The Year of the Bitcoin or the Year of Crypto-Currencies?

The Bitcoin barrage certainly towers prominently among the 2013 phenomena. Having soared in price in a humongous manner and the razzle-dazzle of its many a rags-to-riches story eclipse the true face of this nouvelle contraption.

A certain Norwegian student had obtained 5600 bitcoins worth $27 total and forgot about it. When, in spring 2013, the price per single bitcoin shot up to over a whopping $200, he quickly came back to his senses, sold off his stock-pile of bitcoins and now sits all svelte and suave in his mint new apartment. Or perhaps he doesn’t. Maybe – just maybe – a nagging thought, somewhere at the back of his mind, that had he sold half a year later, he could have cashed four-fold, gnaws at him mental. Despondently remorseful must also be the Briton who finally ditched his decrepit computer disc that had been collecting dust, shelved for good, only to have recollected, a couple months on, that it had contained the only record of a private key to ฿7.5k that he had bought as early as 2009. His hypothetical £4m treasure chest had, thus, been consigned to the dustbin sooner than he was ever cognizant of having it. Now he’s scouring the refuse heap somewhere near Newport in hope of a miracle.

Indeed, miraculous get-rich-fast fairy stories attributable to the Bitcoin frenzy cropped up crazy over the course of the past year, and they keep spellbound not only the relentless investor fortune finders but also the common folk. It’s a pity that the bitcoin’s soaring price relegates its far more captivating characteristics to the realm of disinterest. Unreminiscent of tulip mania, the Bitcoin bubble can bequeath a lasting legacy.

What is a Bitcoin?

Most people will be aware that Bitcoin is a computer currency without a physical form, some may even resort to using the ‘crypto-’ prefix. Bitcoin’s modus operandi is based on a direct communication of computers in a system, i.e. peer-to-peer or p2p, much like so staggeringly popular file-sharing systems, e.g. torrent. But beware that bitcoin (lower case not being a typo; rather it refers to the unit of the Bitcoin currency) is no file being transferred between two computers. It bears more semblance to a sort of big communal ledger entry.

Let’s try a different approach. Without the existence of computers, the Bitcoin’s functioning could be elaborated upon thusly:

One day in the town of Internetville a citizen, a citizen who called himself Satoshi, cried ‘bitcoin!’ whilst pointing toward Johnny. Johnny liked it so much he gave Satoshi an apple. Sure enough, in time Johnny went on to cry ‘bitcoin!’ and pointed at Katie. She rewarded him with a kiss. Later, Katie pointed at Rachel and cried ‘half a bitcoin!’, receiving a muffin in return. In the midst of the city was a huge blackboard. Every time somebody cried ‘bitcoin’ a bunch of people, let’s call them ‘miners’, assembled in front of this blackboard. They always made a record of who cried and to whom they pointed. Invariably attached to the record were everybody’s signatures. Once in a while, as a means of reaping the rewards of this activity, one of them could earn the right to cry ‘bitcoin’ without the need to have first been pointed at by somebody else.

One more thing though. The entire populace of Internetville conceals their faces with masks. They introduce themselves as Satoshi, John or Katie, but these names can be made up. The group of ‘miners’ only write down the names of those on the blackboard, whose identity has been incontrovertibly verified by dint of their unique sign – let’s say voice-recognition, so as to forestall strangers’ indiscriminately giving ‘bitcoin’ hollers.

And so the Bitcoin arcanum is nothing more than a singular entry in a gigantic, electronically administered ledger, which is also known as block chain and instantaneously downloadable online. If you’ve ever obtained a bitcoin (whether by mining or the virtue of another user) you are entered in the accounts as a receiver. Should you want to pass your bitcoin on to somebody else, a record will be entered into the block chain, which will then be approved by the miners (or their devices’ computing power, which is being utilized for the sake of the transaction, to be precise). In line with this activity, they will periodically be rewarded by a host of new bitcoins’ issuance.

For a successful completion of a bitcoin transaction among users, a public key, i.e. some kind of a virtual wallet, and a private key, which is a unique passcode in the form of a strudel of alphanumeric symbols, have to match each other. Seeing as these symbols are the only thing between an owner and his bitcoins, the passcode is to be kept secret, made a note of on a scrap paper, tattooed on a forearm or simply stored in one’s memory (e.g. encrypted in a mnemonic device of sorts, for example a rhyme), lest he should forget it. Wherever sat at a computer connected to the Internet, he can retrieve his particular bitcoin pouch any time, provided he knows his private key. So long as the private key is not leaked to the public, the bitcoins remain sound and safe from theft or deletion.

This is a simplification of the Bitcoin’s workings stripped to the bare bones. For deeper appreciation, the reader (myself not least) would have to do a little cramming on the ephemerally cryptographic Hash Function and the like. Luckily enough, for the active use of the Bitcoin no such fancy fripperies are necessary, for it is also superfluous to even know any of the above. One can rely on a wide array of elaborate user-friendly toolkits that had reduced the sophistry of accepting, safe-keep or payment by means of a bitcoin to child’s play on a par with internet banking or using PayPal.

All you need is to download to your computer or a smartphone one of a plethora of the Bitcoin wallet renditions available online for a free download. You can also use an online wallet that you’ll open up similarly to a new e-mail account or sign up for one at one of many online stock exchanges. Once your identity has been verified, you’ll be able to purchase, sell or trade in bitcoins. Yet another way to obtain the elusive bitcoin is to use cash via the Bratislava Bitcoin ATM (or any other similar ATMs, which emerge around the world), which operates like a reversed ATM. Alternatively, you’ll search for a locally extant shopper or seller of bitcoins in your own locale through and make a hand-to-hand, or rather smartphone-to-smartphone, swap. Should you be averse to the electronic amenities of life, do not despair. For even a physical incarnation of bitcoins exists, intrinsically as a small coin or a coin-like object, containing a sealed private key pertinent to the item’s bitcoin value.

Despite its simplicity, familiarizing oneself with the system’s full scope of intricacies is well-worth the effort. It will enhance your user security at a time when many a naïve investor had fallen prey to hacker assaults due to lax approach to private key safety protocols, or an excessive reliance on a stock exchange’s own security mechanism. Getting to grips with the Bitcoin’s intricacies will also help shed further light on the rationale behind its staggering popularity among hackers, cryptographic aficionados and economists alike.

Get Rich Fast and Simple

Once upon a time, on the last autumnal October day of 2008, there emerged a document online, delineating the functioning of the Bitcoin protocol. It had been published by an anonymous, acting under the moniker Satoshi Nakamoto. His true identity, or nationality for that matter, remain a mystery to this very day. It is wildly conjectured that he is one of the biggest bitcoin owners of today, with an estimated present value worth over $1.0bn. Over the course of 2010, his activities dwindled and slowly disappeared unto oblivion.

The first bitcoins were mined on January 3, 2009. In October the same year, the first exchange rates vis-à-vis the U.S. dollar had emerged. $1 equated about ฿1300 to be acquired from the early enthusiasts. In February 2010, the first Bitcoin stock exchange took form. Subsequently in May 2010, the first Bitcoin shopping transaction had been recorded when somebody expended ฿10k for a pizza. In July the same year, the strength of the bitcoin against the dollar shot up 10-fold in a matter of 5 days. This had, however, still been representative of a mere ¢8 per bitcoin and so given the amount of bitcoins in circulation, practically nobody, save for the community concerned, noticed. In February 2011 Bitcoin soared to topple the psychological barrier of $1 per bitcoin; in November, it had exceeded the price of $30/฿. Following were a sequence of over 18 months during which it had hovered at below this level. Until 2013.

From March till April 2013, the rate has soared 600% in 30 days to $240. The next few days proved detrimental in bringing it back down to $60, convincing swathes of arbitrageurs to discard the concept altogether as a burst bubble. Worries notwithstanding, the price had stabilized little under a hundred dollars, only to have skyrocketed again in November to $1k in a few days’ time. Since 2009, the price has been burgeoned 100 000 000%. The floodgates with news of fortuitous Bitcoin millionaires opened and drew new interested investors.

The rationale behind the Bitcoin’s blossoming is two-fold. First, it’s a paradigm for a classic bubble, i.e. ‘one fool hopes to find an ever bigger fool.’ The Bitcoin economy is still under any set of standard considerations miniscule. The daily traded worth of bitcoins amounts to no more than $0.1-0.4bn – and even that has been endemic in only the past few weeks. For the most part of 2013, daily volumes did not exceed $30m (cf. the daily traded worth of gold, the U.S. treasuries and forex turnover: $250bn, $700bn and $5 trillion respectively). What it means is that a second-class millionaire’s whim to buy or sell several million dollars’ worth of bitcoins can have vast repercussions for the market’s stability. Likewise for the ad hoc leakage of user data from one of electronic stock exchange, or its foreclosure by the authorities. But to condemn it for it could be a bit cavalier. For even the paper money is only accepted because of a fool’s hope that tomorrow, another fool will accept that scrap of paper from us.

Let’s shift our focus for a while away from the get-rich-fast aspect and onto the more compelling reason for the Bitcoin’s humongous increase in popularity. Sure enough, the increase in its prevalence walks hand-in-hand only with the way it’s revolutionized the world of the means of payment.

A Different Kind of Token

Let’s set you straight on something first – the Bitcoin is no money. Money is something that had widely been accepted as a means of payment and a unit of accounts. If it won’t enable you to buy ice cream in in your local shop and a ski lodge in Apls at the same time, it ain’t money. It’s quasi-money or a kind of tokens that, nevertheless, have the potential to one day become money.

These tokens differ from what had hitherto historically been on the menu. For most of history, men have used commodity money such as shells, cloths and of course gold and silver. Then, a few centuries on, another type of money emerged – fiat money. I.e. fiduciary money with coerced circulation backed by nothing but a cockeyed faith in the government and the central bank (the cheekier of ruffians would perhaps go so far as to say it’s backed by truncheons . . . ). Moreover, there’s a whole pantheon of various private payment means, backed by faith in the issuer, e.g. gambling chips, backed by faith in a particular casino, or virtual gold from the very popular computer game World of Warcraft, backed by faith in its creator – games company Blizzard.

The Bitcoin is no commodity either, you can’t eat it or recast as a ring. The Bitcoin has no centralized issuer to betray your trust. Put simply, it’s a mere product of a mathematical function. Again, the Bitcoin is not centralized. Nor is it decentralized, for it has no local nodes. In its stead, it is disseminated, or distributed. Meaning that if a single user shimmers away, it can fully be replaced by any other user. There is no central server, no administrator let alone an umbrella institution. The bitcoin supply increases on the time axis according to a precisely delineated vector until it reaches the summit of ฿21m in 2140.

Another one of its features is anonymity. All transactions are public (see above; for they are inextricably intertwined with block chain), but decipherable is only a user’s electronic wallet address. Granted, that doesn’t guarantee 100% anonymity to the end user. Should your computer or your phone be seized by the authorities, or when you transact bitcoins on a stock market, your real identity could be compromised. With a bit of an effort, though, these risks can be eliminated. This particular peculiarity have long been exploited, for instance, by now defunct online market place with illegal merchandize – the infamous Silk Road and their ilk, or blackmailers. A rather extreme example can be made of the Assassination Market website, wherein anonymous contributors can chip in to the pot of money for an assassination of a selected political figure. The money is being collected to the point when an obliging hitman takes the job. So far, Ben Bernanke is head and shoulders above everyone else on the list, having earned more than $120k worth of bitcoins for his own head.

These crime underworld stories are popular with media, but in actuality no more than 0.5% of the Bitcoin transactions are funnelling funds toward illegal activities’ proliferation. Far more sway is still held by the good ol’ Uncle Sam’s greenback in terms of transacting drugs and kills as the gangster’s currency of choice. The anonymous side of the Bitcoin diaspora augurs substantially better for people who value their privacy and deem it morally reprehensible if the authorities take stock of other people’s lives, keeping an account of when they purchase their erection pills and how much money they squander on a Friday night. Dissent from various dictatorships find it invariably handy as one of the few alternatives to handle their finances. No more treasure chests buried deep beneath the earth. So long as your only private key lays buried in the deep recesses of your mind, there is no way for the authorities to excavate it unless they beat the confession out of you with a rubber hose.

Bare bone simplicity of the Bitcoin’s infrastructure makes it intoxicating for a hinterland with no sophisticated banking infrastructure. The Bitcoin had included into the M-Pesa mobile payment system, in which a third of Kenya’s populace, a tenth of Tanzanians and a growing mass of the citizens of India partake.

Although it’s true that the Bitcoin transactions accrue automated surcharges that go to the miners, these are, compared to banking fees, negligible even for the Third World customer. This makes the Bitcoin irresistible to businesses as well, who see it a cost-wise alternative to card payments. In fact, all sorts of service procurement and an expanding spectrum of goods’ sales in bitcoins are becoming commonplace. Slovak Bitcoin community is thriving as epitomized not only by one of the first-installed Bitcoin ‘cash machines’, but also the fact one can buy a baguette for bitcoins at a Bratislavan Subway, or use it as a means of payment in dozens other smaller businesses.

Forget the Bitcoin, It’s a Crypto-currency

The sudden foray of the Bitcoin from the murky pits of IT underground and into the realm of day-to-day transactions caught many economists and regulators alike by surprise. The former struggle to fit it into the tidy and neat model of the monetary world. Most of them take a step back and warily murmur platitudes along the lines of ‘It’s interesting, we’ll see,’ whilst others, prominently among them, then, Paul Krugman criticize it as a deflationary currency that will end up in a humongous hoard-up and an eventual freeze of transactions. The Austrian School of economics ranks among the most ferocious critics of the contemporaneous fractional reserve banking. Even then, a small number of the Austrian School economists, whose predilections lean toward the gold standard, take a critical approach to this “competitor”. Overall, though, Bitcoin has won a fair share of the hearts and minds of the freewheeling libertarians.

The regulators have tended to opt for ‘wait and see’ tactics. The U.S. has mandated that local stock markets report their data, but otherwise just watch from afar. The Germans, in a ploy to shift the bulk of Bitcoin transactions from the realm of the shadow economy and unto the light, have acquiesced to the use of bitcoin as a unit of account. The rest of the eurozone (including Slovakia’s very own central bank) tacitly limit themselves to comments on the Bitcoins’ risky nature. The toughest blow so far to the Bitcoin’s buoyant burgeoning was dealt to it by China, whose authorities prohibited clearing services to the Bitcoin exchange in mid-December, thus budding an easy bitcoin-renminbi conversion and vice versa in the nip.

Blocking the conversion of bitcoins to paper currency is about all that regulators can currently do. Central banks are faced with a difficult choice. On the one hand, the unhindered proliferation of the Bitcoin bears with it the inherent risk of siphoning off a certain amount of state currency transactions and plunging it into the shallows of a shadow economy and hence out of the reach of politicians and the tax bureau. On the other, a more robust crusade against Bitcoin could cost central banks dearly on the PR front, whilst providing an inadvertent impetus for people to unfold an even more brazen parallel financial structures.

Irrespective of what the future holds in stock for us, Bitcoin has already revolutionized the world of finance and beyond. Walking in its footsteps, swathes of new crypto-currencies have already cropped up, like Litecoin or Dogecoin. A growing market for crypto-currencies where everybody can pick his own crypto-stallion has emerged. The truly mind-boggling crypto-contrivance, though, is that a nouvelle monetary system’s Bitcoin build-up is but one of a myriad of possible applications. The Bitcoin’s revolutionary potential lies in its embodiment of the first sophisticated, virtually ubiquitous distributive cryptographic infrastructure. Bitcoin can now become the building block of a new electronic car registry, real estate register or any other database. No central bureau, no fees, no waiting lists, no deadlines. This may seem a utopian caprice today, but thanks to Bitcoin fairly imaginable. The year 2013 was not the year of the Bitcoin, but the year of crypto-currencies.

Translated by Andrej Arpáš