We now take a look at Bitcoin – its origins, history and its supposed promise of liberty in the digital age.

What is Bitcoin?

Bitcoin is the most widely used peer-to-peer distributed decentralised digital currency in the world. The currency is based on the Bitcoin protocol that allows digital currency (Bitcoins) to be securely, efficiently and quickly transferred between people. It is a widely accelerating form of digital cash that can be used to make online payments for products and services, as well as regular transfers of cash between people. It is also traded online, like fiat currencies, in an online currency exchange known as Mt. Gox.

 

What is a digital currency?

Its important to understand the term digital currency to understand Bitcoins role as a currency. Digital currency or electronic money, exists as an alternative to normal currency and has seen various forms over  the past few years. As of yet, it has not found any national or institu- tional backing across nations and has only been experimented with in smaller communities.

Other forms of virtual currencies like in-game money or closed system currencies are only valuable within the confines of their systems in virtual economies. Bitcoin as a digital currency has found the widest acceptance to use for real world goods and services without virtual world limitations. The most conventional form of digital currency has come to include web-based wire transfers, machine withdrawals, online credit card use and digital bill payments that use electronic means to make payments. However, these are based on a very broad definition of digital currency that is simply an extension of the traditional economic system (system of exchange) that is still rooted to fiat currencies and only transfers records of credit and dues using the internet as a communications protocol.

Decentralised and crypto

Two key features of Bitcoins as a successful digital currency are – decen- tralisation and cryptography. Unlike fiat currencies or theoretical fiat digital currencies, Bitcoin is decentralised, which basically means that it isn’t regulated or managed by a single institution or person. Bitcoin is based on a peer-to-peer distributed network and regulated by an open source network system that regulates the production of Bitcoins on a clearly understood and transparent logic.

Since there is no single authority behind Bitcoins management the fear of currency manipulation through increased production or institutional devaluation is removed. This allows the adoption of the currency to be more welcoming as users don’t have to have trust in a bank or agency, but in the system itself that ensures no means of external manipulation.

Bitcoin is also a cryptocurrency which makes it an ideal digital medium of exchange as compared to other virtual currencies. It is also the first cryptocurrency to be so widely traded and adopted. The security of the open source code has been thoroughly tested and improved over time to ensure that it can’t be “hacked”. Cryptographic principles are also used  in order to regulate the mining of the currency as well as its authenticity. The possibility of digital counterfeiting is completely moot due to the system’s design.

In conjunction to the cryptographic principles involved in its production, Bitcoin is also administered in a decentralised network that can authenticate the validity of all Bitcoins produced using user keys and signatures in a distributed online registry, which ensure that duplication of transactions does not happen and frauds are avoided.

The nature of this cryptographic setup is based on ensuring that the computational cost of hacking such a system far outruns the possible gains that could be made. The processing power required to circumvent this cryptography extends far beyond the reaches of the largest multinational corporations such as Google or Microsoft and are therefore well outside the reaches of basement hackers. The technique used is known as a “proof- of-work” based system which can only be resolved through brute force application of computing power. This power is normally used by swarms of miners through pools of distributed processors over large periods of time resulting in the sharing of the discovered Bitcoins. This ensures that the effort of the miners is rewarded and no single entity is capable of exploiting the system to unfairly gain Bitcoins.

A Brief history of Bitcoin

Before Bitcoin, various attempts had been made towards introducing a feasible digital currency. The key task of these early innovators was based around ascribing value to their new currency. The earliest of these online currencies were based around the gold standard and came in market after the IT-bubble had burst in the late 1990s.

Companies such as OS-Gold, Standard Reserve and INTGold came to existence between 1999 and 2004. But they didn’t last very long due to their externalised dependency on necessary reserves that needed to be held as gold. However the people running these companies diverted the deposited funds leading to several million dollars worth of loss for the account holders.

Other companies such as e-gold and e-Bullion also faced investigation by the United States government with legal disputes still ongoing. Due to enforcement by US government agencies these companies had their assets frozen and seized leading to the discovery of criminal acts as well as fraud. Although not all cases have resulted in clear violation of law, it has effectively placed gold based digital currency in shutdown.

Another form of digital cur- rency that caught the public interest prior to 2001 was Beenz. com’s online currency called beenz. It was earned by indi- viduals when they performed certain online activities and was then used as e-currency for purchasing services online. The marketing campaign was very successful and garnered nearly USD 100 million from venture capitalists from the international market. However, the legality of operating an independent currency led to numerous conflicts with many nations across America and Europe.

Charges of operating an unlicensed bank plagued the company but were soon resolved. At its peak Beenz operated in 12 countries including US, Japan, China and Australia. The company couldn’t survive as a currency due to its dependence on banks and airline points systems which suffered in post 9/11 America. The currency was integrated into their customer relationship management tool and phased out slowly.

The first significant name in true cryptographic digital currency came with DigiCash which was founded far before all others in 1990 but declared bankruptcy in 1998 and was sold off to Ecash. David Chaum’s Ecash was also an anonymous e-cash system secured by RSA signatures. By 2002 the company running the system failed again and was sold off to another company disappearing from public existence.

The only other digital currencies that found footing in the interna- tional market existed in virtual economies or synthetic economies. These economies emerged out of a continuously ongoing virtual world where the exchange of goods took place within the context of a networked game. These massively multiplayer online role playing games (MMORPGs) created virtual worlds that connected millions of people who were the foundation of the economy. Players could use the currency of the virtual economies in these games to purchase virtual goods for use in the game. As time and engagement took over, players were able to leverage the virtual products against real world value and make real economic gains.

Life simulation games like Second Life also created virtual economies that made it easier to link virtual and real economic transactions using in-game currency convertibility. The Linden Dollars from Second Life are used to pay for assets created in the game as reward of intellectual property via in-world content creation and trade. This currency was able to trade for real world goods and currency via third party sites. Conversely, other online games like World of Warcraft, Warhammer and Final Fantasy XI became controversial settings where real money was used to make in-game purchases between players. Game companies attempted to dissuade this by reinforcing in-game currency to be convertible.

All these centralised and loosely based virtual currencies remained highly marginalised by their natural drawbacks until a cryptographic decentralised digital currency system was created – this  was  Bitcoin. The conceptual idea behind Bitcoin was introduced by a mysterious figure using the pseudonym Satoshi Nakamoto in a paper – Bitcoin: A Peer-to-Peer Electronic Cash System – in November 2008. The paper outlined the logic method of attaining an electronic transaction protocol that could eliminate issues of trust. The first active Bitcoin network went live in January 2009 and was accessed using the first version of the open source Bitcoin client.

The first block of 50 BTC was mined by Satoshi Nakamoto. Over a period of months various vulnerabilities were discovered and patched resulting in the rectification of 184 million fraudulent Bitcoins. Since then no new vulnerabilities have been discovered in the protocol.

As the proliferation of the Bitcoin client, protocol and awareness of its system gained wider reach it began to garner a loyal following with various parties using it for payments online. Websites such as Wikileaks started using it as a valid medium for donations as well as secure anonymous pay- ments across the world. Bitcoin garnered lots of negative attention due to its use in the Silk Road – an online black market – as it became the currency of choice for darknet transactions involving various illegal trades and activi- ties including drugs and hitmen.

Various legitimate online communities and business’ such as Reddit, WordPress, Pirate Bay and nearly a thousand others have begun accepting Bitcoins as payment or donations. The faith of the online community in the use of Bitcoins is highly encouraging towards its promise as a future standard for digital currency.

Various nations have dealt with the Bitcoin phenomenon in different ways. The United States has closely monitored the evolution and use of Bitcoins but beyond the individual level. Their concern has primarily been with respect to how it is used in money laundering activities by criminals as well as the monitoring the role of private companies or groups in transacting real money which is in contradiction with financial laws.

Countries like China and Thailand have aggressively discouraged the use of Bitcoins due to the lack of legal frameworks that govern it. Countries such as Germany have even begun considering Bitcoins as a valid form of e-currency due to its exhibited properties as a unit of account but not as a normal currency in real world use. But the bulk of the force behind Bitcoin comes from its users and merchants, with recent revelations in Bitcoin insurance by Lloyds of London and acceptance by mainstream online companies like Overstock and Zynga.

 

Bitcoin as currency

Bitcoins is the name given to the units of money or currency used on the Bitcoin protocol. Its abbreviation is “BTC” i.e. 1 BTC, like 1 USD for United States Dollar. Unlike analogue currency Bitcoins do not exist in physical form, rather only as numbers associated with a Bitcoin address that iden- tify their value. This number can be replicated in physical tokens such as physical coins, paper print outs or card like objects but are only identifiable as genuine currency on the Bitcoin peer-to-peer distributed network by the authenticity of their numbers. This form of currency coding, unlike serial numbers on paper currency, is highly secure due to its unique identification on the Bitcoin registry that vali- dates the coin instantly for online transfers.

Bitcoins are created on the Bitcoin network through the act of “mining” which we cover in greater detail in subsequent chapters. However, the term “mining” refers to the act of discovering Bitcoins through applied effort (computational) on the Bitcoin network similar to the act of mining for gold or other precious commodities. The computa- tional effort taken by “miners” on the network is reflected by the solving of complex mathematical problems which requires brute force processing power and therefore is an investment of time and energy.

The mathematical problem is a “proof of work” solution that result in the awarding of Bitcoins to the miner and the creation of new blocks. The difficulty of these problems can vary based on the strength of the network as well as the proportionate reward of Bitcoins. The network is based on an open source peer distributed software that has rigid parameters that govern the payoff. The system is designed to be easier during the start of the process, resulting in larger payoffs, and reduces by half every four years that the Bitcoin network is active. So a solution in 2010 would have yielded twice as many Bitcoins as it does in 2014 and will yield half as many Bitcoins in 2018 and so on.

The system is designed on a transparent mathematical system that can be predicted to create a finite number of Bitcoins in its running time. The approximate number of Bitcoins generated in the first four years of operations or 210,000 blocks, from January 2009 to November 2012 was 10,499,889.80231183 and will result in half as many more by December 2016. By this count the currency supply will gradually and incrementally keep increasing until it hits a fixed ceiling beyond which more Bitcoins won’t be created irrespective of mining efforts. The total number of Bit- coins that can ever be in existence are just less than 21 million at around 20,999,839.77085749 when using the determined 8 decimal point.

The system is designed to reveal blocks every 10 minutes with the initial value of 50 Bitcoins per block. Along with the runtime reduction in Bitcoin payoff, another aspect of the system is that it adaptively changes the dif- ficulty of the mining process based on the rate at which processing power is dedicated to the task. This adaptive reiteration takes place every 2016 blocks based on the time taken to solve that many blocks.

At the current time (January 2014) there are 12274575 BTC in existence with a steady rate of increase. The number of Bitcoins in existence can  be easily checked at [http://blockexplorer.com/q/totalbc]. And as the network runtime increases the number of Bitcoins mined will half to 12.5 after the next 210,000 blocks and then 6.25 and so on. Due to this iterative division Bitcoins are divisible down to 8 decimal places. Similar to analogue currency, Bitcoins are also used in smaller denominations. The smallest denomination is .00000001  BTC but can be even lower if the existing protocol is augmented. Similar to paise or cents, Bitcoins are used in fractions of centiBitcoin (bitcent =.01 BTC), milliBitcoin. Most people can’t even balance their check books but are expected to understand and accept the mathematics behind Bitcoin!

(mbit = .001 BTC) and microBitcoin (ubit = .000001 BTC). Due to the international nature of the digital currency, Bitcoin denominations are named within the metric SI system rather than imperial or colloquial units such as cents, pence or pound. The only exception is the honorific given to the smallest unit i.e. .00000001 BTC which is called a satoshi. It is named after the pseudonymous creator of the Bitcoin protocol Satoshi Nakamoto.

The steady and calculated production rate of Bitcoins maintains its value in the market.

 

Bitcoin as a decentralised digital currency

Many users of digital currencies, specially Bitcoin, express concerns relating to it being a fraudulent scheme designed to fool people into exchanging real currency for alpha-numeric sequences that have no actual value. But as we have observed value is generated through community trust in the system of the currency itself. The use of Bitcoins within the system doesn’t assure any participant unfair gains or profits. The currency benefits from its decentralised nature which ensures that no individual or institution is at the core of it and positioned to unfairly benefit from its use.

The Bitcoin system is based on early low reward efforts leading to long term community benefits. The first persons to mine for Bitcoins were not at a significant advantage as the value of Bitcoins at the time was negligible or close to 10,000 BTC for a pizza (we don’t know which one). At todays rates just 1 BTC would easily purchase 100 pizzas. But for the system to be functional in the early days the Bitcoins needed to be used in transactions that didn’t value the Bitcoins very highly – a reflection of its nascent trustworthiness.

There was no government or agency that could artificially increase the value of the Bitcoin due to its decentralised nature. The value had to evolve from continuous usage and proliferation of the user network both in the digital as well as real world. Bitcoins are now accepted in over one thousand locations across the world including real world locations such as cafes and restaurants.

Another unique aspect of this decentralised nature is that unlike other fiat currencies, Bitcoin isn’t an inflationary currency with its value being dwindled by increasing supply, however it is the reverse. Bitcoin is predicted to experience deflationary forces over time due to its predeterminedly limited supply. As Bitcoins are lost due to technical issues, accidents or seizure (government) the value of the Bitcoin will more rapidly stabilize and find a normal level. However, there is also the possibility that with occasional and continuous losses due to random events, the supply of Bit- coins in circulation with always remain significantly lower than the total supply created. And unlike normal currency this deflation will effect the laws of supply and demand in unpredictable ways. The likely outcome is that the value of Bitcoins will increase as scarcity will relatively increase over time which will in effect cause aberrant trading behaviour causing Bitcoin value to fluctuate.

In order to resist this possibility the system is designed for infinite divisibility of unit. In practice, while at one point 10,000 BTC could buy a pizza, today only a fraction of one Bitcoin is needed. By continuously being able to engage a lower unit of Bitcoin, a centicoin or an ucoin for trading the problem of deflation could also be managed. By dividing the Bitcoins to its lower denominations indefinitely usage could evolve in a practical and manageable way within the decentralised system.

 

Foundations of Bitcoin’s Value

Bitcoins in most physical forms contain an inscribed motto – Vires in Num- eris – latin for “Strength in Numbers”. The philosophy and design of the Bitcoin protocol is based on this saying and uses it to uphold the system within which Bitcoins function.

For any currency to have usefulness they need to have value, which in the case of Bitcoins comes from its scarcity. The system ensures a limit on the number of Bitcoins and scarcity in its production. As the community of Bitcoin users moves to further adopt the currency and the number of users increase, so does the strength of the currency. The faith placed by the first adopters, the miners who worked to generate the currency, Bitcoins are a unit of trust. Their trust and subsequently the trust of all users is in the mathematical perfection of the system that allows users the comfort of knowing that their Bitcoins are unique, valuable and represent value.

Similar to the older Gold Standard, which was supposed to allow curren- cies to be redeemed for gold as backing, Bitcoins are based on the premise that people within the network – retailers, merchants and individuals – will continue to accept them and trade value will be retained.

At its very core Bitcoins are based in trust and faith in the currency itself, which is similar to most modern fiat currencies with the exception of an institutional or governmental support. The faith usually given to central banks and governments is given to the purity of the code that runs Bitcoin in ensuring that it remains secure and safe in the digital wallets of the users. The value of the Bitcoin also can’t be controlled or manipulated by governments as is the case with fiat currencies and the effects of inflation are negligible in the long run since the supply of the currency can’t be increased. Bitcoin’s value is solely in the hands of its users and based on the foundational laws of supply and demand, clear   of any external manipulations.

This raw dependency on market forces and lack of any correctional or protectionist third party (government) is considered by many as both a blessing as well as a curse. Since the trading of Bitcoins takes place across digital platforms there is a rapid and global influence from a large number of users reacting to a vast variety of reasons such as rumours, fear, confi- dence issues, local laws and other behavioural factors. These variations in motivations, without corrective measures in place, makes the value of Bitcoins fluctuate rapidly, causing further fears of it being nothing more than a bubble. However, this phenomenon isn’t untrue for fiat currencies as history has shown. Bubbles are common in free market currencies such as the dollar and euro but they are always seen to normalise in the long run, which is the expectation from Bitcoin as well.

 

Is Bitcoin a revolution?

Bitcoin is the youngest currency in the world. It is also the world’s first and fastest emerging currency of trust. Pure mathematical certainty. And that trust is what makes Bitcoin a force to be reckoned with more than any of its other features. It represents not only security and efficiency but also a dynamic form of democracy.

And even though it is based on a man-made open source software system, the system can’t be changed without majority approval from those who make up the system. This distribution and decentralisation give Bitcoin its greatest strengths as they free participants from having to trust each other or a central agency. They just have to trust the math. Faced with numerous large scale financial meltdown over the last 20 years, it isn’t unusual for people to seek certainty when it comes to their money. After watching governments plunder, waste and inefficiently use national currencies, the idea of a digital currency free from the flawed clutches of government are a source of peace.

This peace is a form of liberty that many Bitcoiners embrace with great passion and conviction. By taking the control out of governments and private agencies, individuals are able to not only reduce costs of currency transactions (as compared to other forms of online transactions) but also increase the value of the currency over decentralised currency exchanges. The currency attains value as a unit of exchange as well as a speculative investment that can grow. All without having to pay governments any form of tax, fees or other share of profits. And if libertarian philosophy doesn’t motivate people to participate, then surely denying the government any share of profits is incentive enough for a revolution.