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Bitcoin fever: The virtual money everybody may use someday

Published: Friday, Oct. 11 2013 8:30 a.m. MDT

Because bitcoins do not identify their users, they are practically anonymous. A record of the transaction is kept, but who is paying that amount to whom is hidden by the coins' encryption. This means, McIntyre says, bitcoins are great for people who have privacy concerns.

This is the area that has governments concerned, since bitcoins could be sent by terrorists or drug dealers. Forbes recently used bitcoins to successfully purchase drugs online from the now defunct Silk Road — although the transaction was not quite as untraceable as some bitcoin users may think.

McIntyre, however, sees the positive uses of a private currency. He says people in oppressive countries could use it to transfer money or hide it from the government.

Jerry Brito, a senior research fellow at the Mercatus Center, a free-market leaning think tank at George Mason University in Arlington, Va., calls bitcoins a "censorship-resistant currency." A blogger in Iran can pay for their Wordpress.com account in bitcoins without the government being able to track them. A charity operating in Russia can use bitcoins to transfer money into the country easier.

But, in normal life, bitcoins are not yet convenient to use, McIntyre says. Transferring bitcoins can take about a day.

No central authority

The biggest problem bitcoin backers had to solve was an issue that had long made virtual money virtually worthless: Virtual money is just too easy to copy, says Brito.

He says the difference between cash and virtual money is similar to the difference between a book and a Microsoft Word document. The book can only be given to one person. A Word document can be copied and sent to multiple people.

In the same way, a person could take a virtual amount of money and send it to multiple people.

Normally this sort of problem is solved by a third party. The third party — such as PayPal, Visa, MasterCard, etc. — keeps track of who pays what to whom. This central authority keeps everyone honest.

But central authorities are easy to influence, pressure and regulate by governments. For example, the controversial Wikileaks had its funds frozen by PayPal — stopping donations.

Bitcoins' creator, the mysterious "Satoshi Nakamoto," came up with a way to solve the problem of double spending without creating a central authority. Nakamoto (an online pseudonym) created an electronic record or ledger that would keep track of every transaction ever done with bitcoins. Everybody who used bitcoins would have access to the record.

Instead of a central authority creating and maintaining a ledger, bitcoins' ledger, called a "block chain," could be maintained by anyone. To stop hackers, the records of transactions could only be added to the ledger after complex mathematical puzzles were solved by multiple users. The method makes it impossible for even a group of hackers to mess with the records.

As an incentive to get people to work on the ledger block chain, people can be rewarded with bitcoins.

So multiple levels of encryption and mathematical puzzles and incentives and dividing responsibility take the place of a central authority and make bitcoins secure.

"Paper money can be counterfeited," Brito says. "PayPal could be breached. ... But with bitcoins it is cryptographic in nature and to break into it you would have to break the code and it is not clear that that is possible with today's technology."

This isn't to say that individual bitcoins couldn't be stolen. The money is kept in virtual wallets on computers, and if somebody hacks into it, they may be able to steal the key numbers that identify the money. And then, if it is taken, it is gone.

Brito contrasts this with payment systems with central authorities like credit cards or PayPal. "Basically, they offer consumers insurance," he says. "With a credit card, you can have your transaction reversed. There is fraud protection. With bitcoin, it is final like cash."

Bitcoin paying

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