Is Bitcoin the Virtual Currency of the Future or Just a Bubble?

The digital currency, Bitcoin, has experienced unprecedented growth in the past year, rising 700 percent in value since last March and doubling in price since the Cyprus bailout two weeks ago. Bitcoin broke the $1 billion mark last week, causing many to speculate on what the future holds for the most widely used alternative currency.

Critics claim the quick growth and high volatility resembles a ponzi-esque bubble waiting to pop, while supporters tout Bitcoin as the third necessary step in monetary evolution; the first being gold and the second being government-issued fiat currency.

The European financial crisis and bailouts have prompted investors to seek out a more trustworthy and stable place to store their money. A lack of trust in inflation-prone fiat currency, central banks, and government is pushing more to diversify their assets with the Bitcoin as well.

This, coupled with the ever growing list of online and real-world businesses who now accept Bitcoin as payment and the federal Financial Crimes Enforcement Network’s statement on “virtual currencies,” is likely responsible for the increase in popularity.

Popular archive company, The Internet Archive, even offered their employees the option of receiving part of their pay in bitcoins recently.

Bitcoin is the first decentralized crypto-currency based on open-source software which operates through a peer-to-peer Internet protocol. The Bitcoin system is self-regulated through the use of complex computer code, advanced cryptography, and a decentralized ledger that is available to every user in the network.

Issuing money and managing transactions are done collectively by the network of users. Because of this, Bitcoin is able to operate completely independent of any financial institution or world government — a true free market currency unlike anything the world has seen.

“By not being tied to any particular financial institution and by being independent from world governments, Bitcoin will become a safe haven for anyone trying to save their money from the crippled international banking system,” claims Max Keiser, the host of RT’s Keiser Report.

Keiser further stated:

“It is inevitable that Bitcoin will become a multi-trillion dollar enterprise because every other currency in the world is tied to dying central banks that are encumbered with impossible-to-pay debts and bankrupt counter-party risks.”

Introduced in 2009 by a still anonymous developer (or possibly a group of developers) with the pen name Satoshi Nakamoto, bitcoins can be used like most other currencies. Prior to the Bitcoin software being released, the developers published a detailed paper outlining the entire process and how exactly the system works.

Bitcoins are initially generated through a process referred to as “mining,” which can technically be done by anyone with sufficient computing power. Coins are then distributed when miners buy something or sell them to non-miners.

The process is essentially solving complex “proof of work” computer problems through the use of high-tech computer rigs. This requires a certain amount of work for each block of coins, which is automatically adjusted by the network such that bitcoins are always created at a predictable and limited rate.

Once a problem is solved, along with earning bitcoins, transaction records are confirmed and added to Bitcoin’s public record, the ledger, which consists of all past transactions listed in chronological order. This is referred to as the block chain and is shared between all Bitcoin users.

Along with serving to verify that all past transactions actually occurred, the block chain prevents double spending. As more people participate in the mining, the more difficult the self-regulated computer problems become for each individual to solve, effectively permitting only one block to be mined every ten minutes.

Once you acquire a Bitcoin, through the mining process or by purchasing them from other users through one of the many currency exchanges, it should be sent to your secure “wallet,” which is similar to a bank account. Your coin is assigned a public address, which is the only information you need to provide for someone to send you a payment and a cryptographic private key.

Similar to gold, bitcoins are available in a finite amount. Unlike government-issued money which is often printed at will and accompanied by rising inflation and devaluation, the Bitcoin is designed to be immune to inflation.

There are currently nearly eleven million bitcoins in circulation. Twenty-one million bitcoins are set to be in circulation by the year 2140, when the last Bitcoin will be mined and released into the market.

Satoshi Nakamoto wrote a blog post at the P2P Foundation describing the difference between Bitcoin and fiat currency:

“Bitcoin is completely decentralized, with no central server or trusted parties, because everything is based on crypto proof instead of trust. The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts… With e-currency based on cryptographic proof, without the need to trust a third party middleman, money can be secure and transactions effortless.”

Because every user has copies of the transaction database, it’s next to impossible for a government or bank to seize or freeze bitcoins. The most a third party can do is force a user, through blackmail or physical means, to send their bitcoins to someone else.

Bitcoins are designed to be completely anonymous. No one can trace user transactions and no one can even know how many bitcoins a user has. Transaction costs are negligible and there is no risk of charge-backs because once a Bitcoin is sent, the transaction cannot be reversed.

While it is still required by law to report all income, the anonymity involved makes taxing Bitcoin transactions very difficult. Unlike gold or fiat money, bitcoins can also be secretly taken anywhere in the world for free or sent electronically instantaneously with minimal transaction fees.

However, there are undeniable events that could cause the Bitcoin “bubble” to pop.

Bitcoin exchangers are susceptible to being hacked and can experience technical malfunctions in their systems. Depending on the severity, a hack or glitch could send the Bitcoin value plummeting, at least temporarily.

On Wednesday, one of the largest Bitcoin services, Mt. Gox, experienced power outages likely caused by unusually high traffic volume. On the same day, an online wallet service, Instawallet, was hacked, causing the indefinite suspension of the service.

Combined, these two incidents caused Bitcoin value to fall from $145 to around $120 within hours. Mt. Gox was also hacked back in 2011 which triggered a massive Bitcoin sell-off.

While Bitcoin transactions are considered extremely secure, online services are not completely tamper-proof. That being said, there is currently no foreseeable method to counterfeit the currency.

A popular concern in the Bitcoin community is how world governments will react to the currency. If the U.S. government chooses, it can enact regulations forcing ISP’s to sniff packets, prohibiting banks from interacting with Bitcoin exchanges, or pushing heavy taxes on merchants. The government can even flat out rule Bitcoin illegal, which could devastate the currency.

The first move from a U.S. federal entity came in the form of a statement released by the Financial Crimes Enforcement Network on March 18, which classified some Bitcoin exchanges as Money Service Businesses.

“Money Services Businesses must register with the federal government, collect information about their customers, and take steps to combat money laundering by their customers,” reported Arstechnica.

Additionally, the process of obtaining and securing bitcoins is still somewhat complicated compared to withdrawing money from a bank. However, Business Insider recently reported that one company already has orders to install Bitcoin ATMs in 30+ countries.

While Bitcoin could certainly be a bubble on the verge of permanently popping, so could the U.S. dollar or the euro. Since none of these have any inherent value — only value in exchange and confidence — if everyone suddenly stopped accepting dollars, euros, or bitcoins, the bubble would burst and their values would plummet to zero.

Bitcoin is only valuable because it’s scarce and people are willing to accept it in exchange for something. The more people who use Bitcoin, and the more merchants who accept it as a form of payment, the more valuable it becomes.

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