Show me the money

Its growing popularity and move into the mainstream has led to calls for it to be regulated: in the past few weeks Chuck Schumer, a US senator, called Bitcoin “an online form of money laundering used to disguise the source of money” and demanded a crackdown on the currency. One prominent technology analyst called it “the currency that could topple governments, destabilise economies and create uncontrollable global bazaars for contraband”.

That may be overstating things, but the fact is that the online currency is increasingly gaining a foothold in the real world. So what is Bitcoin? How can you get it, what can you spend it on and should you trust it?

Unlike traditional currencies, which are minted in government-managed facilities and backed up by real assets such as gold, Bitcoin is nothing but pieces of code stored in digital wallets on users’ computers. Its value depends on what other people are prepared to exchange for it — goods, services or, of course, real money. A set amount of Bitcoin is released each year, awarded to computer users who run a complex program that effectively generates random numbers. If one of those numbers is the same as one assigned to a new Bitcoin, you win it.

Invented in 2009 by a programmer known as Satoshi Nakamoto, Bitcoin quickly gained popularity among libertarians who wanted to use a currency that bypassed governments. Bitcoin can be traded against a number of currencies, including sterling, the euro and the US dollar. On one exchange last week deals were being logged at just under £12 for one Bitcoin.

To use Bitcoin online, the first thing you need to do is go to the website bitcoin.org and download some software that will act as a digital wallet — essentially an account on your computer that will hold the currency. Next, go to an exchange such as BitMarket.eu to find someone willing to sell the currency. In order to buy or sell whole or partial Bitcoins, you need to make a bid — for example, offer $30 to buy two Bitcoins. The system will then search for a matching seller’s rate. If there is no matching offer, the exchange waits until one comes up.

It’s the potential for the currency to be used by criminals that has worried American authorities A key part of the system is that the website only brings together buyers and sellers; the actual transfer takes place directly from one user’s computer to another. This is the same filesharing concept that, because it is nearly impossible to police, is threatening to destabilise the film and music industries.

When I bought some Bitcoins I had the option of using a bank transfer or PayPal, the online payment service owned by eBay. Opting for PayPal, it took a day to verify the transaction — a far cry from the sort of instant payments made by eBay users. Eventually, though, I bought 2.02 Bitcoins for $39.39. Once the Bitcoins were credited to my digital wallet on my desktop, I could start spending.

And this is where the real problem for the currency lies. Few mainstream sites take the money — try going to Tesco Online and you will be disappointed. Instead, the majority of sites that accept it are niche players specialising in niche goods: I managed to spend some money at muffler.pl (Polish car accessories), cryptoanarchy.us (bumper stickers) and bitbrew.net (organic coffee).

I may have had better luck if I needed to hire a web designer or rent a broadband line. Many web tradesmen — who can work from anywhere in the world — accept the currency for services rendered. Even so, the process of buying Bitcoin and spending it is frustrating.

But it’s the potential for the currency to be used by criminals that has worried American authorities. With transactions hard to trace and accounts that can’t be frozen, Bitcoin seems tailor-made for money laundering, illicit gambling or the sale of stolen credit-card numbers.

To those involved in the Bitcoin project, such accusations are overblown. And as Amir Taaki, the owner of a Bitcoin exchange in Britain, points out: “If a government did ban Bitcoin, it’s impossible to shut down the network.” That’s because the code to generate, store and exchange Bitcoin does not exist centrally but on thousands of individual computers that make up a global network. Governments could only try to shut down the websites that allow people to exchange Bitcoin for other currencies.

Or they could hope the currency implodes. Previous attempts to create a virtual currency have had only limited success and any that survive remain in obscure corners of the internet, used by only a few enthusiasts. (The exception has been those virtual currencies used in gaming: for example, you can use Facebook Credits to buy chickens on FarmVille.)

The signs are that Bitcoin may even have become a victim of its own success. On June 19, Bitcoin’s most popular currency exchange, a Japanese site called Mt Gox, was the victim of hacking. A huge sell-off caused the exchange rate to plummet from $17 to just a few cents before the site went offline. Mt Gox has since promised to cancel the invalid transactions and restore rates, but the damage to Bitcoin’s credibility remains unknown.

So, will virtual currencies such as Bitcoin ever take over from cash or credit cards? Until the payment system is simplified and better security is established, it seems unlikely they will catch on with large numbers of people. Bitcoin enthusiasts like the idea of being free from meddling third parties, but for most of us, while banks are far from perfect, we appreciate that intermediaries such as governments and financial institutions give us some degree of protection against fraud and theft. Overdraft fees and all.

Bitcoin basics

What is it?
A currency that exists purely online, traded over websites for goods, services and real-world cash.

Who invented it?
A programmer who posts under the name of Satoshi Nakamoto, almost certainly a pseudonym. The intention was that it would become a new gold standard — the currency against which real-world currencies would be compared.

How is it made?
To avoid inflation and help make it into a gold standard, a known amount of Bitcoin will be released into the market every year until 2040. To win some, you have to set a computer to run a complex algorithm and hope it strikes lucky in matching a number that has been allocated to a new coin.

Where is Bitcoin held?
Like the software that governs the release of new Bitcoin and checks its authenticity, it resides in the digital wallets of tens of thousands of individual users worldwide.

The virtual currency crash

ecash
Launched in the early 1990s, ecash could be downloaded from the internet through a virtual cashpoint. Several banks offered to handle ecash payments but, because online shopping barely existed at the time, the currency folded in 1998.

Flooz
Endorsed by an unholy trinity of Whoopi Goldberg, William Shatner and Anna Kournikova, Flooz credits could be bought and used at participating online stores. But despite the celebrity input, not enough companies took part and Flooz declared bankruptcy in 2001. The credits became worthless.

Beenz
Founder Charles Cohen said that one day Beenz, which worked in a similar way to Flooz, would supplant all others as the universal currency. But after burning through nearly £60m in investment the “Beenz economy” collapsed in 2001.

E-gold
E-gold was launched in 1996, backed by gold and silver. Ten years later it was the most successful online payment system after PayPal. However, the anonymity it provided users made e-gold popular with fraudsters and in 2008 it was hit by damaging legal action in America. The company limps on.