A brief introduction to the Bitcoin, What is it?

Bitcoins are the internet’s first decentralized digital currency.  People get confused because unlike traditional currency, which I’ll refer to as fiat currency, Bitcoins aren’t backed by any banks.

So who backs it?

Bitcoins are backed by software.  And since there’s no central bank the coins are anonymous, arguably more secure and completely disparate from government regulation.

Coins are transfered directly from person to person with no middleman so fees are lower, the coins can be used in any country and there are no prerequisites to get started.

How it Works

US currency is backed by the Federal Reserve, which is the central agency that actually issues the currency.  Conversely, Bitcoins are generated through a processes called mining.

Basically you have a bunch of computers connected to a network that are all trying to solve a resource intensive math problem.  Whoever successfully solves it creates a new block.

There is CPU, GPU, and even ASIC mining which is super fast but currently only in the hands of a small pool of miners.

The catch is that it costs real dollars to outfit a system that can mine coins more efficiently.  For example some groups have purchased entire collections of high-powered computers to mine new blocks with the expectation that the value of the mined block will offset the exorbitant hardware costs. People have used employed assorted hardware to ease the mathematical burden of mining the coins but it’s a delicate balance.  You need a stronger machine to mine more coins; however, a stronger computer costs more money; therefore, it might not make sense.

The network automatically adjusts the mining activity so that the total amount of bitcoins in circulation is created at predictable and limited rate. .

And this is the thing: the software is completely open source so anyone can review it.  And not only that: anyone can create a bitcoin by downloading a free program called a Bitcoin Miner.

Why it Matters

You can actually purchase real, physical goods and services with Bitcoins.  There are exchanges such as Mt. Gox and CryptoXchange that let you trade your Bitcoins for real cash such as Dollars and Euros.   Moreover, some small businesseses and online sites accept Bitcoins as a valid form of payment.  On the flip side, since Bitcoins are anonymous people have abused it to buy and sell illegal drugs online.  It’s hard to track who is actually making these purchases because of the nature of Crypto-currency.  This innate feature of anonymity has unwittingly abetted drug dealers in their machinations.

But alas, you can use a knife to kill or eat.

Bitcoins are here to say and are getting the attention of some big names.  Cameron and Tyler Winklevoss, also known as the Facebook Twins, are trying to bring bitcoins to public investing.  Today, they filed a proposal to allow investors the right to trade Bitcoins through an exchange traded fund.

I wonder what effects this will have on Wall Street?

Implications

Is this where our world economies are heading?  Are we heading to decentralized digital currencies that are completely independent of regulation?  How will we obviate fraud?  How will we account for the nascient digital drug selling markets that are exploiting Bitcoins?  What happens if people start using it in other illegal activities such as Sex Trafficking and Prostitution?

Also how will Bitcoins be taxed?  Also, since the code is open source does this open the door for data theft?

What do you think?  Let me know in the comments below.

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