Last Friday the Studio hosted a talk about Bitcoin; an online currency that has been attracting comment and debate right across the mainstream media. Sam Phippen came in to explain some of the ins and outs of this peer-to-peer cryptographic system, and to debunk some of the myths surrounding it. This is my understanding of some of the key areas discussed in the talk.

Sam began by discussing what Bitcoin actually is, and in order to do this, gave us a bit of insight into what it is trying to replace. He did this by going through the history of our use of gold as something to trade with. We began smelting gold into jewellery and coins, and trading with the metal itself. When this became impractical, we built banks to hold the gold, and carried around promisary notes to exchange for things. The government then bought the gold, and promisary notes turned into cash. The amount of cash you had represented a portion of the amount of gold the government had in their deposits. Now, cash is backed by the government; the government asserts it has its value, but this value is unrelated to gold, or any other physical commodity. This is more or less exactly where Bitcoin is now, except Bitcoin is digital, not physical. It exists on the Internet, and some say that it is an ‘Internet Currency’, but that is only a useful label if you compare it with the things that define that term.

Some examples of Internet currencies reside in games such as Second Life and World of Warcraft. Second Life has its own online economy, where things are bought and sold in exchange for Linden Dollars. The Creators of Second Life, Linden Lab, created a real money exchange. They have effectively created a foreign currency, where things like exchange rate and transaction fees are not decided by supply and demand, but by the game developers themselves. World of Warcraft has its own currency, but the makers of the game did not want any players to have a financial advantage, and so have not set up a way to buy game currency with real money. One bi-product of this has been that there are people in poorer countries whose job it is to mine for gold in the game world, and sell it to richer players for real money. PayPal is also an interesting example of Internet Currency. PayPal charges large fees for exchanging between currencies, and has been known to freeze people’s accounts. When the creator of Minecraft had his account frozen due to what PayPal thought was fraudulent activity, and had 600,000 euros stuck in PayPal that he couldn’t use. This is an example of the more active role PayPal play in overseeing accounts and transactions.

These examples of Internet currencies are centralised; there is a single party that is in control of these currencies and their exchange values. Bitcoin, at its core, tries to do away with that. Having no central authority, all computers connected to the Bitcoin network are considered equal. There are no transaction fees, and using Bitcoin is one of the easiest ways to move money across international borders (although it has now been banned in China). Your account cannot be frozen by anyone except you, and once you have Bitcoins, you can send them to anyone else in the world with a computer, unless you lose or destroy your own computer. There is no central issuing authority, instead, Bitcoin is acquired through a process called Bitcoin mining. The creator of Bitcoin designed a clever algorithm in order to be able to do this. This requires some difficult computing, which Sam attempted to explain with an analogy; you have a bucket with a thousand dice. If you roll all the dice and get one or more sixes, you win a prize. The problem gets more difficult if you are told you have to get two hundred or more sixes in order to win the prize. The network itself measures how fast everyone is running this computation (how fast buckets of dice are being rolled all over the world) and calibrates the difficulty of the problem so that there is one winner every 10 minutes. The winner of the ‘mining problem’ gets 25 Bitcoins. If this were to continue forever, inflation would start to occur, as the more Bitcoin there are, the less value they hold. The creator/s of Bitcoin (whose identity is unknown, though they work under the pseudonym of Satoshi Nakamoto) didn’t want this to happen, so the award halves every 210,000 winners. Bitcoin mining will stop completely after the 21,000,000th coin has been mined. This number will not stay at 21,000,000, as Bitcoins can be lost or destroyed, so the number will decay over time.

In order to use Bitcoin, you have to download a piece of software called a Bitcoin Wallet, which is a peer-to-peer client, much like a torrent client, which generates a cryptographic key, with both a public part and a private part. Your public key allows people to send you Bitcoins, and your private key allows you, and only you, to send your Bitcoins to other people. All transactions are public. A lot of the media frenzy surrounding Bitcoin was and is due to the assumption that it is anonymous, but research has shown that you can capture IP addresses and recover identity from Bitcoin transactions relatively easily, unless additional measures are taken to withhold identities.

Because it is decentralized, Bitcoin has been used for a number of causes that have been described as crypto-anarchistic. One of these is Wikileaks. In 2010, just before an archive of 90,000 files, logging the history of the war in Afghanistan was posted on the Wikileaks website, MasterCard and Visa stopped processing transactions to Wikileaks. In order to keep their servers running to host the huge amount of traffic that was about to arrive at the site, Wikileaks needed donations. They decided to take Bitcoin donations, and received 3500 Bitcoins, which at the time amounted to $35,000; more than enough to keep their servers alive for a few months. Similarly, Edward Snowden’s journalistic legal defence campaign, takes Bitcoin donations, as donating in Bitcoin seems to carry a lower risk of being flagged by the NSA.

Perhaps one reason why Bitcoin has made such a name for itself is down to its use as a payment for Silk Road; an online black market on which you can buy weapons, drugs and all manner of illegal things. Silk Road was a hidden website, which used a software called Tor to camouflage traffic to the site, making it almost impossible to monitor. Bitcoin was used as payment as its transactions were hard to track, and the website was only closed down because the FBI found a coding error in the site, two years after the website was first launched. When Silk Road was closed down, the US government seized Silk Road’s Bitcoins, but had no regulatory framework around the currency. All in all, the US government has seized around 27 million dollars worth of Bitcoins, which they are planning to sell. Another Silk Road (Silk Road 2.0) has now been launched, and it is said that the site is even more secure.

One very interesting phenomena that has emerged because of decentralised online currencies like Bitcoin, is the fact that it has enabled a certain amount of experimentation with financial systems. The Bitcoin economy can be seen as a kind of stock exchange for hackers. Bitcoin’s price curve consists of violent peaks and troughs, beginning four years ago at $10 a coin, and today is around $915, with a peak of $1200. This sort of fast paced and unstable economy proves a bit of a playground for economists. A crash in the Bitcoin market won’t really affect the majority of the population, so hackers feel more able to play around and see what they can do with this sort of financial system. Around 10,000,000 dollars are put in or taken out of the Bitcoin economy every day. It acts much more like a digital commodity than a digital currency; people aren’t using Bitcoin to buy things, but as a way to trade between other currencies and experiment.

Bitcoin is open source, and so people have been making their own versions; these are called ‘Altcoins’. Some bizarre examples of these are Dogecoin, Coinye West, which are almost exactly the same as Bitcoin, and Ron Paul Coin, which has a slower rate of release. These Altcoins, due to their humour, have spread like memes, and they seem to be doing rather well (except for Coinye West, which stopped being circulated after Kanye West’s lawyers filed a lawsuit against its developers). An interesting and less bizarre Altcoin is called Litecoin. The coin has a faster rate of release, and transactions are verified quicker, which means that it will be worth less, but easier to use as currency to buy things.

At the end of the talk, Sam told us that Bitcoin doesn’t quite feel like a currency yet. The ten-minute transaction lag has a huge effect on its usability, and its user interfaces are terrible. The progression of these Internet Currencies is so rapid, that we are sure to see very interesting developments in the future of Bitcoin and its alternatives. It is definitely something to keep an eye on.