Bitcoins

July 9, 2011

I've been researching bitcoins a bit the last two days.

People who only read the popular media might be quick to discard it as the currency of criminals, but that would be missing the point. Every single bitcoin is perfectly and publicly traceable, from the moment it was created until now. The whole history of where a coin has been is viewable on blockexplorer.com. This is so because every single transaction is stored in the distributed bitcoin database, and thus accessible by everyone with a bitcoin client.

The economist in me is very exciting to see what we will learn from this data. Never before has there been a perfectly trackable currency. We can see every single payment, gift, handover, transfer. And we can run statistics on them!

But first watch this video if the idea of a virtual currency still spooks you:

I personally think the cryptographic system is genius! For more details, read the original paper by Satoshi Nakamoto.

However the system also has serveral problems:

Security: Because a bitcoin address is not linked to an individual for the purpose of anonymity, the only way to claim the coins from an address are if you have the wallet.dat file. So to steal bitcoins from anyone you only need to steal a single computer file. This cost allinvain 25,000 BTC (~ 375,000 USD). Lesson: encrypt your wallet file and store it somewhere very safe!
Transparency: Using statistical analysis + information available online it is often possible to find out who the owner of a bitcoin address is, revealing all of the transactions of that person.
Authorities: Governments will probably (and maybe they should) regulate the system. Or they might even ban it completely.
Fairness: The initial wealth distribution was unfair. People who joined early have received huge numbers of bitcoins from mining, whereas now you will only receive 50BTC every 4 months using a ~1000 USD mining rig 24/7 (excl. power costs of ~ 370 USD in europe). If you still think it is profitable, think again.

The benefits on the other hand there are benefits that have never been seen before:

Zero transaction costs: You can choose to include a transaction fee to speed up validation, but it is optional.
Decentralized: Anyone in the world can join and become the consumer and the banker!
Perfect information: Everybody can access the full database!

Do you remember economics 101: In a perfect economy... Without transaction costs and perfect information, the bitcoin currency comes pretty close to the textbook definition of a perfect economy.

Oh, and to get you excited, there are currently 6,774,650 Bitcoins (aka: 101 Million USD). And the BTC-USD exchanges are active with volumes around ~ 30 Million USD per month, so there is liquidity! The inflation is fixed at +50 BTC / block (about every 10minutes) or 0.33 % per year.

Later I might look into the statics a little deeper, but first I have to get back to work!

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