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Summary:

There have been many failed attempts at launching a digital-cash system, but that hasn’t stopped a group from trying to launch a “peer-to-peer” currency called Bitcoins. Although supporters are optimistic, the venture is fighting a massive uphill battle: for one thing, Bitcoin may actually be illegal.

Over the past decade or so, there have been dozens of attempts to create a new kind of electronic currency that people could use for online transactions — there was CyberCash and DigiCash, and even smaller startups with bizarre names like Beenz and Flooz. None of them managed to gain much traction, but that hasn’t stopped a group of hackers from trying to launch a new “peer-to-peer” currency called Bitcoins. Although some of its supporters are optimistic about the potential for this new kind of open-source e-money, the venture is fighting a massive uphill battle: for one thing, Bitcoin may actually turn out to be illegal.

The project was started by programmer Satoshi Nakamoto in 2009. But it has picked up steam during the past several months, in part because of some publicity around the project. Bitcoin also benefited a bit from the controversy over PayPal cutting off the ability to send money to WikiLeaks, which for some raised red flags about one company’s ability to impede the transfer of money. One of Bitcoin’s features is that it is completely decentralized, and so is theoretically immune to censorship or restraint. It doesn’t require the use of a bank or payment-handling system like PayPal (which is blocking Bitcoin payments, coincidentally enough).

Bitcoin isn’t the only venture that is going after the e-currency pie: we’ve written before about Flattr, the micropayment startup founded by The Pirate Bay co-founder Peter Sunde, which is trying to create a “tip jar”-style payment system for content (the company recently launched a way to integrate payments with Twitter).

But Bitcoin is somewhat more ambitious than Flattr, or many of the other micropayment and e-currency experiments that have gone before it. Rather than simply create a kind of virtual points system in which the points can eventually be converted into “real” money — or used to buy goods, the way that frequent-flier points and other quasi-currencies (such as “Canadian Tire money”) can — the founders of Bitcoin want to create a completely separate and virtual monetary system. In other words, one that could theoretically replace the existing system if enough people decided to use it.

That’s the difficult part, of course. Why would anyone use a virtual currency that has no “real” value, and is based on a system run by a group of shadowy hackers? Some programmers have started to accept payment in Bitcoins, but that’s not really a great indicator of a robust monetary platform — in a sense, it’s just like people exchanging goods or services in a barter system, something that is a big part of what economists call the “underground” or shadow economy. Supporters (including the Electronic Frontier Foundation) promote the idea that Bitcoins are free from government interference and can’t be frozen or devalued by anyone.

The idea of virtual currency isn’t really that far-fetched in some ways. Money as we know it is already somewhat virtual, since the pieces of paper and bits of metal that we use to pay for things don’t have any actual value themselves — their only value is that they can be exchanged at stores for things that actually have value, like food. Their underlying worth is determined by the central banking system and the government, through a series of federal guarantees, the setting of interest rates and so on (money used to be backed by physical gold in Fort Knox, but that hasn’t been the case since the 1970s).

And what is Bitcoin’s value backed by? Well, that’s where things get complicated. The value of a Bitcoin is determined in part by supply and demand — the system is set up so that there are only a finite number of Bitcoins in existence, which prevents the problem of people just “printing” more Bitcoins the way crumbling governments have in places like Germany in the 1920s. Bitcoins are actually generated by the routine functions of a computer that is processing large mathematical problems (known as “Bitcoin mining”), so the supply is controlled, and will never exceed 21 million.

Even apart from convincing people that they should start accepting or using it as currency, however, the biggest problem Bitcoin could have is a legal one: if the U.S. government decides to treat it as a “private currency,” then it could be subjected to all kinds of strict regulation — such as the need to integrate with the taxation system, or provide for exchange into U.S. currency at certain rates — or it could simply be outlawed entirely.

Post and thumbnail photos courtesy of Flickr user Quazifoto

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  1. Sounds really hockey and borderline illegal.

  2. Lucian Armasu Monday, May 16, 2011

    If Bitcoin keeps spreading like this for the next 6-12 months, I don’t think they’ll be able to stop it anymore.

    Jason Calcanis was right in his show on Bitcoin. In many ways Bitcoin is like BitTorrent and once it’s out of the box, you can’t put it back in. But Bitcoin would most likely bring much bigger changes than BitTorrent ever did, and I mean in that in a good way. People might need things like Bitcoin in the future to escape their increasingly oppressive Governments that want to control and censor everything.

    And speaking of which:

    http://arstechnica.com/tech-policy/news/2011/05/new-bill-upgrades-unauthorized-internet-streaming-to-a-felony.ars

    1. Thanks for the comment, Lucian — I’m not sure that Bitcoin has an obvious use for most people though, unlike BitTorrent.

      1. You’re not sure that people will have a use for a decentralised method of paying for things online that doesn’t require an account?

  3. Rube Suckerman Monday, May 16, 2011

    Imaginary digital money. What could possibly go wrong with this idea?

    1. As opposed to the imaginary fiat money that powers most of the global economy now?

      Well, by that comparison, a whole lot could go wrong, but would it be any worse than the status quo?

  4. Bitcoin is not in any way illegal! But the rich1% that looks down at you as their slave would very much like you to think so and they’ll do anything to protect their precious Dollar.

  5. “shadowy hackers” Your article is kinda crap. For one the Bitcoin project is Open source. There is nothing “shadowy” about an open source project. Any one can see the code and commit on it. Thats the main reason why bitcoin is completely different from other digital currencies backed by a “private” company.

    Just because someone knows how to read computer code does not designate them as a “Hacker”.

    1. Mathew Ingram N/A Tuesday, May 17, 2011

      You’re right — “shadowy” makes those working on the project sound shady, and that’s not what I meant. I should have said “little-known” or something like that. I also thought it was a little odd that no one is sure whether Satoshi Nakamoto is even a real person. In any case, thanks for the comment.

  6. It doesn’t really matter what the US government does. There’s a world outside the US, you know?

  7. As opposed to the imaginary fiat money that powers most of the global economy now?

  8. I think you are safe to use words like “shadowy”. You also could of called it “magic” or “witchcraft”. Most people that are scared of change and things they dont understand result to words like that. The next big test will be if China trys to stop it by bringing online some super computer nodes. The idea is out of the bag for sure, but bitcoin has not yet been tested or attacked by governments yet.

  9. US Government won’t bother until this system gets any traction to speak of. And of course if system offers possibility to pass transactions outside of taxation system (which looks like it’s the case with bitcoins) – it will have hard time surviving.

    1. The system has actually already gained quite a lot of traction and it’s growing by the day. The article’s tone (though not that bad overall) doesn’t really do justice to the amount of popularity bitcoin has already gained. For one, it was already featured in NY Times, for instance. Also, the BTC/USD exchange market is growing and an experimental stock market in BTC is already open. The number of services available by paying in BTC is growing by the day too.

  10. Zbigniew Lukasiak Wednesday, May 18, 2011

    There is a draft paper on the possible legal status of bitcoin: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1817857

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