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Bitcoin, a purely digital currency, is backed by no commodity and governed by no central bank, but it exists because a small number of humans have chosen to believe in its legitimacy.

Its pseudonymous creator (or, more likely, creators) “Satoshi Nakamoto” willed it into existence in 2009, not only describing how the so-called cryptocurrency would work but shipping a full working implementation. The original software had all the hallmarks of a gag or hack: a great, metastasizing practical joke played by clever cyberlibertarian coders upon all who put their faith in fiat (that is, government-backed) currencies.

Then came the believers. Today, there are thousands of people loyal to the ideology and opportunities that Bitcoin represents. They imagine a world where economies are less dependent on banks and governments, and they’re actually using Bitcoin, often in disruptive ways. The currency had a rocky start when it became the medium of exchange for illegal drug transactions on Silk Road, but that huge narcotics marketplace was shut down last October and its founder arrested. Indeed, the currency seems more or less respectable. Since Bitcoin is essentially a kind of transaction log, where past transactions are public and known to the world, it is of great interest to prosecutors, who have called the coins “Prosecution Futures.” Last year, even U.S. Federal Reserve chairman Ben Bernanke gave them his cautious endorsement.

Bitcoin may or may not become a commonly used currency. As a form of money, it is an established medium of exchange; but so far it is a poor store of value. (See “Bitcoin Economics.”) More than 60 percent of the bitcoins created remain unspent: they are being hoarded speculatively. No wonder: the value of an individual bitcoin, which was less than a dollar in January 2009, was around $932 in early February. Those unspent coins could flood the market at any time, depressing their value. Even now, the bitcoin’s value fluctuates wildly; it plunged below $500 later in February because of glitches that forced the shutdown of Mt. Gox, the biggest trading service.

But while it may be wishful thinking to imagine Bitcoin as a true currency, it’s a highly functional and effective technology. Bitcoin’s “block chain protocol” is built atop well-understood, established cryptographic standards and allows perfect certainty about which transactions occurred when. Nakamoto’s original paper is admirably clear. Free and open implementations of software, as we learned from the immense success of the open World Wide Web and Linux, trump everything else.

Money from nothing

What can you do with bitcoins, or with cryptocurrencies in general? You can spend them, of course. You can hold them in a digital “wallet.” But whereas fiat currency is minted by a sovereign entity of some sort, you can make new digital money—in fact, it’s the only way currency can be created. The process, called “mining” in the Bitcoin vernacular, involves repeatedly running a computationally intensive mathematical function (called a cryptographic hash function) on a set of randomly seeded inputs until a specific pattern pops up. Many computers all over the world are racing to solve the same function—but typically only one wins. The results are publicized on the Internet for the rest of the Bitcoin network. To create scarcity, the Bitcoin system is designed so that over time the function becomes harder and harder to solve (and therefore requires more computer resources). The number of bitcoins given out as a reward is halved at regular intervals. After 21 million coins have been created, mining stops and no more can be created. For some people, this means Get in now!—often using specialized, expensive “mining rigs.”

There are other ways to participate in the crypto-economy. Some people have built exchanges, and others have built websites that track the entire transaction history of every coin or fraction of a coin. Still others have built gambling websites like Satoshi Dice, which allow punters to gamble in a weird, automated fashion.

If you already feel jaded about Bitcoin, there are alternatives. Litecoin is a version of Bitcoin that can be mined with regular computers. Dogecoin is a variation on the Litecoin idea that was named after an Internet meme featuring a proud Shiba Inu dog. It is trading vigorously; $30,000 in Dogecoin was raised to send the Jamaican bobsled team to the 2014 winter Olympics. Hundreds of such currencies now exist, such as TeslaCoin or ElephantCoin. They differ in the hashing algorithms they use, the number of coins they make available over time, and other details. Each of them hopes to find a sweet spot in the emerging global cryptocurrency marketplace.

Most interestingly, cryptocurrencies can be used for purposes other than those that conventional currencies fulfill. For example, Namecoin is a system used to create and exchange domain names: the coins contain information about the domain names themselves. Recall that the domain name market has about $3 billion in revenue per year: it’s a good example of a weird, scarce digital resource. And Bitmessage is a Bitcoin-inspired messaging platform that allows for anonymous (or at least pseudonymous) communication. What Namecoin and Bitmessage share is that they allow data to be added to the transaction, making the exchange one not just of perceived value but also of information.

Or take digital art. Larry Smith, a partner at the business architecture consultancy The matix and an analyst with long experience in digital advertising and digital finance, asks us to “imagine digital items that can’t be reproduced.” If we attached a coin identifier to a digital image, Smith says, “we could now call that a unique, one-of-a-kind digital entity.” Media on the Internet—where unlimited copying and sharing has become a scourge to rights holders—would suddenly be provably unique, permanently identified, and attached to an unambiguous monetary value.

Smith believes that cryptocurrencies will have wide application across business and culture, including both banking and online advertising. For banks, Bitcoin is “just a new source of money,” he suggests. “Banks are very hungry to advance their value through technology.” It’s easy to imagine, say, HSBCoin, or BarclaysBucks, giving investors who want choice in the currencies they use the services of a trusted financial brand.

And what of the enormous revenue-generating engine of online advertising? Advertisers pay to reach highly valued online audiences; they use a variety of technologies, many surprisingly ineffective, to find these individuals. Could cryptocurrencies help? Smith asks us to consider the following scenario: imagine a brand like Dunkin’ Donuts that wanted to create a loyalty program. Now imagine that brand creating its own currency: DunkinDollars. Finally, imagine an online advertising campaign where people who clicked on an advertisement would be given the virtual coins. Small amounts of money might be distributed without friction. If large brands could create their own currencies and allow individuals to participate in this marketplace, they could create consumers who were truly invested, in every sense.

The entire web of advertising would suddenly become a more interesting place. Before, the ads seemed to hunt you, but now you would have reason to hunt for ads. The coins you earned could then be exchanged for branded goods, but they could also be exchanged on an open market, like a kind of penny stock. “Pay consumers for clicks and acquisitions,” says Smith, defining this new kind of model.

The idea of paying people to look at ads was tried during the last Internet boom (by the startups AllAdvantage—“the dumbest dot.com in the world,” according to CNN Money—and the infamous FreePC). And failed virtual currencies such as Beenz and Flooz preceded the success of Bitcoin. But there might be advantages to trying again with the newer cryptocurrencies: offering more value to consumers might make the idea work this time. Right now, the cookie model of Web tracking is dominant; ads are just media objects. But cryptocurrency-mining software, written in Java-Script, has been demonstrated running in a Web browser; you can break up the task of mining and parallelize it. So an advertiser could treat ads as executable software, creating a multimillion-node supercomputer cluster. By engaging with an ad, the user might earn virtual currency while mining and verifying transactions in the network. Perhaps the future of advertising will involve a new set of activities for consumers, as yet unknown.

A post-scarcity economy

Expand banking, make digital art unique, reinvent online advertising—these are just some of the things Bitcoin might do. In response to the perceived opportunities, the venture capital community has entered a state of hallucinatory excitement about cryptocurrencies, with Marc Andreessen, cofounder of Netscape and the venture firm Andreessen Horowitz, performing as the principal cheerleader.

And yet … these applications seem prosaically narrow in comparison to the more perfervid claims of Bitcoin’s cyberlibertarian enthusiasts. (According to a video on bitcoin.org, “Bitcoin is changing finance the same way the Web changed publishing”—a claim that would recommend itself only to those who have enjoyed the discomfort of traditional media.) But perhaps that’s the point: to succeed, Bitcoin will need to offer real utility to existing markets. The last two decades have suggested a post-scarcity economy, where infinite copies of attractive digital things have a price approaching $0. Maybe that was merely a passing moment that we will look back upon with wonder once limited coins enforce scarcity—once the owner of a piece of digital art can look upon it with satisfaction and know with total, cryptographic certainty that because he paid for it, it belongs to him and no one else.

 

This article was updated on February 25, 2014.

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Credits: Illustration by Jon Han

Tagged: Computing, Communications, Business, cryptocurrency, Bitcoin

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