Bitcoin Primer: What You Need to Know About the New Virtual Currency

By Sarah E. Needleman and Spencer E. Ante Bitcoin startups are beginning to raise sizable investment capital even as industry leaders warn that hackers are abusing the Internet virtual currency for profit. Supporters of Bitcoin say it offers anonymity and a cheap way to transact business across borders. But critics say Bitcoin faces so many regulatory and technical hurdles it will never mature into a mainstream currency. Heres what you need to know: What is Bitcoin? Its a virtual form of currency that can be used to make payments over the Internet without transaction fees or involving a financial institution. Each Bitcoin is subdivided into 100 million smaller units called satoshis, defined by eight decimal places. Where does it come from? Bitcoin was created in 2009 by a person or group that goes by the name Satoshi Nakamoto. A 2008 paper written by Nakamoto proposed the creation of a peer-to-peer electronic cash system that would allow online payments to be sent directly from one party to another without going through a financial institution. Instead of a trusted third party like a bank, Bitcoin creates trust through a cryptographic system. How is it made? Like gold, no central bank controls Bitcoin currency so governments cant print or mint more of it. Using computers and complex software, people can mine Bitcoins by solving complex mathematical problems. If they solve the problem, they get Bitcoin. But since the process is so difficult most people just buy Bitcoin from various exchanges popping up. How does the system work? The problem that Bitcoin aimed to solve was that the person using a virtual currency cant verify that one of the owners did not double spend the coin. Bitcoins answer involves a lot of complex math and software but the essence is that the system publicly records all transactions with a timestamp, which lets participants to agree on a single history of the order in which they were received. The first transaction is the real one. How safe is it? Nakamoto wrote in his paper that the system is secure as long as the honest nodes collectively control more [computing] power than any cooperating group of attacker nodes. In 2010, there was bug in the Bitcoin code that allowed someone to create a fake transaction. But the problem was identified and resolved. There have been reports of other incidents as well. The chief scientist of Bitcoin said that the chances of a major breach are decreasing over time as the system and software matures. The chances of the types of breaches we saw in 2010 happening again are very small, he added. Is there an unlimited supply of Bitcoin? No. The anonymous creator of the currency capped the number of total possible Bitcoins at 21 million. Since 2009, nearly half of them, or 11.1 million have been mined and put into circulation.

The cap on Bitcoin has attracted the interest of some investors who believe that the fixed supply will lead to an increase in the price of Bitcoin over time. What can you buy with Bitcoin? A growing list of online merchants is accepting them, including the content-aggregation site Reddit.com and dating site OKCupid.com. Some bricks-and-mortar businesses are taking them, too. You can also use them as form of currency to pay people for goods and services. The relative anonymity of Bitcoin has attracted criminal elements to the system, say some experts Where can I get Bitcoin? You can buy Bitcoins from online exchanges like the Japanese site Mt.Gox.com. You can also buy them from sites like Coinbase.com, which also allows users to store Bitcoins in a virtual wallet and pay merchants for goods or services with Bitcoins. Virtual exchanges typically charge a fee of 1% or less to convert traditional currency into Bitcoins and vice versa. How much is it? Since the system is new and has been vulnerable to Internet attackers, the value of the Bitcoin has been very volatile. Bitcoin rose in value from roughly $5 in June 2012 to a high of $266 in April and was down to about $108 on Tuesday, according to date from the Mt. Gox exchange. Is Bitcoin the only virtual currency on the Web? No. There are others, such as Ripple, a new currency from a startup called OpenCoin.com.

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