We’ve noticed with interest the rise of Bitcoin and other digital currencies during the past year. Since we’re not sure what to make of the breakneck and volatile change in value of something most people don’t understand, we decided to take a closer look and provide you information in the plainest language possible.
First, a little history, concentrating on Bitcoin while taking into account there are at least 104 other cryptocurrencies available. Much of the information comes from Wikipedia, with other sources identified as used.
Bitcoin was started in 2009, originally as a decentralized peer-to-peer payment system, not based on a value set by a government, central bank, or single administrator. That is, participants use it as a medium of exchange, or money. Transactions are recorded on a public electronic ledger called the blockchain.
The blockchain records transactions without any so-called trusted authority, but rather by a network of electronic communication nodes. A simplified analogy would be a network of accountants verifying every Bitcoin transaction, adding them to their ledgers and concurring with each other on ownership of each Bitcoin. This prevents duplicate transactions as there are several networks concurring on the ownership of units or fractions of Bitcoin, all in micro-seconds.
In the blockchain, a Bitcoin amount is registered to a private key the owner will need to maintain in order to utilize the amount later. There’s no other evidence of ownership that can be substituted.
Think of this like money in your pocket. If you drop a $20 bill out of your pocket and not realize it, it’s nearly impossible to reclaim your money. Just like you can lose money out of your pocket, you can lose Bitcoin if you don’t maintain evidence of your ownership of your digital currency.
To remedy this problem, there are several providers of digital wallets. Digital wallets allow users to connect to the network and spend their digital currency while securing on their behalf the privacy of their keys that provide evidence of their ownership of the virtual currency. Some of these wallet providers even offer debit cards for ready access to funds.
Using a digital wallet to hold Bitcoin and other digital currencies is relatively easy. There are several options available for download, and some allow users to use only a particular digital currency for transactions. Others allow users, for a fee, to purchase digital currency with funds from a bank account or a credit card. Still others allow for trading between digital currencies.
Bitcoin is accepted for payment by several merchants. According to a 99bitcoins.com article by Jonas Chokun (Dec. 6), merchants accepting Bitcoin payments include: Microsoft, Subway Restaurants, Expedia, Zynga, Intuit, and even a soccer team from San Jose.
To address banking issues in the medical and recreational cannabis industry, there’s a digital currency called PotCoin, advertised on its website as “an ultra-secure digital cryptocurrency, network and banking solution for the $100 billion global legal marijuana industry.” They’ve developed a PotWallet, which allows transactions using PayPal, wire transfers, cash deposits, and Bitcoin.
The price explosions of Bitcoin and other digital currencies in the past year is attributed to several developments. Charles Bovaird, writing in Forbes on Sept. 1, says some of these developments include: rising industry acceptance, attractiveness in times of political turmoil, the large number of initial coin offerings, and implementation of Segregated Witness, which increased transaction capacity and reduced pressure on the network.
There are pitfalls to digital currencies. One of the biggest is wild price swings, or volatility of their value (unlike most money). Bitcoin itself has experienced 25 percent drops in price in short periods. On the other hand, its dollar value may also increase 30 percent shortly thereafter.
The server capacity of digital wallets has also been an issue, which makes it difficult to transact digital currencies during the high trading volume associated with the wild price swings.
There’s still a “wild west” feel about the entire blockchain. So, the continued growth of digital currencies such as Bitcoin is worth watching.
The potential elephant in the room? The federal government is starting to investigate digital currency, and everything is better when government gets involved.
Right?
Ron Knecht is Nevada controller. James Smack is deputy controller.