Bitcoin 101

Business | Tech Finance Technology

Imagine this: you’re shopping online for a new Hello Kitty iPhone cover. You go to pay the merchant, but rather than giving them a credit card number, you transfer money directly from your browser to their server. No banks, no credit card companies, no consortium of financial firms sharing data (like Canada’s Interac). There is just you, the website, and the payment.

Welcome to Bitcoin, the original, much imitated, never duplicated “cryptocurrency” that has libertarians salivating, bankers irate, and techies riveted. Delivered unto the world Athena-like from the mind (or minds, nobody knows for sure) of Satoshi Nakemoto in 2009, both the invention and its elusive inventor appear to exist only online.

Bitcoin is a currency that could make conventional online payment methods obsolete. Those methods rely on one rare, precious phenomenon: trust. When you’re drunkenly buying Ty Beanie Babies off eBay at 3 a.m. (check out “mlutsky”—best stock around), you’re engaging in an intimate four-way between you, eBay, your credit card company, and a midwestern woman who wears pink sweaters with Bejeweled cats on them. Your credit card company pays the merchant, and expects that you’ll be able to pay them, and will charge you interest if you don’t do so promptly. The merchant then sends the merchandise to you on threat of a charge-back, such as when you realize you totally needed that money for smartphone data fees.

Bitcoin kicks that whole process to the curb. It’s seen the X-Files, it knows the truth: trust no one. When you buy things with cash, you don’t need somebody from Visa chaperoning you, you just shove that fiver at the hipster barista and take your sugar-free half-caf extra spice gingerbread latte with whip. So too with Bitcoin, except your computer and the merchant’s computer play the role of you and the barista’s hands, with no intermediary.

If it’s all electronic ephemera, what makes Bitcoin worth anything? Bitcoin is maintained by a massive, multi-million-computer-strong distributed network of “miners” working to make sure that Bitcoins can’t be duplicated or counterfeited, and that transactions cannot be reversed (so you can’t use the same Bitcoin twice). There is a finite number of Bitcoins made available for circulation with a very small decay due to fees (paid in Bitcoins) for processing Bitcoin transactions.

Unlike fiat currency (money declared legal tender by government), there is no organization with guns, an army, or a flag (like a nation-state or Wal-Mart) to back up Bitcoin as a medium of exchange, nor is there an inherently valuable material, like gold, to act as a standard. Instead it relies on people to use it as a mechanism for exchange based on its security and scarcity, a strategy common to all cryptocurrencies.

Cryptocurrencies are a whole family of digital currencies, all based on Bitcoin with only minor variations. For example, Dogecoin, named after the shiba inu meme, uses a different algorithm to secure the underlying data. Despite being very similar to Bitcoin, Dogecoin managed to capture enough exchange value of its own to fund the Jamaican bobsled team for the Sochi Olympics. There are many others, notably Zerocoin which, unlike Bitcoin, is anonymous rather than pseudonymous (which I assure you is not a Harry Potter spell—I checked).

All this alternative currency stuff might seem super dodgy. This is really a matter of perspective. Bitcoin is quite new, and while it has gained a lot of traction in the last couple of years, it’s not mainstream yet. Many people, including some who are paid truly obscene amounts of money by established financial firms to do so, are predicting that Bitcoin will crash and burn either from a technical flaw in the system, or from the social factors in how the system is used. That said, some major investment firms, including Andreessen-Horowitz, have invested American dollars in cryptocurrency-related start-ups. Some retailers, like and TigerDirect, have started taking them as payment. Regulatory bodies in Europe and the U.S. have made disapproving noises about cryptocurrencies or have taken steps to dissuade users, but no government has banned them outright*. Is Bitcoin itself actually illegal? Not in Canada—at least, not yet.

*UPDATE: As of Feb. 7, 2014, the Central Bank of the Russian Federation announced that it has banned Bitcoin, forbidding it as a method of payment. Russia isn’t the first country to take steps to prevent Bitcoin use, but this is unprecedented in its severity.

The U.S. National Security Agency has to have cracked this thing wide open by now, right? It’s unlikely. Without going into the math (it involves exponents!) the computational power necessary to “crack” Bitcoin is likely outside the reach of even the NSA, or any other organization. Moreover, it’s unlikely that anyone actually using Bitcoin would attempt to crack it, as success means a total collapse of the system, and the loss of its value; however, Bitcoins can still be stolen and used fraudulently. It’s really a lot like cash in that respect, except your kooky aunt could fit a lot more in Bitcoins under her mattress, since they can be accessed via her laptop.

For those of us who don’t have an Erdős number, Bitcoin seems like something from the future, like a naked Arnold Schwartzenegger demanding your clothes. Cryptocurrencies will certainly exist in one form or another for the foreseeable future—they’re convenient, accessible, affordable and, perhaps most importantly, difficult for states to trace, seize, or control. Whether they hit the mainstream depends largely on if the mainstream can find profit in them. The network of trust model we’ve depended on for over a century, online and off, is rickety, inefficient, and rife with bugs. It seems fitting that on the 20th anniversary of the commercial web, we are being faced with a new innovation that could be just as disruptive.