Banking on Bitcoins

Some say that it’s going to revolutionise the global monetary system, while others argue that it’s nothing but another clever cyber-ponzi scheme. Whatever it is, Bitcoins have changed the way the world perceives currency online and off it.

In the news for the wrong reasons of late — with the bankruptcy of one of the largest Bitcoin exchanges, Mt Gox, last week — the cryptocurrency made a quick recovery, however. “Bitcoin has shrugged off Mt Gox’s death rattle” reported Forbes.com, even as the exchange rate to the dollar continued to be an eye-popping $550 (approx.) a Bitcoin.

Already a common fixture in online trade, the Bitcoin’s success story may not be over yet. So as long as you don’t throw away your digital currency in the bin — like James Howells of Wales, who while cleaning up his table, threw away a hard drive containing a digital wallet with 7,500 Bitcoins (worth over $7.5 million) — you might still end up cashing in on the “Bitcoin revolution”.

What is a Bitcoin? On November 1, 2008 a research paper was posted by one Satoshi Nakamoto on an obscure cryptographic listserv titled ‘Bitcoin: A Peer-to-Peer Electronic Cash System’. Traditionally, the origins of Bitcoins are traced back to this paper. Nakamoto (an alias, the original identity of the person is as yet unknown) proposed the creation of digital money that is convenient and untraceable, liberated from the oversight of governments and banks. One that could avoid all the usual problems that arise when making online payments.

The basic premise underpinning Bitcoin’s potential success is that because it is decentralised and not issued by any government, in theory, it is free from interference and manipulation, unlike the world’s tangible fiat currencies. In several ways however, it works in the same way as paper money. Bitcoins are also available in a physical form in some cases. But its primary form continues to be data; you can use it to buy things online, peer to peer, using wallet softwares or an online service.

Where does it come from? Bitcoins are created or “mined” as a result of complex number crunching by a network of computers. This process currently creates 25 Bitcoins every 10 minutes. A predetermined upper limit of 21 million is expected to be reached in the year 2140. After that the total number of Bitcoins will stay unchanged.

There are two ways to get your hands on Bitcoins. The easy way is to purchase them by signing up for online “Wallet” services — Mywallet and Coinbase are among the more popular sites at the moment. Once you have signed up and linked it to one of your existing bank accounts, you can buy or sell Bitcoins as you please.

The hard way is to “mine” Bitcoins. This is similar to mining for gold. But here you’re scouring the web for 64-digit numbers. By getting your computer to solve puzzles constantly, you can compete with other miners to generate the number that the Bitcoin network is on the lookout for. If your computer generates it, you receive 25 Bitcoins. This is a tall order though, and miners often do this in groups, sharing the spoils between themselves. While this might reduce their individual yields, at least it ensures some sort of return for the time and effort they invest.

Satoshi Nakomoto had mined the first block of Bitcoins or “genesis block”, with a reward of 50 bitcoins. Negotiations to fix the value of the first few transactions were done on Bitcoin forums; notable among them was the trade of a pizza for 10,000 BTC or Bitcoins.

What is it used for? A Bitcoin can be used for many purposes but its most important use continues to be the buying and selling of it. Much like traditional stock dealers, the idea is to buy low and sell high to reap maximum returns. Other uses — legal and illegal — exist all over the internet. Bitcoinmagazine.com lists many options in various price categories where the mined or bought Bitcoin can be spent — anything from paying for online dating (okcupid.com) to buying a house.

Gregory Simon, an American Banker, for instance, quit his job and decided to shift to Nicaragua. He used Bitcoins to pay for 0.3 acre of land in the new country. Houses at the Hamptons near New York and the Alberta Province in Canada can also be bought now using Bitcoins. Even Richard Branson of the Virgin Group has decided to give customers a chance to buy a seat on the Virgin Galactic using Bitcoins!

Why should you care? With e-tailing becoming the preferred way of shopping and selling, regardless of whether you’re a business analyst or just someone looking to pick up a pair of headphones, it is good to keep with the trend, currency-wise too. Besides, the anonymity of the Bitcoin service — which is what makes it scary for many — can work in your favour too.

What are the risks? Barely six years old, Bitcoin is not without its risks and is very much a work-in-progress. As the Mt Gox fiasco highlighted, a Bitcoin user could lose a lot of money due to events that are not under his control as well. Mt Gox, created in 2011 as a Bitcoin exchange, grew to handle over 70 per cent of the world’s Bitcoin trades by April 2013.

On February 7, 2014, all withdrawals were halted by Mt Gox. The company issued a statement saying, “A bug in the bitcoin software makes it possible for someone to use the Bitcoin network to alter transaction details to make it seem like a sending of Bitcoins to a Bitcoin wallet did not occur when in fact it did occur.” It was all downhill from there. The company finally filed for bankruptcy in Tokyo on February 28, and reported that they had lost almost 750,000 of its customers’ Bitcoins and about 100,000 of its own. It added up to about seven per cent of all existing Bitcoins and was worth around $473 million. In a follow-up statement, Mt Gox said, “The company believes there is a high possibility that the Bitcoins were stolen.”

With the increasing popularity of Bitcoins, many phishing and malware setups specifically targeting Bitcoin users are coming up as well. A DellSecureWorks report estimates that there are at least 150 kinds of malware designed specifically to steal Bitcoins.

What does the future hold? With many countries and corporations now willing to accept Bitcoins, the currency’s future looks strong. The Indian situation is still unclear though. The Reserve Bank of India issued an advisory against the use of virtual currency and stated that it doesn’t have any plans of regulating Bitcoin usage. Currently there are over 2,000 active Indian users of Bitcoins, but with the third largest number of internet users in the world (150 million), the number of Bitcoin users too is expected to shoot up.

No one can argue against another apocalyptic online event that takes the whole thing down. At the same time, the precise engineering of the Bitcoin system, its finiteness and anonymous setup, gives it an edge over traditional currencies and other attempted digital currencies as well.

Even if the Bitcoin experiment fails, the technological innovations — such as the Bitmessage client, which allows users to receive and send e-mails anonymously — it has helped foster, are sure to carry the legacy of this cryptocurrency forward.

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