Okay, my fingers hurt
Here it is, just the main story without the sidebars. I may go back and re-edit with some corrections to the story. He got most of it right but flubbed a few technical points. It is overall positive for bitcoin in my opinion.
Here's the text:
CoverStory - Currencies - Finweek 9 June 2011
(Virtually) The Strongest Currency - By Simon Dingle
What reached parity with the us dollar in February and is now worth almost nine times as much? The answer
will blow you away...
In debate, currency is very similar to religion. Sane conversations soon head south as the lunatic fringe
takes over. What starts out as civil talk about standards and reserves soon degenerates into an argument
about gold and the US dollar. Money talk is crazy talk. Because - let's face it - money is a crazy
business. But what if we could go back to the drawing board and design an inherently better currency?
In part, that's the goal of Bitcoin - a new, alternative currency taking the online world by storm. It's
being actively traded via Internet-based exchanges. A digital mining community has sprung up to develop
the currency and an ecosystem of goods and services is already accepting it as tender.
So what is Bitcoin? Is it viable? And should you be thinking about it? My conclusion, having researched
the currency, is that you should at least read on. Bitcoin has been around since 2009. The reason it
didn't hit the news two years ago is because it was purposefully kept secret at first. The father (or
mother) of Bitcoin is a mysterious character known as Satoshi Nakamoto. Nobody knows if it's an
individual's real name or something made up.
Whoever Nakamoto is, or isn't, the foundation for Bitcoin is smart and required sophisticated mathematic
modeling and advanced development in computational algorithms. Bitcoin is referred to as a
"crypto-currency". The network that supports it uses complex encryption so everything - from the units of
the currency itself to the supporting transactional system - is very secure. More secure than any current
transactional systems or conventional currencies can be.
While traditional monetary systems attempt to build security around basic units of currency, Bitcoin
builds security into the money itself. Bitcoin was designed from the ground up to be decentralised. The
currency can't be controlled by any government or single institution. Instead, it's powered by a
distributed network of computers on the Internet.
Anyone who uses Bitcoin adds their computer to an international grid network that forms its transactional
system. Your computer becomes a node in that system when you start exchanging Bitcoins. It contains
transactional data of the currency, which is imprinted into every node. In that way Bitcoin uses
peer-to-peer connections to build a global transactional system that can't be stopped without turning off
the Internet.
That's the primary difference between Bitcoin and fiat currencies that only have value due to either
regulations and laws. But Bitcoin derives its value from a decentralised network.
But there's more to value than that. A currency must be accepted for trade of goods and services, or be
based on a resource - such as gold - in order to have value. Indeed, if you ask the Bitcoin community
where the currency gets its value from you'll be told it has value because it's already accepted as
payment by many providers.
The other side of the Bitcoin value debate is how it's generated - which is currently a key point in
discussing any currency, given our less than ideal global status quo, when most things hinge on the US
dollar. And we've seen the consequences of that over the past two years. The greenback is a shoddy
currency in terms of value, which isn't stopping it being bought up to hedge against its own demise...
and back to my point about the sanity of current global markets.
The US dollar is controlled by the US Federal Reserve, which can also print more of the money. So one
organisation is empowered to make key decisions about the entire global economy.
However, the Bitcoin is generated by computers running complex calculations. And that's where things
become really interesting. When you download the Bitcoin software to your computer a digital wallet is
created on your hard drive. That's essentially an encrypted file that stores your Bitcoin balance. That
file can be backed up like any other.
But you can also use your computer to generate Bitcoins. When in that mode your computer's spare
processing capacity will be used to conduct calculations that are fed back into the Bitcoin network.
Nobody knows exactly what those calculations are for, but the consensus seems to be they're progressing
the encryption mechanism for the currency.
Every time a new mathematical problem is solved, the node, or computer, that solved that problem is
rewarded with 50 Bitcoins. A block is created on the network and work begins on solving the next problem.
As the problems are solved they become more complex - so the next block becomes more difficult to
achieve.
In its early days a single Bitcoin user with his PC could realistically expect to solve blocks and get
coins every now and then. But that process - known as "mining" - has become more demanding on computer
resources, so you require a pretty substantial super-computer if you expect to make any real money from
generating Bitcoins. Some miners are using graphics processors (GPUs) because they're better equipped to
solve mathematic problems than a computer's CPU; others are investigating the use of more powerful
computer architectures.
The mining community is now massive and had generated more than 6,2m Bitcoins by the beginning of May
this year. That number will grow at a slowing pace over the coming years until around 2040, when it's
expected a final limit of 21m units of currency will be reached. At that time more blocks could be
created or a decimal shift could be used to adjust the availablity of Bitcoins.
Given they're generated by increasingly powerful computer processing it's been suggested the underlying
value of the currency is in the cost of electricity to power computers over the network. But leaders of
the growing Bitcoin community dispute that. Bitcoin's website -
www.bitcoin.org - states: "It's a common
misconception that Bitcoins gain their value from the cost of electricity required to generate them. Cost
doesn't equal value: hiring 1000 men to shovel a big hole in the ground may be costly but not valuable.
Also, even though scarcity is a critical requirement for a useful currency it alone doesn't make anything
valuable. For example, your fingerprints are scarce but that doesn't mean they have any exchange value."
I decided to track down Bitcoin miners and discuss their prospects with them. What I soon learned was
many of them are less interested in getting rich and more in volunteering their time and computers to
furthering the currency's development, which they see as a worthy cause. However, many are very serious
about making money and have formed mining pools that collectively generate Bitcoins and share them
according to contributed computational power.
I also spoke to one Bitcoin miner in Pretoria who has to date managed to generate only one coin but is
active in answering questions and solving problems with the community. A tracking site for Bitcoin
traders showed more than 100 active in SA - and those are only the traders who sign up to the tracking
service. There are definitely many more playing the game.
Obtaining real names from the community is tricky. Bitcoin is designed to be anonymous. When you pay
someone in Bitcoins you give them a string of numbers and letters: your Bitcoin address. That encrypted
string contains the information their computer needs to send the currency to you.
The actual transaction itself is verified by the network of millions of computers that all carry the DNA
(for lack of a better word) of transactional history. They don't require your name, location or any other
information about you. You can also generate new strings all the time and some Bitcoin traders tell me
they generate a new string for each transaction, making it impossible to track them down.
There are many good reasons why identities should be protected in distributed computing systems and it's
a debate we don't have space for: suffice to say, laundering would be one of the bad reasons, while the
good reasons mostly involve ethics and necessity in some countries.
Another South African trader I spoke to online said it was tricky to buy Bitcoins because most traders
are in the US and will only allow you to buy Bitcoins via EFT or cash transactions. They don't like
accepting PayPal because it's too easy to reverse transactions, claiming no goods or services were
received. He (or she) trades via a US bank account.
There are also concerns in the community about exchange control regulations in SA that have long crippled
our ability to conduct business online, depending on who you speak to. At the time of writing the value
of one Bitcoin was just more than US$8,45. It was at around $7,20 to the Bitcoin when I began my research
in earnest a week ago and was at 1:1 with the US dollar in February. As an investor, that kind of growth
looks too good to be true. Perhaps it is.
One of the most active exchanges for Bitcoin is called Mt Gox (
www.mtgox.com), where Bitcoin traders meet
and set up transactions. Another site of interest is Bitcoin Charts (
www.bitcoincharts.com), where the
currency can be tracked.
One of the only viable arguments I've heard against the Bitcoin currency was from an economist posting
anonymously to a discussion group, who pointed out the system could lead to runaway deflation of the
currency, referred to as a "deflationary spiral".
That's been widely debated by the trading community and a study on the subject has been posted online.
The study suggests Bitcoin won't be subject to deflationary spiralling because it's fundamentally
different from fiat currencies.
The study reported: "The key difference is that people don't forsee a fixed cost (unit amount) that they
must pay with Bitcoin. If the value of the Bitcoins they own increases, then any future cost will take a
proportionally smaller amount of Bitcoins. There isn't any fixed incentive to holding Bitcoin other than
speculation."
It adds: "If the economy that uses Bitcoin grows, the per-unit value of Bitcoin proportionally increases
also. Everything is the opposite of the fiat fractional reserve banking system (because Bitcoin isn't a
debt but an asset). Bitcoins only deflate in value when the Bitcoin economy is growing."
At the crux of the argument is that elaborate controls are in place to ensure Bitcoin generation slows
with time: unlike fiat currencies, where more can be generated at will. The absolute, mathematical
control of Bitcoin protects against many of the problems encountered with traditional currencies and
runaway debt cycles.
You can already buy and sell goods for Bitcoin, its community grows every day and there are some serious
traders investing in the currency - even if they won't tell me who they are. So to write off the idea of
Bitcoin would be short-sighted. For now it's meeting its goals and support is mounting. Things are also
happening rapidly - as they tend to do online.
If nothing else, Bitcoin is an interesting experiment and provides good food for thought about currency,
central bank reserves, resources and financial systems. It answers a dichotomy of economics by being both
tightly controlled but decentralised. It might become a niche system for online payments and displace
PayPal. Or it could grow to become something much more than that. Either way, it would be silly to ignore
it.
