Cryptocurrency And The Channel: Brother, Can You Spare A Bitcoin?

It would be hard to invent a story more interesting than the true events surrounding Bitcoin, the virtual currency introduced in 2009 that's currently sweeping the planet. In the past month or so alone, its once-anonymous founder admitted then denied involvement, his discovery was debunked, and its largest exchange crashed and misplaced bitcoins worth nearly a half-billion dollars. Also, at least one possible suicide was linked to the fledgling currency. The value of one bitcoin has been as much as $1,250, an increase of more than 9,500 percent from its low of $13. It's currently worth about $630.

Bitcoin is an infrastructure for generating and exchanging monetary units between one person or company and another. It involves no banks or credit-card companies, and there are no countries to control, manipulate or potentially destroy the currency. Transactions are private, encrypted and secure -- conducted between one buyer and one seller located anywhere in the world with no oversight whatsoever.

For technology companies, accepting bitcoin as payment for goods and services can bring numerous benefits with minimal potential downside. It's free to accept bitcoin as a merchant and there are no chargebacks or bank fees. There are numerous POS apps, including a free one released by bitcoin wallet provider Blockchain.info in mid-March. Bitcoin accounts cannot be frozen, they can be used in every country, and there are no prerequisites or arbitrary spending minimums. What's more, companies accepting bitcoin gain exposure to the bitcoin economy and tend to receive additional business that way.

"It's a good way for startups to get noticed," said Tom Peterson, director of technical marketing at Nvidia, whose graphics processors are a key part of many Bitcoin mining rigs.

"It's easy to criticize Bitcoin as a crazy idea," said Jim Murphy, CEO and founder of BoltMade, a solution provider based in Waterloo, Ontario. "But as you compare it with our currency, maybe it's stronger physics-wise because it doesn't rely on optics." Founded in 2013, BoltMade partners with customer development teams to create purpose-built Web and mobile applications. It doesn't currently accept bitcoin.

"It's easy to like the current system, but it's really an amazing Rube Goldberg contraption in the 21st century, where bitcoin as a technology is impressive and solves a lot of problems." Will cryptocurrency be the payment system of the future? "I'm not sure," said Murphy, "and I'm [also] not sure the tech will be the most important factor."

So What Is Bitcoin?

Bitcoin is one of about 70 cryptocurrencies, known collectively as altcoins. Bitcoin software is open source, which has given rise to dozens of altcoins. Most are variations of either Bitcoin or its lightweight spinoff, Litecoin. Some -- with names such as Coinye and BBQcoin -- were created on a whim and will likely remain relatively worthless. But about a dozen have a market capitalization in excess of $10 million, and two -- Bitcoin and Ripple -- are valued at more than $1 billion. In terms of trade, Bitcoin and Litecoin top the charts with daily dollar volumes of $50 million and $10 million, respectively. Another three altcoins trade in excess of $1 million daily; the remainder have less.

One might acquire bitcoins (lower case "b," for the currency) in three ways. The first and easiest is to simply buy them. Bitcoins can be purchased with cash, wire transfer, debit card and other means through numerous exchanges in many countries. If a credit card is the only option, a group of developers in Waterloo built Tinkercoin, which sells fractional bitcoins in $25 chunks and will set up the digital wallet in which to store them.

The second way is to begin accepting bitcoin as payment for goods and services, as TigerDirect recently did. "Customers were increasingly asking to buy with bitcoin," said Steven Leeds, the company's director of marketing and brand management. TigerDirect doesn't actually accumulate bitcoins, however. Instead, the company sought to minimize complexity and risk by engaging with BitPay, an independent clearinghouse. "It's a transaction tool, like PayPal," Leeds explained. BitPay takes bitcoin from customers and pays TigerDirect in U.S. dollars, with customers never the wiser. "They never even leave our website," he said.

The third way is to earn bitcoins by hosting part of the Bitcoin network. A Bitcoin transaction is processed by an ordinary computer that's equipped with one or more high-powered GPUs and running an app called bitcoin miner. When transferring bitcoin from one party to another, a secure signature is added and verified by a bitcoin miner. Once that's done, a commission is paid to the owner of the mining rig and the transaction is anonymously recorded and stored in the network.

NEXT: Intrinsic Value

Intrinsic Value

From where does the bitcoin acquire its value without gold or even a good-faith promise to back it up? Aside from bitcoin's value to speculators, who have profited from its volatility, cryptocurrencies are attractive to businesses because transactions are untraceable, indifferent to borders and effectively free. The digital wallets in which bitcoins are stored cannot be frozen, confiscated or stolen.

The anonymity of cryptocurrencies is attractive to libertarians as an alternative to national currencies, and to criminals as a means of hiding illicit activities. It has hence drawn scrutiny from governments and law enforcement agencies but has yet to be strongly regulated.

However, in July 2011, the U.S. Treasury Department added language to its definition of money services businesses to include substitute currencies. And in 2013, the department designated exchangers and administrators of convertible virtual currencies as money transmitters that must comply with rules to prevent laundering, terrorist financing "and other forms of financial crime."

The value of bitcoin also is aided by the Bitcoin algorithm itself, which controls the creation rate to keep supply predictable and limited. Currently, about 25 bitcoins are added to the circulation every 10 minutes. That rate will be cut in half every four years, and with a cap of 21 million bitcoins, increases will continue for more than 100 years. There are 12.5 million bitcoins in circulation today.

The Security Of Hash

In peer-to-peer file sharing, no one is harmed if a shared file is distributed to more than one person. But peer-to-peer currency must include a mechanism to prevent double-spending that does not involve financial institution. In Bitcoin, transactions are protected by being highly complex. "We define an electronic transaction as a chain of digital signatures," reads a white paper at bitcoin.org attributed to Satoshi Nakamoto. "Each owner transfers the coin to the next by digitally signing a hash of the previous transaction and the public key of the next owner and adding these to the end of the coin." Each payee can verify all the signatures and thereby verify the chain of ownership, but still has no way of knowing if that bitcoin also was spent elsewhere.

To address the problem of double-spending, the Bitcoin solution begins with a time stamp. "For our purposes, the earliest transaction is the one that counts," and later attempts to double-spend are ignored, according to the paper. "Each time stamp includes the previous time stamp in its hash, forming a chain, with each additional time stamp reinforcing the ones before it." But the only way to confirm the absence of a transaction is for the system to be aware of all transactions.

So Bitcoin implements a compute-intensive proof-of-work system that hashes a block of time-stamped items and widely publishes it to prove their existence. This keeps the system safe from fraud because "to modify a past block, an attacker would have to redo the proof-of-work of the block and all blocks after it and then catch up with and surpass the
work of the honest nodes." The probability of this "diminishes exponentially" as blocks are added to the chain.

"Bitcoin assures that no one commits fraud because miners evaluate the entire ledger as if from scratch at fixed intervals," explained Nvidia's Peterson. New transactions have to be seen as consistent by a majority of nodes or they're disregarded.

"The process of mining is to verify the ledger and perform proof of work -- a very large computation that's difficult just to be difficult," continued Peterson. That difficulty is intended to make it harder for attackers to crack than to earn bitcoins legitimately. "After verifying the new transaction, the first miner to complete the work broadcasts that fact and gets to add to the public ledger. Mining is like a global race to verify transactions, and the reward for winning the race is 25 bitcoins."

NEXT: Homegrown Exchange

Homegrown Exchange

Before scrambling to build your own mining rig, there are serious risks to consider. First of all, it's late in the game. "The more people that enter, the less likely you are to mine successfully," said TigerDirect's Leeds. To have any chance of winning the transaction race, your mining rig needs to be super-powerful. And that generally begets a power hog. "The power consumed by the rig might cost more than the bitcoins you've mined," said Leeds. "People are setting up mining rigs in Finland because electricity costs over there are super-cheap."

According to Peterson, companies were building ASICs to handle some of the Bitcoin workload and unburden those power-hungry GPUs. This gave rigs at some companies an unfair advantage. "So a new currency -- Litecoin -- was invented to counteract ASICs getting all the transactions."

Then there are the large-scale issues, among the biggest of which is currently playing out in U.S. courts. On March 12, a federal judge temporarily froze the assets of Mark Karpeles, former CEO of Mt. Gox, the failed Bitcoin exchange that was once among the world's largest. The exchange on Feb. 7 halted bitcoin withdrawals and subsequently issued a statement citing "a bug in the bitcoin software that makes it possible for someone to use the Bitcoin network to alter transaction details to make it seem like a sending of bitcoins to a bitcoin wallet did not occur when in fact it did occur." It was ultimately disclosed that 850,000 bitcoins valued at nearly $475 million were missing, mostly belonging to customers. The company on March 9 filed for bankruptcy protection in the U.S. It is now facing at least one civil suit.

About a week after Mt. Gox began having trouble, Bitstamp, another of the world's largest bitcoin exchanges, was down for four days due to denial-of-service attacks. According to Peterson, events like these definitely have an effect. "It's all about investor confidence," he said. "If you shut down an exchange, and some currency is missing, that's a huge blow to confidence." Mt. Gox was the biggest bitcoin exchange, at its peak handing 70 percent of the world's transactions, yet it's still unclear where the fault lies. "Some are saying that bitcoin is OK; that it was a problem with Mt. Gox."

The cryptocurrency saga took a tragic turn when the body of Autumn Radtke, CEO of virtual currency exchange First Meta, was found at the foot of her Singapore apartment building. Though not officially ruled a suicide, her death was widely reported as such. What also remains unclear is whether bitcoin played a role. First Meta is not an exchange for bitcoin but does accept bitcoins as payment for other virtual currencies.

Bitcoin Accepted Here

These and other recent events have left Bitcoin bruised but not beaten. High-profile incidents over the past few months include the closing of Bitcoin bank Flexcoin, resulting in the loss of $600,000; the January theft of $1 million by hackers from European bitcoin payment processor BIPS; and the disappearance of China's GBL exchange along with $4.1 million. Yet the currency still thrives. Even Mt. Gox has shown signs of life. The troubled Japanese exchange last week reopened its doors to allow investors to check their balances, although it isn't yet allowing asset transfers.

Bitcoin development, meanwhile, continues apace. Bitcoin version 0.9 was released last week, along with numerous fixes and the separation of wallet and other functions from the newly branded reference client called "Bitcoin Core." With an eye toward the future, this allows noncore functionality to follow a different development track. The release also includes enhancements to receive-coin workflows and a new feature called Coin Control, which lets users decide how to spend their change following each transaction.

With thousands of transactions an hour and growing, the world has seemed to demonstrate a need for a mechanism for moving money that's free of government interference, institutional control and fees of any kind. And one that lets users control their own privacy.

As regulators figure out what they'll need to make it work, the Bitcoin world simply shrugs and moves on.

PUBLISHED MARCH 24, 2014