Bitcoin: Birth of an online currency
A new anonymous digital currency that allows instant payment to anyone, anywhere. Sounds great, just not for the average consumer.
Imagine an online payment system that functions exactly like cash with no associated fees that leaves you completely anonymous and can be exchanged across borders as simply as buying a hotdog from a street vendor.
Enter Bitcoin — a decentralized digital currency created and transacted via peer-to-peer software that doesn't require an external payment system (like PayPal) to process transactions and can be traded around the world without penalty.
Sounds great, right? Well, even though Bitcoin is also encrypted against forgery and duplication at the highest level, advocates like Donald Norman, Bitcoin developer and co-founder of Bitcoin Consultancy, admit it's still not ready for prime time.
"People got so hyped up because of the possibilities with this currency, but the problem is it's not end-user friendly," he says. "There's a huge limitation in terms of who can use it right now. It's like the Internet before the web browser."
Bitcoin was created by an anonymous figure — Satoshi Nakamoto — in 2009 as open source digital transaction software that doesn't require a third party to mediate transactions. It is built on cryptographic proof, instead of human trust, and prevents double-spending (or the spending of digital currency more than once) through a publicly available, time-stamped record of every transaction to exist in the network since its inception.
"It works on the same technology as BitTorrent," says Norman of the peer-to-peer file sharing protocol. "Instead of many files, Bitcoin just has one file and that file is called a block chain. It's the history of all the transactions that have ever occurred in the network — it's a continuously growing file."
In addition to being acquired through a currency exchange or exchanged for cash, a Bitcoin can be mined by solving a coded proof-of-work puzzle at the beginning of a new block chain. The Bitcoin is a reward for solving the puzzle and expending the computational power it takes to keep the block chain going and the network running. Solving the block chain's puzzle will become increasingly difficult until Bitcoin production ceases in 2140; Bitcoins will be capped at 21 million to protect against inflation.
Every resulting Bitcoin from this process is encrypted with a digital signature that Norman says ensures safety for every transaction:
"There are ways that you can put a digital signature on something, where everyone will know that you signed it, but they can't forge or counterfeit that signature. This way you can have the Bitcoin, with its digital signature; you get my address and then that contract is signed over to me. It doesn't matter where I am in the world. Plus, you are the only one with access to your funds through your private key, which is on your computer or wherever you decide to store it."
MSN.ca Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.