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Return to The Money Mentor Blog
By Paul Brucker
Updated March 7, 2014, to reflect recent news involving bitcoins.
Today, about 1,000 brick and mortar retailers and 35,000 online businesses, including Overstock.com and WordPress, accept the digital currency called bitcoins.
Bitcoins are free from regulation (for better or worse) by governments and government-backed banks. Their value is not endorsed by the full faith and credit of a national government, regular currency or a central organization. Rather, the worth of this digital money is kept secure in cyberspace by a stringent, if complex, series of mathematical controls and encryptions by its users.
Skeptics see bitcoins as a Ponzi scheme and the most dangerous enterprise since the Internet. Enthusiasts see them as a cyber gold rush – an impeccable investment and a thrilling antidote to the flawed government oversight that precipitated the Great Recession of 2009.
Currently, bitcoins are released into the bitcoin network at a predetermined rate of 300 every hour, and the pace is programmed to halve in increments until the year 2130, when the currency will reach its preset upper limit of 21 million coins. Each bitcoin entering circulation is verified and registered with a timestamp that prevents double spending. And new bitcoin transactions are broadcast and analyzed across the system’s massive peer-to-peer computer network.
Today, there are about 12 million bitcoins in circulation, with as many as a million people possessing at least one bitcoin and 927 people owning over half of all bitcoins, according to businessinsider.com. As of February 26, 2014, the value of a single bitcoin was $464.80, per the bitcoinexchangerate.com. (The bitcoin value fluctuates. For example, a bitcoin was worth 14 cents in April 2010, $55 in March 2013 after the financial crisis in Cypress, and $794.75 on January 29, 2014.)
How many people use bitcoins on a regular basis to pay for goods and services? In June 2011, Economist magazine estimated 10,000 users. But go to the online Bitcoin Forum for users and you’ll find a far different story, with estimates ranging in the millions.
Does anybody control bitcoins? No, but its software community is primarily coordinated by the Bitcoin Foundation, a group of administrators funded by grants. Its mission is to standardize, protect and promote the use of bitcoins for the benefit of users worldwide.
Bitcoins are not the only digital currency out there, but they are the most prevalent. Others include Ripple, Litecoin and e-gold. The Bitcoin system was created in 2009 by a mysterious “person” named Satoshi Nakamoto. “Nakamoto” disappeared from the Web in spring 2012. Perhaps it remains a mystery whether this person is a he, she or it (some surmise the founder is really an elite team of savvy computer geeks who work for various major tech companies). On March 6, 2014, Newsweek magazine tracked down a 64-year-old Japanese-American actually named Satoshi Nakamota and reported that he is the mysterious inventor of bitcoins. He lives in the foothills of Los Angeles and had a career history of performing classified work for big corporations and the U.S. military. Newsweek quoted the man as saying about bitcoins: “I am no longer involved in it and I cannot discuss it. It’s been turned over to other people. They are in charge of it now. I no longer have any connection.” Nakamota has since denied that he is the bitcoin founder.
Bitcoin users only need an email address to transact business. This anonymity has allure for some investors and others. Indeed, such anonymity allegedly provides criminals with ample opportunities to launder money, arrange contract killings and sell drugs and weapons.
A case in point: In October 2013, the U.S. government seized the bitcoin-based Silk Road website and accused its owner of using it to peddle narcotics and launder money. No one has approached the Fed to reclaim their bitcoins from Silk Road, so the United States now owns $28 million worth of the currency. Then, on January 27, 2014, the bitcoin system got another black eye. The U.S. government arrested Bitcoin Foundation Vice Chairman Charlie Shrem for facilitating illicit Silk Road exchanges. The government’s indictment focuses on Shrem specifically and not the Foundation or the bitcoin community as a whole. After his arrest, Shrem resigned from the Foundation, which commented that it “does not condone illegal activities and values transparency, accountability and a high level of responsibility towards its members and overall community.”
Bitcoin investors, such as Jeremy Liew, point out that the vast majority of bitcoin transactions are perfectly legal and only 0.5% of all bitcoin transactions took place on Silk Road. Meanwhile, New York is considering a framework to regulate digital currency businesses that operate within its state. But so far, worldwide, bitcoins remain free from government regulation.
Then, the reputation of bitcoins suffered another big bruise when Mt. Gox, once the world’s largest bitcoin exchange, suspended trading and went offline (at least temporarily) on February 25, following allegations of lax security that enabled hackers to heist 744,000 bitcoins. On February 28, Mt. Gox filed for bankruptcy protection. (That same day, Autumn Ratke, the CEO of First Metra, another bitcoin exchange, was found dead in her Singapore apartment, apparently from suicide.)
Does this signal the demise of bitcoins? No, according to other bitcoin exchanges and users who consider the these developments as isolated instances that do not not tarnish the value and legitimacy of this virtual currency.
Today, getting a bitcoin is a bit of a chore. To “mine” newly released bitcoins, you’ll need to have a computer with immense CPU power and compete with techies to solve irreversible cryptographic puzzles. It’s far simpler to obtain the coins by buying them or transacting business with others who already have some. And although bitcoins are digital, you can purchase hard copies from vendors who store the coin’s value with a private key on paper, metal, wood or plastic.
The use of bitcoins continues to grow, but will it ever reach mainstream? Maybe. On the one hand, the owner of the Sacramento Kings NBA team, Vivek Ranadivé, thinks so. Bitcoins have already made the transition from being “a curiosity to becoming a legitimate form of doing commerce,” he says. Indeed, Ranadivé plans to enable his team’s fans to buy tickets, merchandise and refreshments with bitcoins by this spring. Previously, on “Bitcoin Black Friday” in 2013, bitcoin users could take advantage of exclusive online deals from over 400 retailers. These retailers included high-profile companies, such as Nike and Old Navy, and more obscure vendors, such as a Vancouver guitar instructor who sold a series of four individual 30-minute lessons.
On the other hand, banks do not accept bitcoins. And even Fight for the Future, an Internet activist group that helped promote Bitcoin Black Friday, proclaimed that “Bitcoins will only be safe once millions of people rely on them every day.”