Bitcoin: The realities of virtual currency

Published: Tuesday, April 8 2014 12:00 a.m. MDT

A person arrives for the Inside Bitcoins conference and trade show, Monday, April 7, 2014 in New York. Bitcoin users exchange cash for digital money using online exchanges, then store it in a computer program that serves as a wallet. The program can transfer payments directly to merchants or individuals around the world, eliminating transaction fees and the need for bank or credit card information. (AP Photo/Mark Lennihan)

Mark Lennihan, AP

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SALT LAKE CITY — The digital age is broadening in new ways as more individuals and merchants are transitioning into the realm of cryptocurrency — a digital or virtual medium of exchange that uses cryptography for security, making it more difficult to counterfeit.

One of the defining features of cryptocurrency is that it is not issued by a central monetary authority, therefore making it hypothetically immune to government manipulation.

But critics argue the anonymous nature of cryptocurrency transactions makes them well suited for potential illicit activities such as money laundering and tax evasion.

The first high-profile cryptocurrency was bitcoin, which was launched in 2009. Following bitcoin's moderate acceptance, other cryptocurrencies were born, including Litecoin, Namecoin and PPCoin.

What is bitcoin?

Bitcoin is described by bitcoin.org as "an innovative payment network and a new kind of money." It is a peer-to-peer payment network with no middleman. Users send and receive bitcoins within the network of those honoring the system.

Supporters claim cryptocurrencies make transactions easier to facilitate, allowing funds to transfer between two parties more expeditiously. The electronic transfers are typically facilitated through the use of public and private online “keys” for security purposes.

Transactions are processed with minimal fees, enabling users to avoid the higher wire transfer fees charged by most financial institutions. However, a major drawback of cryptocurrencies is that because they are virtual and do not have a central repository, a user’s digital balance can potentially be stolen by a hacker or wiped out by a computer crash if not backed up properly.

Another criticism has been that since prices are based on supply and demand, the exchange rate for a cryptocurrency can fluctuate wildly. The total number of bitcoin that could ever be “mined” is 21 million, though less than 9 million is currently in circulation.

Since its inception five years ago, the value of bitcoin has ranged from virtually nothing for the first two years to a high of $1,151 late last year. A single unit of the digital currency was worth about $452 as of April 7, according to Blockchain.info.

Because of the fluctuation, some people have decided to buy bitcoin as an investment similar to commodities like gold or silver, hoping it will increase in value, which makes the digital medium unique in the real world of money.

“It behaves like a commodity, but you can spend it like a currency,” said Roger Altizer, cryptocurrency researcher at the University of Utah.

Understanding bitcoin

Despite the relative volatility of bitcoin, Altizer said there could be a time when cryptocurrency creates an environment that allows consumers to avoid the complication of exchange rates and currency conversions that are required in trading traditional monies today. Using a universal digital medium could simplify the process greatly for everyone, no matter where they might live, he explained.

“If bitcoin stays around, it’s going to change the way that money works on our planet,” he said. “It’s exciting to see what a truly democratic currency would look like.”

When bitcoin was originally created, people “mined” it using powerful computers to solve complex math problems, receiving bitcoin as a reward for identifying the algorithm. But today, most people acquire bitcoin through exchanges where the cryptocurrency is bought and sold globally. Users can also transfer bitcoin to each other online or using mobile apps, similar to sending cash digitally.