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Monday, April 15, 2013

What is this Bitcoin Nonsense?

In the Internet age there's always something to buzz about. Bitcoin is the latest craze: the virtual currency has been dominating the news recently. It was trading as high as $266 and then fell to as low as $54 last Friday when Mt. Gox, the Japanese bitcoin exchange, was hit by a cyberattack and stopped trading. The Winklevoss twins (of Facebook fame) were calculated to have lost tens of millions of dollars on paper.

What is bitcoin? An artificial currency that is backed by no government and is not tied to any real-world commodity such as gold. Bitcoins are fabricated out of thin air, in pretty much the same fashion as "gold" is in online roleplaying games like World of  Warcraft. Instead of slaying electronic orcs or chipping away at virtual rock outcroppings, bitcoins are created by running computers through complex algorithms to "mine" bitcoins which can then be sold on exchanges.

But that play money doesn't come cheaply: it's estimated that the current production of bitcoins uses $147,000 of electricity a day (enough to power 31,000 homes) just to crank out 25 new bitcoins every 10 minutes. But don't worry, it won't go on forever; in the year 2140 the maximum number will be reached, a total of 21 million.

Supporters of bitcoin decry governments that just print fiat money, claiming this destroys the economy by causing massive inflation. But the bitcoin "miners" are doing exactly what they're accusing government of: making money out of thin air. Many libertarians are calling for a return to the gold standard, but with the recent crash in the price of gold to $1,400/oz (down almost 30%  since 2011) you have to wonder if it's such a stable commodity.

The fact is, the supply of gold is always going up, just like the supply of dollars -- it's just slower. In fact, once we develop the technology for asteroid mining, the price of any precious metal could drop through the basement if we snagged an asteroid with a particularly rich vein. The total amount of gold in the world is amazingly small: a mere 171,300 tons, which would make a cube 60 feet on a side, the size of two adjacent volleyball courts.

So why would anyone use bitcoins? Because it's theoretically untraceable. People like bitcoin because they can buy things over the Internet without any records. It's the perfect medium for paying for prostitutes, laundering drug money, buying illegal weapons, and so on.

That also means bitcoins are easily stolen: if anyone gets hold of yours, it's gone for good. Stories about hackers stealing bitcoins are rampant. That's why the Winklevoss twins supposedly have put their bitcoins on flash drives they've stored in safe deposit boxes in three different cities. All in all, it's not a very safe or useful currency.

The value of any currency depends solely on the trust society has in the institution that backs it. The US government backs the dollar. The EU backs the euro. Precious metals are backed by exchanges that buy and sell them, though gold and copper also have an intrinsic value because they are essential components of every piece technology we use today, and some people still feel gold has an intrinsic value as jewelry.

But the only backers of bitcoin are other bitcoin users. And if those users are primarily criminals, hackers and the Winklevii, how much trust can you possibly put in bitcoin?

The guy who invented bitcoin, Satoshi Nakamoto, doesn't even exist.  He's just a pseudonym for one or more programmers of unknown nationality who posted on Internet forums. So there isn't even a "founder" who will back bitcoin.

Still, I bet the guy who paid 10,000 bitcoins for two pizzas is kicking himself now.

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