What If Banks Didn’t Control Your Money, Machines Did?

What if the concept of money as we know it today were to change forever? What if instead of central authorities like banks, your money was controlled by machines? As fictional as these concepts may have sounded only a couple of years ago, the wheels of this incredible change have already been set in motion. We are witness to one of the biggest social experiments of our time: crypto-currency, the most popular and controversial example of which is the Bitcoin.

What’s all the fuss about crypto-whatever or this Bitcoin thing?

Bitcoin is a digital, decentralized, global crypto-currency. On the 29th of March this year, the market cap of the Bitcoin network (combined value of all Bitcoins) crossed the USD 1 Billion mark, on the 10th of April it crossed the USD 2 Billion mark, and on the 11th of April the USD 2.5 Billion mark. But astonishing as that sharp rise in value is, it’s not the only reason for the unprecedented interest in Bitcoins. The coincidental timing of the sharp rise in its value and the Cypriot financial crisis of 2012-13 has sparked major speculation that many European savers used it as a financial haven in the face of the government contemplating high bank deposit levies and freezing of bank accounts (see here, here and here). Of course it’s difficult to verify this for sure as Bitcoin transactions are next to anonymous, and make it one of the best and most ingenious payment mechanisms our world has ever seen. Reviews from analysts the world over are rife with speculation that Bitcoin might soon become an accepted currency around the world. But guess what, it already is getting there and people are buying stuff right from pizzas through Porsches with Bitcoins!

Uh-huh, but how does this Bitcoin thing work?

GigaOm puts it concisely,

Bitcoin is to state-issued currencies – often referred to as fiat money – as P2P file-sharing is to traditional broadcast media.

A simplified way of understanding how Bitcoins work is this:

• First, you obtain Bitcoins (BTC), for example by buying them from a currency exchange like Mt.Gox
• Store them in a digital wallet (on your computer or in a cloud-based service), which contains cryptographic addresses and keys that confirm that the wallet holder owns the Bitcoins
• To receive payment, the seller or the payee gives one of their addresses to the buyer or the payer
• The buyer, in turn, using the seller’s address and his/her own key signs-in the decentralized Bitcoin network and initiates the transaction
• The transaction is processed and certified by a network of computers (known as the ‘miners’), and added to a log (a public record of all Bitcoin transactions that have ever taken place) and the seller receives the payment

The miners solve complex mathematical problems of varying difficulty to process such transactions and create new Bitcoins (to avoid double-spending). Those interested can read and understand the technical details here.

Hmm…so what makes Bitcoin so awesome?

The designer of the original Bitcoin protocol and network was Satoshi Nakamoto, who shortly afterwards moved on to “other things”. The name was later found out to be a pseudonym and the real identity of the actual creator (or maybe even creators) hasn't been confirmed to date, in spite of multiple investigations (see here, here and here)!
But it’s not the legend of Satoshi Nakamoto that makes Bitcoins so popular. Some of the reasons why the Bitcoin popularity is climbing through the roof are:

• Bitcoins are transferred straight from payer to payee, without any intermediation from a bank or any other third-party, reducing/eliminating among other things the usually high processing fees (think PayPal, etc.)
  
• Safer than real money, which is subject to political risk, plus your account can’t be frozen (something the Cypriots recently had to face)
• Makes possible highly secure and almost anonymous transactions
• A single global currency, which can be used in every country

Multiple other factors contribute to its popularity, and every day Bitcoin is receiving more and more endorsement from organizations that now accept its usage like Reddit, WordPress, and Expensify, among others.

Okay, so where’s the catch?

Well, like most other investments, Bitcoins too are subject to theft. And apart from this obvious thing, there are others that are deterring a wider acceptance of Bitcoin:

• The dollar value of Bitocoins is simply too volatile right now (just to give you some perspective, the price of Bitcoins, in just the last couple of months, has varied between ~15% and ~205%)
• Then there are issues associated with its inherent deflationary nature (the Bitcoin network is designed to increase the money supply as a geometric series until the hard-limit of 21 million Bitcoins is reached; out of that, 11 million have already been produced, and the rest are projected to be produced within the year 2140)
  
• There have been multiple hacking attempts (some of them even successful) on Mt.Gox as well as many cloud-based wallets (notable among them, the hacking of Instawallet)
• And as you might have figured by now, it’s simply too intimidating for most folks, aside from a few tech-savvy enthusiasts

Because of these and other reasons (botnet mining, DDoS attacks, negative associations with the underground market Silk Road, etc.), Bitcoin has generated a lot of criticism and heated debate over its stability and legitimacy as a potential currency.

So your point is?

These are exciting times we live in. The debate over Bitcoins is still at equipoise, there are some who are heralding it as a disruptive technology, while some are downplaying it as just a digital collectible. Even its developers say it’s still experimental. It certainly has put a lot of focus back on crypto-currency, generating immense interest from VCs, and other competitors, and this open-source and decentralized approach to the concept of money, will surely have very interesting and important consequences. The Bitocin experiment represents a paradigm of novel thinking that the digital world has unleashed, and whether this incredible experiment succeeds or fails, it would have some really amazing repercussions…and the world would be closely watching.

What do you think about this experimental new currency, and crypto-currencies in general? Do share with us in comments.

© Jayant Rana, 2013

Photo credit: zcopley / Foter.com / CC BY-SA; Adam Crowe / Foter.com / CC BY-NC-SA; suphakit73 / njaj/ FreeDigitalPhotos.net