This post was contributed by a community member. The views expressed here are the author's own.

Health & Fitness

Bitcoin, the Decentralized Monetary Phenomenon

What is this bitcoin? Is it money?

The Saturday Night Austrian met at Jake O'Connor's in Excelsior to discuss the bitcoin electronic currency phenomenon. We pondered:

What is money?

Money is a medium of exchange.  "Moneyness" is that medium's ability to facilitate an exchange. Is it reliable, and does it have credibility to be commonly accepted?

Find out what's happening in Lake Minnetonkawith free, real-time updates from Patch.

Commonly understood monies are the US dollar and other government issued notes, gold and other precious metals, credit, locally issued or entity-issued (eBay, Facebook) currency, even stocks and bonds, and any goods used for barter.  A new form of money is electronic currency, predominantly bitcoin.

So bitcoin IS money.  But is it good money?

Find out what's happening in Lake Minnetonkawith free, real-time updates from Patch.

What is bitcoin?

Bitcoin (BTC) is a decentralized and limited currency, a medium of exchange, that is accounted on a peer-to-peer network, or thousands of individuals' personal computers synchronizing transaction logs via the internet. A bitcoin has its own unique identifier that is necessarily associated with a bitcoin address.  Any existing bitcoin is owned by an address, which changes upon a transaction.

How does bitcoin work for the user?

On its face, bitcoin operates much like a PayPal account but with no to miniscule transaction fees.  A user sets up a "wallet" online or on their computer or smartphone. (There is also a paper option.) There are several wallet application providers for both the PC and smartphones.  A user first buys bitcoins through an exchange such as Mt Gox or uses bitcoins already in his wallet to complete a transaction.  Payments are made to an "address" or public key, often upon invoice, just as they would to an email address on PayPal.

Each bitcoin owner or user has at least one unique alphanumeric "address" or public key, similar to an email address, that signs each transaction at issuance and receipt.  These addresses are assigned when a user creates a wallet or requests a new address. Users will sometimes create a new address for each transaction via software or merchant programs.  A private key stored in a wallet is also necessary for each address, but this is all done programmatically and is not something the user needs to worry about.

Because bitcoin is a peer-to-peer currency with no central authority to issue new money or track transactions, it is managed by a vast decentralized network of voluntary "miners." (More about the miners below.)  These miners are contributing their computer's processing power to update transactions across the network. This vast network of computing power is constantly updating the transaction log, creating hundreds of thousands of copies of this log.

Origins

The first Bitcoin transaction was completed by an anonymous person or persons under the name "Satoshi Nakamoto" in January, 2009, allegedly the same person or persons who created the first open-source bitcoin software, though the concept dates back to 1998, and many of the mathematical algorithms and encryptions date up to hundreds of years ago.  The first dollar exchange rate was published in October, 2009 at $1 = 1,309.03 BTC. 2010 through 2012 saw a progression of early adopter activity and associated hiccups.  2013 saw acceptance and adoption speed up significantly.  This was evidenced by a single bitcoin value breaking $100 USD on April 1 -- up from dollar parity in February, 2011 and $20 to 1 BTC February 1, 2013 -- and an arguable bubble up to $250 USD this month, correcting to the current $133.

How bitcoins are created

An algorithm established at the outset of the open-sourced bitcoin's release sets the number of bitcoins available to be mined.  Acquiring fractions of bitcoins through mining is a small incentive to those who voluntarily allow their computing power to be used to process transactions.  The new number of bitcoins released each year decreases until the total number of created bitcoins reaches 21 million in the year 2140.  Ostensibly this algorithm was set to mimic precious metal mining and the scarcity which makes metals monetarily valuable.

Downsides and dangers

All money has some downside and danger.  One can lose cash.  Identity theft threatens bank accounts.  Stock markets crash, dollar inflation siphons off savings.

Bitcoin is extremely difficult to steal, but it has happened.  On March 1, 2012 nearly 50K BTC were stolen from eight users after security breach at web host Linode.  Admittedly there was lax wallet security, and users would be wise to better secure their bitcoins just as they would their wallets and checkbooks.

Bitcoins CAN be rarely lost.  The private keys stored in a wallet on a computer can be lost in a computer crash, meaning the associated bitcoins can never be accessed.  If you're storing digital money on your computer, back it up.

Like anything else, bitcoins are subject to human action, even irrational exuberance.  Until there is greater general acceptance, understanding, and an ability to anticipate market conditions relating to bitcoin, bubbles and busts will likely occur.

There is no FDIC of bitcoin.  With freedom comes an assumption of risk.

Government will likely respond to healthy competition to its dollar system.  While the peer-to-peer network is decentralized and elusive, government doesn't well tolerate competition.

But when human ingenuity is involved, there are always answers to any weakness, and the open-source system will step up to solve most of these.  In fact, we discussed numerous solutions at the Saturday Night Austrian.

Upsides

Privacy.  Freedom.  You can receive or hold your money in Ecuador or Minnesota, and no one needs to know where it is, where you got it, where you're spending it, or how much you have.  It is not linked to you.  You merely possess the key to use it.

Currency competition.  As with anything, all are better off economically when maximum choices allow for the best system, forcing improvement of all other systems. Inspired by bitcoin, other, even better, systems are likely to emerge. My hope is that bitcoin itself will see competition necessitating its and others' open-source improvements.

Proof that humans can be ingenious without or in spite of government. In answering the question, "who will coin the money," we may be more open to contemplate the question of "who will remove my trash" or "who will educate our children." Remember Ma Bell?  Often there's a better way.

 ~ ~ ~

The Saturday Night Austrian contemplates a different economic matter in an informal discussion each Saturday evening.  We just moved to Jake O'Connor's in Excelsior.  Watch the Patch for event postings or check our Facebook group.

We’ve removed the ability to reply as we work to make improvements. Learn more here

The views expressed in this post are the author's own. Want to post on Patch?

More from Lake Minnetonka