May 13, 2013 7:53 pm

Q&A: Why fear Bitcoin?

What is Bitcoin?

Bitcoin is a decentralised currency, so it is not issued or guaranteed by a central bank. It exists predominantly in digital form – besides a small number of notes and coins that represent their digital counterparts, it has no physical presence. Transactions are untraceable, providing its users with almost total anonymity, which has sparked fears of abuse by criminal groups. Claimed to be the “first digital decentralised currency”, it is administered over a shared computer network, much like the one that runs the chat service Skype.

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You can buy the currency on a Bitcoin exchange using regular currency (one Bitcoin currently costs $116), at which point it will be transferred to your digital wallet. From there you can send Bitcoins online to anyone else willing to accept them, or convert them back into a standard currency. New Bitcoins are created all across the internet by anyone running a free piece of software known as a Bitcoin miner. By solving complex algorithms, miners can unlock small amounts of the currency. However, the increase in the money supply is fixed, so only small amounts are released over time.

Who is behind it?

The project has its roots in the anarcho-libertarian hacking community, and was formally proposed in 2008 by Satoshi Nakamoto. Thought to be a pseudonym for a mysterious hacker – or even group of hackers – its inventor has since disappeared without trace. He released Bitcoin in 2009 as an open-source project that anyone could contribute to, with no governing institution or single owner.

Is it safe?

To date, the currency has proved very volatile. On April 4 this year a number of Bitcoin exchanges fell victim to hackers, causing its value to fall sharply. Six days later its value soared to an all-time high of $260, before plummeting to $130 just six hours later. MTGox, the main Bitcoin exchange, blamed a technical hitch which meant it struggled to process the sheer volume of transactions.

What can you buy?

Much of the trade in Bitcoins is simple currency speculation. Recently, though, a number of tech-savvy businesses – such as online dating site OK Cupid and blogging platform WordPress – have begun accepting payment in the new currency. Bitcoin’s inherent anonymity has made it a popular way to make transactions on the black market as well. Silk Road is an online marketplace primarily for drugs and other illicit products, and is estimated to trade items worth $1.22m each month.

Are we in the midst of a bubble?

Comparisons with the Dutch tulip bubble are rife. Many commentators claim that although intended as a currency, Bitcoins have essentially become a commodity. The most common explanation is that the Cypriot financial crisis caused savers in other countries to panic and purchase Bitcoins en masse. Worse, it is estimated that most of the digital currency is being hoarded, as investors hold out for ever higher prices.

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