Bitcoin: The realities of virtual currency

Published: Tuesday, April 8 2014 11:37 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.

Bitcoin is typically stored in “digital wallets” that exist either in the cloud or on a user’s computer. The wallet is like a virtual bank account, allowing users to make interpersonal or merchant transactions or save their money. However, unlike bank accounts, bitcoin wallets are not insured by any government entity like the Federal Deposit Insurance Corp.

Even though each bitcoin transaction is technically recorded in a public online log, the names of buyers and sellers are never revealed — just the individual wallet identifications.

Such anonymity allows transactions to remain almost completely private, letting people buy or sell anything with no way to efficiently track them. It is one of the major condemnations leveled at cryptocurrency, which has become the exchange medium of choice for some individuals trafficking in drugs or other illicit activities online.

Potential for fraud

“We have seen a few frauds perpetrated using either bitcoin or potential investments in bitcoin,” said Keith Woodwell, director of the Utah Division of Securities. While some are using the digital currency as a medium of exchange, others have schemed to use it as a way to commit crime.

“Bitcoin, due to its nature, lends itself to potential frauds because of its anonymity,” Woodwell said. “Unlike setting up a bank account where money can be traced, you don’t know who is owning the bitcoin or trading the bitcoin and what its transactions are being used for.”

Conversely, among the advantages of bitcoin is that it can be used to buy merchandise anonymously. Additionally, international payments are easy and less expensive because bitcoin is not tied to any country or subject to any federal regulation. Small businesses may like it because there are no credit card fees. On each transaction, a business saves about 3 percent because they don’t pay bank fees related to debit and credit card use.

In January, Utah-based online retailer Overstock.com became the first major online shopping site to accept bitcoin. Worldwide, thousands of individuals and hundreds of merchants accept cryptocurrency.

Overstock is partnering with San Francisco-based Coinbase.com to process the payments and handle the conversion of bitcoin into U.S. dollars. Earlier this month, the company announced it had sold over $1 million in product to bitcoin users since the online shopping site started accepting the digital currency.

Of the more than 4,300 bitcoin customers that made purchases since then, Overstock estimated that almost 60 percent were new customers.

Noting the lower cost of doing business, Overstock.com Executive Vice Chairman Jonathan Johnson said, “I think people are going to be using bitcoin more and more. I can foresee a time when there may be a credit card price and a (cheaper) bitcoin price,” similar to the lower cash prices offered at some gas stations.

While bitcoin is still only accepted on a very limited basis, bitcoin community organizer Alan Walker believes that will eventually change. He travels the state, educating people on how to use the currency and what to do if problems arise.

“I think we're ahead of the game," Walker said. "Utah has a great entrepreneurial spirit, and because of that, there's a lot of people looking into it."

What's next

Despite the optimism of some supporters, the future of cryptocurrency is still somewhat uncertain. While it is unregulated for the most part, that could change as governments investigate and work to determine the taxation consequences and the current lack of control over the currency.

In Washington, D.C., and other national capitals worldwide, leaders are convening hearings to discuss the current and future economic implications of the latest entry into the world of digital currency. Currently, many countries around the world heavily restrict the use of bitcoin and other digital currency.

During an interview with CNBC, Berkshire Hathaway CEO Warren Buffet denounced bitcoin as “not currency” at all and expressed concerns about its long-term viability, telling the financial news network that he would be surprised if the digital currency was still around in the “next 10-20 years.”

Lately, the cryptocurrency world has been rocked by a number of troubling events. In February, Autumn Radtke, 28, CEO of bitcoin exchange firm First Meta, was found dead in her Singapore apartment. And in one of the biggest collapses on record, Mt. Gox, the world’s largest bitcoin exchange, recently folded after hackers made off with almost $500 million in bitcoin.

Utah County computer and software entrepreneur John Pestana said the Mt. Gox failure was an issue not with cryptocurrency but rather with the exceptionally lax security measures employed by the exchange.

“It would be like driving to New York City to the most dangerous neighborhood in town in your brand new Mercedes and leaving the keys in the car with the window down,” Pestana said.

He added that companies and individuals could easily protect themselves and their bitcoin by storing it in a secure exchange, a cloud-based “wallet” or an offline account.

Pestana described the increase in cryptocurrency usage as “revolutionary” and a movement he expects to grow in the coming years.

Walker concurred, saying there is always the possibility for human error in exchanges, like with Mt. Gox, but the actual cryptocurrency is not to blame.

"It's like someone losing a suitcase of money and blaming money for it," Walker said. "The idea of electronic money is absolutely here to stay."

Contributing: Ashley Kewish

Email: jlee@deseretnews.com

Twitter: JasenLee1

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