The definition of digital money can be confusing. With online banking and Internet shopping, that’s basically money in digital form. Also, there are services like PayPal that handles online transactions between private parties online. But both examples are tied to fiat currency — money that derives its value from government regulation or law.
But now there are new options that aren’t linked to any government or traditional good.
The most popular — and, let’s face it, they’re not that popular — is Bitcoin.
This currency has no bankers, no printing presses and no taxes. It enables instant purchases over the Internet, and unlike credit cards or PayPal, Bitcoin has no central authority and no way to block out entire countries (like PayPal).
Bitcoin is based on cryptography — the practice and study of techniques for secure communication in the presence of third parties. In 2008, a man named Satoshi Nakamoto — now believed to be a pseudonym — posted a theory that challenged powerful computers to “mine” currency using complex cryptographic algorithms.
The challenge with designing a digital currency is the necessary elimination of double-spending. If a digital dollar is just information, unprotected by the regulations and laws of a government, what’s to stop people from copying it and spending it as many times as they want?
Conventionally, a real-time ledger keeps track of all transactions, so that if someone spends their last digital dollar, they can’t spend it again. But that requires a third-party to administer it.Bitcoin eliminated the third-party by making all transaction information public. Users willing to commit CPU power to running software to solve cryptographic algorithms would be “miners” in the network monitoring the ledger.
In the process, they would generate currency.
Transactions would be broadcast to the network and the computers involved would compete to solve irreversible algorithms that contain data from several transactions. The first miner to solve a problem would get 50 new Bitcoins, and the associated information would be added to the network and made into another puzzle for a computer to solve.
The difficulty of the problems would increase as the number of miners increased and the size of the bounty would halve every time 210,000 problems were solved, from 50 to 25 to 12.5, etc.
According to Wired.com, around the year 2140, the currency would reach its preordained limit of 21 million Bitcoins.As its popularity grew, vendors got in on the game and began accepting the currency for payment. Online exchangers made room for online bank accounts of Bitcoins and allowed owners to spend Bitcoins by exchanging them for other currencies.
Like me. I sent $20 U.S. via my Dwolla.com account to someone in Denmark. And in exchange, I got 4 Bitcoin. The transaction information was made public on the network ledger and made into another algorithm, that way the previous owner of the Bitcoins could not spend or sell those same 4 again.
The price of Bitcoin fluctuates with the market. It was worth more a few years ago during the height of the economic crisis when trust in government-backed currencies was thin.
In April 2010, one Bitcoin was worth about 14 cents. By June 2011, the price was $27 per Bitcoin. By December 2011, the price was down to $5 per Bitcoin.
In addition to price fluctuation, the nascent currency has seen other challenges — like theft and hacking, which I’ll get into in a future post — but hardcore bitcoiners are still hanging on.
Like my dad. As far as I know, he still has his 4 Bitcoin. And maybe my $20 investment will pay off in the long term. According to Preev.com, 1 Bitcoin is now worth $17.39. That’s almost a 250 percent increase.