three gold-colored bitcoins on black surface

What is Bitcoin?

As the world economy continues to flounder, a new economic frontier seems to be developing: digital currency. Amazon has given Kindle Fire users a reason to get fired up over its new online currency by distributing 500 Amazon Coins, equivalent to $5, which may be redeemed for apps, games and even in-app items. Amazon Coins aren’t much more than a dollar-surrogate, with a direct conversion and very limited uses (you can’t even buy movies or books with them), but they’re just the tip of the iceberg for this new kind of money.

If your house doesn’t look suspiciously like the underside of a rock, you’ve likely noticed the ever-growing market for online purchases. Amazon, eBay, iTunes, and hundreds of other services provide an electronic outlet for all our hard-earned cash. To facilitate this, a variety of methods have come about for converting real money into something electronic. Most commonly, the user inputs credit card information and the money is transferred — sometimes into electronic “points” like Amazon Coins or XBox Live Points. Other services like PayPal have come under scrutiny for their security problems.

Bitcoin currency Bitcoin for Dummies

But what about an actual online currency, not just electronic dollars, but a new currency with its own conversion rate and economy? Enter Bitcoin: a digital currency that first emerged in 2009. Bitcoins have been slowly but steadily growing in potency and acceptance over the years, from having almost no ways to spend the e-coins to being able to even pay for your apartment with them. More recently, the Winklevoss twins (whom you may know as the guys in The Social Network who sued Facebook) bought up $11 million worth of Bitcoins.

Bitcoins are created through a process called Bitcoin Mining — the technicalities are fairly intensive, but the overall process can be explained simply. To “mine” for Bitcoins, a user runs a program on his computer that lends out his unused processing power to the Bitcoin network. Imagine a farmer who can lend his donkey out to his neighbor whenever he isn’t using him, and the neighbor pays the farmer for the time — except the donkey is your computer’s processor. The computer helps the network run the algorithms it uses to verify that bitcoin transactions are legitimate, and it pays the user back in an ever-shrinking supply of new bitcoins.

Wait, “ever-shrinking?” That’s right. Bitcoins are created every day, but at a steadily decreasing rate, until they reach the predetermined final amount of bitcoins: 21 million. That doesn’t seem like very much for an entire currency, until you find out that at the moment a bitcoin converts to a dollar at a rate of around $150 for a single bitcoin — and that number has been rising for years with little sign of it slowing. And while the creation of money out of “nowhere” may seem strange, remember that most modern currencies (including the dollar) already do that on a regular basis.

Star Wars currency The Implications of Bitcoin

Still, Bitcoin faces considerable difficulty as a currency. Bitcoin is decentralized and managed by the entire community of users. With no central bank or significant financial institutions to control its growth, Bitcoin is seen as volatile and unpredictable, with some prominent economists decrying its actual utility. Because Bitcoin is still largely limited in purchasing scope, many experts see it as more of a commodity than a currency. And because bitcoin transactions are untraceable, they’ve become commonplace in online black markets.

But for all its faults, there’s something endearing about Bitcoin. For Paypal or the digital dollar transactions that fuel Amazon Coins, a middleman takes a small percentage of the money exchanged: but using Bitcoin is free. And for those of us who love our science fiction, the untraceable, digital Bitcoin might look like the first step toward a “Credits” system like that of Star Wars.

For now, it may be safer and easier to stick with the Amazon Coins and XBox Live Points. But don’t be too surprised if your friends are using bitcoins – or something similar – to buy their groceries in the near future.

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