Bitcoin (sign: ; code: BTC or XBT) is a distributed, peer-to-peer digital currency that functions without the intermediation of any central authority. The concept was introduced in a 2008 paper by a pseudonymous developer known as “Satoshi Nakamoto”.
Bitcoin has been called a cryptocurrency because it is decentralized and uses cryptographyto control transactions and prevent double-spending, a problem for digital currencies. Once validated, every individual transaction is permanently recorded in a public ledger known as the blockchain. Payment processing is done by a network of private computers often specially tailored to this task. The operators of these computers, known as “miners”, are rewarded with transaction fees and newly minted Bitcoins. However, new bitcoins are created at an ever-decreasing rate.
In 2012, The Economist reasoned that Bitcoin has been popular because of “its role in dodgy online markets,” and in 2013 the FBI shut down one such service, Silk Road, which specialized in illegal drugs (whereupon the FBI came into the control of approximately 1.5% of all bitcoins in circulation). However, bitcoins are increasingly used as payment for legitimate products and services, and merchants have an incentive to accept the currency because transaction fees are lower than the 2 to 3% typically imposed by credit card processors. Notable vendors include WordPress, OkCupid, Reddit, and Chinese Internet giant Baidu.
Speculators have been attracted to Bitcoin, fueling volatility and price swings. As of July 2013, the use of Bitcoin in the retail and commercial marketplace is relatively small compared with the use by speculators.
Bitcoins are stored by associating them with addresses called “wallets”. Wallets can be stored on web services, on local hardware like PCs and mobile devices, or on paper print-outs. Thefts of bitcoins from web services and online wallets have been covered in the media, prompting assertions that the safest way to store bitcoins is on secure paper wallets.
Integral to Bitcoin is a transaction history log. Making a purchase involves updating this decentralized log, called the blockchain, which shows who owns how many bitcoins currently and records the participants in all prior transactions as well.
Anyone wishing to use Bitcoins is assigned one or more Bitcoin addresses, which are collected and tracked in “wallets”. Wallets have public and private addresses. Anyone can send Bitcoins to a wallet using the public address provided by the owner of the wallet, while the private address must be entered by the wallet owner to send Bitcoins. Securing and protecting the private address is the essence of wallet security. Wallets allow a user to complete transactions between addresses by requesting an update to the blockchain, the public transaction log instrumental to Bitcoin. Wallets come in a variety of forms: apps for mobile devices and computers, hardware devices, and paper tokens. When making a purchase with a mobile device, the use of QR codes to simplify transactions is ubiquitous.
Bitcoin payment processing fees are substantially lower than those of credit cards or money transfers. The competitive advantage lower fees confer to Bitcoin may lessen or vanish in the future, however. Without a sustained increase in the value of Bitcoin relative to other currencies, payment processing fees must rise over time, and once the Bitcoin ceiling is reached, processing transactions will no longer be rewarded with new Bitcoins. This is due to the fact that the total number of Bitcoins is capped at 21 million and because the creation of each successive Bitcoin requires a larger amount of payment processing work than the last. Fees are generally independent of the amount being sent, making Bitcoin attractive for those seeking to transfer larger amounts of money. In one instance, Bitcoins worth millions of US dollars were transferred for only a few pennies.
While Bitcoin uses cryptography, it does not do so to protect the privacy of individuals, and all transactions are logged in a public file called the blockchain. It is possible, although difficult, to associate Bitcoin transactions with real-life identities. In addition, Bitcoin intermediaries such as exchanges are required[by whom?] to collect personal customer data.
Through various exchanges, Bitcoins are bought and sold at a variable price against the value of other currency. On average, Bitcoins have appreciated rapidly in relation to other currencies including the US dollar, euro and British pound, even though the issuing network halves the inflation rate at four-year intervals.:3
While there may be a seemingly large number, exchanges regularly fail, taking client Bitcoins with them.
First mentioned in a 2008 paper published under the pseudonym Satoshi Nakamoto, Bitcoin became operational in early 2009. The currency had early technical problems such as a 2009 exploit that allowed the creation of unlimited bitcoins.
In 2011 the value of one Bitcoin rapidly rose from about $0.30 to $32, before falling back down to $2.
Bitcoin began attracting media attention in late 2012, and numerous news articles have been written about it. In 2013, some mainstream services such as OkCupid, Baidu, Reddit, Humble Bundle and Foodler began accepting it. That year also saw the first interventions by law enforcement. Assets belonging to the Mt. Gox exchange were seized, and the Silk Road drugs market was shut down.
During November 2013, the China-based Bitcoin exchange BTC China overtook Japan-based Mt. Gox and Europe-based Bitstamp to become the largest Bitcoin trading exchange by trade volume. On 19 November 2013, the value of Bitcoin on the Mt. Gox exchange soared to a peak of US$900 following a United States Senate committee hearing, at which the committee was informed that virtual currencies were a legitimate financial service. On the same day, one bitcoin traded for RMB¥6780 (US$1100) on BTC China. With roughly 12 million bitcoins in existence, the new price means that the market cap for Bitcoin is at least US$7.2 billion.
Large fluctuations in the value of Bitcoin have led some to question its ability to function as a currency. In addition, its deflationary bias encourages hoarding. This reduces the use value of a currency, and has been the downfall of other private currencies.However, currently Bitcoin does see some use as a currency.
Bitcoins are often traded as an investment. Critics have accused Bitcoin of being a species of Ponzi scheme. A case study report by the European Central Bank observes that the Bitcoin currency system shares some characteristics with Ponzi schemes, but also has characteristics that are distinct from the common aspects of such schemes.
Bitcoins have been described as lacking intrinsic value as an investment because their value depends only on the willingness of users to accept them.
Derivatives of bitcoins are thinly available. One organization offers futures contracts against multiple currencies.
Certain investment funds have shown interest in Bitcoin with Peter Thiel‘s Founders Fund investing US$3 million, and the Winklevoss twins making a US$1.5 million personal investment. A Bitcoin ETF may also soon be on offer.
Many have mentioned speculative bubbles in connection with Bitcoin, and Reuters journalist Felix Salmon correctly predicted the bursting of one such Bitcoin bubble in April 2013.
Alternative to fiat currency
Some have suggested that Bitcoin is gaining popularity in countries with problem-plagued national currencies, as it can be used to circumvent inflation, capital controls, and international sanctions.
Bitcoins are used by some Argentinians as an alternative to the official fiat currency, which is stymied by inflation and strict capital controls. In addition, some Iranians use Bitcoins to evade currency sanctions.
Financial journalists and analysts have suggested that there was a correlation between higher Bitcoin usage in Spain and the 2012–2013 Cypriot financial crisis.
Bitcoin’s association with criminal activities has historically hindered the currency from attaining widespread, mainstream use as well as attracted the attention of financial regulators, legislative bodies, and law enforcement. The Washington Post has labelled it “the currency of choice for seedy online activities,” and the FBI stated in a 2012 report that “Bitcoins will likely continue to attract cybercriminals who view it as a means to move or steal funds”.
Some have suggested that due to its close association with illegal purchases, Bitcoin could be made illegal. This assertion has been made by Steven Strauss, a Harvard public policy professor, and was also mentioned in 2013 SEC filing made by a Bitcoin investment vehicle.
In June 2011, Symantec warned about the possibility of botnets engaging in covert mining of bitcoins, consuming computing cycles, using extra electricity and possibly increasing the temperature of the computer. Some malware also used the parallel processing capabilities of the GPUs built into many modern-day video cards. In mid-August 2011, Bitcoin miner botnets were detected again, and less than three months later Bitcoin-mining trojans infecting Mac OS X were also discovered.
In 2013 The Guardian reported that the currency was primarily used to purchase illegal drugs and for online gambling, and The Huffington Post stated that “online gambling accounts for a huge portion of Bitcoin activity.” Legitimate transactions are thought to be far less than the number involved in the purchase of drugs, and roughly one half of all transactions made using Bitcoin are bets placed at a single online gaming website. In 2012, an academic from the Carnegie Mellon CyLab and the Information Networking Institute estimated that 4.5 to 9% of all bitcoins spent were for purchases of drugs at a single online market, Silk Road. As the majority of the Bitcoin transactions were at this time speculative in nature, this academic asserts that drugs constituted a much larger percentage of the products and services bought using the currency, however.
Several news outlets assert that the popularity of Bitcoin hinges on the ability to use them to purchase illegal substances. In addition to such utility, Bitcoin is thought by the FBI to be a potential tool of money launderers, and The Huffington Post stated in 2013 that it is used by online gun dealers to allow the purchase of arms without background checks.
Fears have arisen that Bitcoin may be used to launder money, and a 2012 report by the FBI acknowledged these fears but stated that there were no known instances of this occurring. However, in 2013 US authorities seized assets belonging to Mt. Gox, a service that allowed users to exchange bitcoins for US dollars. Some say one obstacle to bitcoins becoming widely used to launder money may be the fact that the transaction history is public.
Theft and exchange shut downs
It is possible to steal bitcoins, and documented theft has occurred on numerous occasions. At other times, Bitcoin exchanges have shut down, taking their clients’ bitcoins with them. A Wired study showed that 45 percent of Bitcoin exchanges end up closing.
On 19 June 2011, a security breach of the Mt. Gox Bitcoin exchange caused the nominal price of a bitcoin to fraudulently drop to one cent on the Mt. Gox exchange, after a hacker allegedly used credentials from a Mt. Gox auditor’s compromised computer illegally to transfer a large number of bitcoins to himself. They used the exchange’s software to sell them all nominally, creating a massive “ask” order at any price. Within minutes the price corrected to its correct user-traded value. Accounts with the equivalent of more than US$8,750,000 were affected.
In July 2011, the operator of Bitomat, the third largest Bitcoin exchange, announced that he lost access to his wallet.dat file with about 17,000 bitcoins (roughly equivalent to US$220,000 at that time). He announced that he would sell the service for the missing amount, aiming to use funds from the sale to refund his customers.
In August 2011, MyBitcoin, a now defunct Bitcoin transaction processor, declared that it was hacked, which resulted in it being shut down, with paying 49% on customer deposits, leaving more than 78,000 bitcoins (roughly equivalent to US$800,000 at that time) unaccounted for.
In early August 2012, a lawsuit was filed in San Francisco court against Bitcoinica — a Bitcoin trading venue — claiming about US$460,000 from the company. Bitcoinica was hacked twice in 2012, which led to allegations of neglecting the safety of customers’ money and cheating them out of withdrawal requests.
In late August 2012, an operation titled Bitcoin Savings and Trust was shut down by the owner, allegedly leaving around US$5.6 million in Bitcoin-based debts; this led to allegations of the operation being a Ponzi scheme. In September 2012, it was reported that the U.S. Securities and Exchange Commission had started an investigation on the case.
In September 2012, Bitfloor, a Bitcoin exchange, also reported being hacked, with 24,000 bitcoins (roughly equivalent to US$250,000) stolen. As a result, Bitfloor suspended operations. The same month, Bitfloor resumed operations, with its founder saying that he reported the theft to FBI, and that he is planning to repay the victims, though the time frame for such repayment is unclear.
On 3 April 2013, Instawallet, a web-based wallet provider, was hacked, resulting in the theft of over 35,000 bitcoins. With a price of US$129.90 per bitcoin at the time, or nearly $4.6 million in total, Instawallet suspended operations.
On 11 August 2013, the Bitcoin Foundation announced that a bug in a pseudorandom number generator within the Android operating system had been exploited to steal from users’ wallets, the vulnerability affecting wallets generated by any Android app; fixes were provided 13 August 2013.
A Bitcoin bank, operated from Australia but stored on servers in the USA, was hacked on 23 and 26 October 2013, with a loss of 4100 bitcoins, or over A$1 million.
In Hong Kong a Bitcoin trading platform owned by Global Bond Limited (GBL) vanishes with 30 million yuan (US$5 million) from 500 investors on 26th October 2013.
Taxation and regulation
In 2012, the Cryptocurrency Legal Advocacy Group (CLAG) stressed the importance for taxpayers to determine whether taxes are due on a Bitcoin-related transaction based on whether one has experienced a “realization event”: when a taxpayer has provided a service in exchange for bitcoins, a realization event has probably occurred and any gain or loss would likely be calculated using fair market values for the service provided.”
In August 2013 the German Finance Ministry characterized Bitcoin as a unit of account, usable in multilateral clearing circles and subject to capital gains tax if held less than one year.
CNN has called Bitcoin a “shady online currency,” and its links to criminal activities have prompted scrutiny from the FBI, US Senate, and the State of New York.
Some economists that have commented on Bitcoin have been critical. Economist Paul Krugman has been critical of Bitcoin, suggesting that the structure of the currency incentivizes hoarding and also stating its value from the expectation that others will accept it as payment. Krugman considers it wasteful to spend real resources, such as electric power, on the creation of bitcoins.Larry Summers has expressed a “wait and see” attitude when it comes to Bitcoin.
Professor John Quiggin of the University of Queensland has noted that since Bitcoin by design has no intrinsic value, it is “perhaps the finest example of a pure bubble” currently known, but cautions that we have no way to predict when the value of bitcoins will return to zero. Economist Steve Hanke has also mentioned the possibility of a Bitcoin bubble.
Research on Bitcoin has been conducted by the ConvergEx Group and an assistant professor at Carnegie Mellon, Nicholas Christin.