Could Bitcoin be the global online currency?

With the rapid growth of eCommerce over the last decade, online payment has become a hugely influential area. This niche has made fortunes for credit card companies, and services like Paypal, providing the ability for real currency to be used online with relative ease. With the estimated total value of eCommerce approaching a trillion US$, there is another solution that may be even more useful.

Perhaps it is time for a global online currency?

Bitcoin is such a currency, created in 2009 by Satoshi Nakamoto. It is an anonymous, open source and peer to peer fiat currency. There is no central authority that issues new Bitcoins or tracks transactions, instead this is handled by the CPUs of the distributed nodes of the network. Every user has their own Bitcoin address, where they can transfer and be transferred Bitcoins. With no middleman, Bitcoin has negligible mandatory transaction charges. With no centralised authority, there is no possibility of value manipulation or unstable inflation.

But how does this work? Surely, if there is no authority behind a currency then what protects it? What stops people from creating their own Bitcoins, or double spending?

Bitcoin is a cryptocurrency, securing itself via automated encryption. It protects itself from fraud by using public/private key digital signatures (ECDSA). Almost by definition, the explanation of this can get a bit complicated, but I’ll give a very simplified overview. Every Bitcoin user has an address (your Bitcoin identity). A Bitcoin is defined by its history of addresses of the current and previous owners. Every transaction is announced and verified by the participating nodes of the network (other Bitcoin addresses).

A timestamped list of all these transactions is stored over the network (called a block chain), protected by the proof-of-work cryptographic hash that is created by trial and error computations from the participating nodes. For a full description of the technical side to this cryptocurrency, you can read Nakamoto’s original white-paper here. For an easier to understand description, check the Wikipedia page. The crux of the matter is that its highly complicated to con the system, although it is not yet proven to be impossible.

How it works

New Bitcoins are introduced slowly by users running nodes for the network as they create blocks for the system. Batches of 50 Bitcoins are distributed by the system every six hours effectively to any node creating blocks for the network. There is little chance of the coins generated to make up for the electricity usage of creation. It will take over a year for an average PC to be allocated a batch, making it more a token of appreciation for helping rather than a form of earning. This amount goes down as time increases, halving every 21 000 blocks created.

In total this means that the amount of Bitcoins in the system will approach, but never reach, 21-million Bitcoins. Currently there are only 5 748 900 Bitcoins in existence. Despite their finite nature, they are technically divisible up to eight decimal places. This means that when the Bitcoins cap out at 21-million, the currency will still be able to increase in value and remain functional. Also, at this point, it is aimed that the incentive for nodes creating blocks will shift from generating new Bitcoins to collecting transaction fees from large transactions (which will be distributed in the same manner as new coins the participating network).

This may sound complicated, but it doesn’t affect the basic user (the program does it all for you). All you need to do to use the system is go to Bitcoin.org, download and install the software. To pay for something, you simply click “Send Coins”, type in the address of the vendor and the amount and the transaction goes through almost instantly. Getting Bitcoins requires going to a Bitcoin exchange site and purchasing them. So despite the cryptic system, it’s very simple to use. Bitcoins are stored in local or online “wallets”. They should be backed up, as the loss of data will result in the loss of the Bitcoins.

It is a currency built in the spirit of a free and open global internet community. Its open source nature means that the code is free for anyone to inspect. It is decentralised, relatively anonymous, and, at least in part, crypto-anarchist in nature. Of course, it is not backed by anything other than the prices that merchants set. Most fiat currencies (e.g. the US$ and ZAR) are normally only backed by regulation in addition to merchant’s prices (rather than the gold standard, for example), however history has shown the fall of previous online currencies, with no remuneration for those caught in the slump. Beenz, Flooz and Internetcash.com are all examples of major online currencies that failed in the 2001 bubble burst. e-gold and Liberty Dollar were shut down by the US government.

Bitcoin could fail for numerous reasons, including the devaluation of the currency, lack of users or simply being shut down by a government. It is anonymous and anarchistic nature suggest it might be the last of the three. It is unclear how one would go about shutting down such a distributed system, though. Its nature is very different to the others.

So far, however, things have looked good for the fledgling project. Bitcoins are currently trading on Mt. Gox and Bitcoin Market (Bitcoin exchange sites) at 0.8 of a US$ (there was a South African site, www.bitcoin.co.za, but it appears to be down). And the list of online merchants that accept Bitcoins is growing. A word to the wise, however, Bitcoin transactions are non-reversible. It is one of the fundamental tenets of the system, which both protects and endangers its users. Although the Bitcoin addresses are relatively anonymous, a web of trust can be built over networks like this one. There is also talk of it integrating with the Ripple Project.

Bitcoin is still in its beta stage of development, although it already has a large community of early adopters. It has become a highly controversial subject in forums and other online discussions, with some claiming it will fail completely like its predecessors and others hoping for a monetary regime change. Although it is unclear whether such a thing could replace national currency, that is a far cry from it becoming a workable online solution or even a successful proof of concept.

If it does take off, those with Bitcoins now will see the value of their investment grow immensely. If it fails, they may see their entire stock of a currency become worthless. Either way, it’s an interesting development… perhaps more politically than practically. It is a sign of how much revolutionary potential still lies in the innovative use of the internet.