The Bitcoin Phenomenon

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The Bitcoin Phenomenon is a blog dedicated to exploring the entry into mainstream America of the Bitcoin cryptocurrency. It is an attempt at getting people thinking about a phenomenon that has been in the news lately, but which many still seem to be missing.

I am not a financial or legal expert, and my goal is not to make money. I want to discuss with you what Bitcoin (and other cryptocurrencies) are, what they mean for society, how governments should respond, and how it all fits into an understanding of why the world is as it is. I welcome you to comment on anything posted here; however, this blog is generally intended for a general audience and should not be taken as financial advice. Keeping up with current events in this area can be challenging–check out some of my other blogs if you’re interested in learning more.

If you like what you see here and want to keep up with new posts, please feel free to follow me on Twitter: @BitCoinPheno.

Even if you were keeping an eye on the cryptocurrency world, you might not notice that Bitcoin had entered the mainstream. After all, the price of Bitcoin and other cryptocurrencies fell by 80% this year. And every other coin has fallen by at least as much.

But Bitcoin is different. It was the first cryptocurrency to break into the mainstream, in a big way, back in 2011. But it is not alone in that respect: There are now several dozen cryptocurrencies worth less than one-tenth of one percent each (or even less). The total value of all cryptocurrencies has risen tenfold in the last six months.

There used to be one Bitcoin; now there are 100s of them, many with new names and new algorithms. And they are worth a lot more than they were then: Some have risen by an order of magnitude or more in the last six months alone. A few others have tripled or quadrupled.

I first became interested in Bitcoin in December 2010, shortly after its creation. I had been tracking it for a couple of years, and by then it was causing a stir. But I had no idea what the fuss was about: I have never been able to understand anything that went on in the crypto-currency world, and so it was just more stuff that went over my head.

Until one day I read an article that explained Bitcoin to me. It suggested that Bitcoin was important for the same reason gold is important: because we use money. Elsewhere in the article I found a description of how you can use Bitcoins to make purchases from web sites such as Overstock or Expedia. That did it for me.

I now see Bitcoin, not just as a fascinating topic, but as something with enormous potential both for good and for bad. So here is my attempt to explain it all to you–with very little math and almost no technical jargon (and therefore with all the boring parts left out).

At the time of writing, the Bitcoin network is processing more transactions than Visa and Mastercard combined. In other words, it has a bigger market than those two payment processors. The currency is being used by governments (though how often depends on how much they want to be paid in Bitcoins), by major corporations, by central banks, by individuals, and in some cases by criminals.

The currency itself can be thought of as a kind of electronic cash that operates with no concern for government oversight or regulation. The only thing stopping you from using it today is that you can’t use it directly without having a computer running a Bitcoin program. The idea is to have everybody accept the program as payment for their goods and services and use the system’s internal value to settle transactions between them.

The advantages over traditional currencies are many: no inflation or deflation; low transaction fees; anonymity; speed; security; and so on. It’s hard to get a better deal than that!

Bitcoin is a fascinating experiment.

It’s a cryptocurrency, which is an electronic money system based on cryptography and mathematics. Cryptography is the science of scrambling messages so that you can send them, but not to eavesdropping spies, and mathematics is the science of turning things into numbers. The original idea was to create something like gold, without the annoying political and legal complications of gold. You could design a cryptographic scheme that could not be manipulated by government or banks or other institutions.

But Bitcoin didn’t really start taking off until it started taking off in China. The Chinese government has been having some economic problems lately, so they are spending money in an effort to stimulate the economy. Like all governments, they have limited money supply, and they need to spend money quickly if they are going to spend it at all. So they have a big problem: how do you quickly move money around the country? Cash doesn’t work because the bank can just take it back later if they don’t like how you used it. Electronic transfer is fast and easy but hard to control: your bank reports where its money has gone and who owns it, and that information is available to anyone who asks (and sometimes doesn’t ask). So China had two options: let ordinary people hold physical cash

Bitcoin is a virtual currency that has made the front pages of newspapers around the world. It’s so new that its value fluctuates wildly, and it’s not yet accepted by any major retailer. Yet its potential is massive, because it could eventually replace all other forms of money. The reason for this is that Bitcoin is a new kind of money. It’s called a crypto-currency, because it uses cryptography to control the flow of coins into and out of accounts.

Cryptography was invented for military purposes during World War II, and early computers were used mainly to break codes. But it didn’t really become practical until the 1970s, when microprocessors first became small enough to fit onto a chip. To encrypt data, you need an algorithm to encrypt and also one to decrypt it; that’s why encryption algorithms have names like “RC” or “AES” (for “Rivest Cipher”).

Bitcoin is different from existing crypto-currencies like Liberty Reserve in two ways: first, it’s based on something much older than microprocessors: mathematics called “concentrated knowledge”; second, it uses something newer than both: cryptography. In short, Bitcoin isn’t just another crypto-currency; it’s a crypto-currency that uses cryptography instead

Bitcoin is a cryptocurrency, a form of money that has value because people agree that it has value.** This might seem like a trivial point; after all, people have agreed for millennia that the dollar has value, and it does. But there is no consensus on Bitcoin yet. Some of its supporters think it should have value simply because it is valuable. Other supporters think it should have value because they believe other people will agree to value it.

The first group say: “Bitcoin is an experiment in peer-to-peer cash.” The second group say: “Bitcoin is a way for me to make money off people who don’t know what they are doing.” Neither group understands why the other group is wrong.*

This may seem like a trivial point; after all, people have agreed for millennia that the dollar has value, and it does. But there is no consensus on Bitcoin yet. Some of its supporters think it should have value simply because it is valuable. Other supporters think it should have value because they believe other people will agree to value it.*

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