For many people, apart from those with a high Internet affinity, the Bitcoin concept is probably still a fairly abstract notion. Satoshi Nakamoto invented Bitcoin as virtual money and a means of payment in 2009. The concept is based on cryptographical techniques and thus belongs to the category of cryptocurrencies.
As a consequence, the currently common intermediate steps of money transfers—via financial institutions and authorities—are skirted. With regard to the degree of anonymity of financial transactions, Bitcoin is thus on a level with exchanging cash nowadays, because the cash flows are difficult to trace.
History of Origins
One of the core concepts of Bitcoin has been shaped by the skepticism of its inventor Satoshi Nakamoto towards conventional currencies, central banks and today’s banking system. His concept aims at excluding every possible scope of influence from third parties on the money system. This contradicts today’s fiat money, where the amount of money is controlled by politicians and central banks.
Satoshi Nakamotohe root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts. Their massive overhead costs make micropayments impossible.
A generation ago, multi-user time-sharing computer systems had a similar problem. Before strong encryption, users had to rely on password protection to secure their files, placing trust in the system administrator to keep their information private. Privacy could always be overridden by the admin based on his judgment call weighing the principle of privacy against other concerns, or at the behest of his superiors. Then strong encryption became available to the masses, and trust was no longer required. Data could be secured in a way that was physically impossible for others to access, no matter for what reason, no matter how good the excuse, no matter what.
It’s time we had the same thing for money. With e-currency based on cryptographic proof, without the need to trust a third party middleman, money can be secure and transactions effortless.
Functioning
Money creation is a central aspect of the concept of the Bitcoin currency. New coins are created and administered by use of processing power in a decentralized computer network. This process is called mining. The network consists of all participants who have installed a Bitcoin software on their computers. The network protocol limits the maximum number of Bitcoins ever to be produced to approx. 21 million units. Money creation beyond that amount is not possible. Bitcoins can be transferred freely between the members of this network. Each of these transactions receives a digital signature and is recorded in a public database. Within this concept, payments are final as soon as the network has approved the transaction and cannot be revoked anymore. Users can prove their ownership of Bitcoins through the ownership of cryptographical keys.
Exchange into other currencies
For a long time, there was no exchange rate for Bitcoins until the first transaction in 2010, when two pizzas were delivered in exchange for 10,000 Bitcoins (see Wired.com). At today’s current rate, this amount of 10,000 Bitcoins paid four years ago would approximately equal USD 6.5 million.
Nowadays, there are a number of exchange platforms that bring together buyers and sellers or even trade with Bitcoins at their own expense and convert them into conventional currencies such as euros or dollars. For the most part, these exchanges are unregulated. The trading venues allow for administrating the crypthographic key mentioned above and thus make a software installation and backup on the part of the end user superfluous. Mt. Gox, based in Japan, was one of the oldest and largest of these exchanges.
The shutdown of Mt. Gox
The shutdown of Mt.Gox at the end of February gave impetus to the critics of the currency, as with this exchange, one of the oldest and largest providers of Bitcoin accounts has disappeared from the market—millions of dollars of customer deposits seemed to have vanished into thin air. Problems had been looming over Mt. Gox for quite a while, as payouts Bitcoins had not been possible anymore for weeks. However, the way in which the liquidation took place surely exceeded the imagination of most customers. According to various media reports, it seems that a systemic security loophole at Mt. Gox was abused in order to strip customer deposits (see Forbes, NY Times). There could not have been worse publicity for a currency that ultimately depends solely on the confidence of its users. CEOs of several large Bitcoin exchanges immediately got together in order to issue a joint statement depicting the demise of Mt. Gox as a tragic individual case and pointing out major failings on the part of the operator (see Coinbase Blog).
An important aspect in solving the Mt. Gox theft will be whether it is a loophole in the concept of the Bitcoin system or a loophole of a single provider. However, it is already clear today that one of the largest banks of the Bitcoin community has been shut down. Similar to the crash of Lehman Brothers, this will above all become a crisis of confidence for the Bitcoin banks. It remains to be seen whether the joint statement by other large market players will convince the Bitcoin users and whether the crisis of a “bank” will be followed by a serious crisis of the Bitcoin currency. Perhaps new points of view on the regulation of Bitcoin trading venues will emerge amongst Bitcoin users, now that the first large-scale theft has occurred.
The future of Bitcoin
Until the insolvency of Mt. Gox, the year 2014 had begun with promising news for Bitcoin users. With SecondMarket, an established online provider appeared on the market intent on opening a Bitcoin exchange exclusively for the Bitcoin trade of large institutions (see CNN)—another step towards establishing Bitcoin as a serious alternative to traditional currencies.
Now, a little while after the insolvency of Mt. Gox, the Bitcoin system does not seem to have suffered any serious harm. In the meantime, the rate has recovered slightly to approx. USD 630.00 per Bitcoin. It seems that the negative publicity has put Bitcoin back into the public limelight without causing severe damage. Cryptocurrencies aim to tackle and remedy the flaws of the traditional currencies and thus have advantageous qualities that are valid irrespective of the current security loophole. There is also a considerable share of Internet users who support the idea of a democratic, unregulated and finite currency and thus establish and secure the value of Bitcoin. With an increasing number of (intensive) Internet users, this group is likely to grow rather than shrink and the value of Bitcoin will mirror this development.
