. In addition to banking, currently existing sectors that could be affected include title companies, lending services, billing services, ownership of anything digital (cars, phones, computers), home loans, car loans, funding services, etc. The cost of creating these contracts in bitcoin will be practically zero. (more...)
The 21 Million Coin Limit
Many people are concerned about this "21 million coin limit" for example this blog post about Why Bitcoin Will Fail as a Currency is based on this belief. But it's not actually a problem because Bitcoins are divisible into eight decimal places (and future versions of the protocol could easily be designed to divide it further if there becomes demand for that) so even if there were only a few Bitcoins in existence, the entire Bitcoin economy could still operate properly.
Inflation and Transaction Fees
By convention, the first transaction in a block is a special transaction that starts a new coin owned by the creator of the block. This adds an incentive for nodes to support the network, and provides a way to initially distribute coins into circulation, since there is no central authority to issue them. The steady addition of a constant of amount of new coins is analogous to gold miners expending resources to add gold to circulation. In our case, it is CPU time and electricity that is expended.
The incentive (for nodes to support the network) can also be funded with transaction fees. If the output value of a transaction is less than its input value, the difference is a transaction fee that is added to the incentive value of the block containing the transaction. Once a predetermined number of coins have entered circulation, the incentive can transition entirely to transaction fees and be completely inflation free.
The following links suffer from dubious credibility, bearing hallmarks of poor writing and fuzzy understanding of cryptography, economics and monetary terminology and concepts. Nevertheless, they point out some useful and interesting information:
Further reading on bitcoin's value
- The clear divisions on Bitcoin, Blogdial, June 22, 2011
- Another Take on Bitcoins, Gary Kinghorn, June 22, 2011
- A Bit of Sound Money: Free Banking or 100% Reserve Banking, Theodore Phalan, June 21, 2011
- Bitcoin's Value is Decentralization, Paul Bohm, June 17, 2011
- The Economics Of Bitcoin – Why Mainstream Economists Lie About Deflation, Michael Suede, June 11, 2011
- Bitcoin and the Denationalisation of Money, C. Harwick, June 8, 2011
Economics & Liberty articles