PEER-TO-PEER networks like Napster and Skype have already disrupted the music and telephone industries. Now a bunch of libertarians and internet geeks are hoping to do the same for cash with an online currency called Bitcoin.
The currency is created and distributed over a P2P network, and the developers hope to attract users by exploiting some people's disaffection with the government-controlled central banks that control conventional money. This virtual cash is already being accepted by some online businesses in exchange for goods and services – and some users claim to be making a living from it.
Here's how it works. As with Skype, each Bitcoin user downloads and runs a P2P client program on their PC that communicates with similar programs being run by other users. Then a lottery ensues: the software on each P2P client runs a mathematical routine that attempts to generate a number lower than a constantly changing target figure. Every 10 minutes, one client succeeds and is rewarded with a certain amount of virtual money – currently 50 bitcoins (BTC). Because striking lucky this way is seen as akin to prospecting for gold, users have been dubbed “miners”.
The bitcoins can then be used to buy services such as web design or various types of goods that include T-shirts and ground coffee. Miners pay by sending bitcoins to a receiver's P2P network address – a sequence of alphanumeric characters – which serves as the public key in a cryptography system. The sender transmits coins to the receiver's address by combining them into a message with a private key known only to the sender. There are other ways to earn bitcoins: miners can charge transaction fees if buyers want payments processed faster than the average, which also happens to be around 10 minutes.
Bitcoins have value simply by virtue of the fact that people are willing to accept them as payment for real goods and services. They can be exchanged for conventional currency at a rate that is now hovering around 1 BTC equating to $8, making the entire Bitcoin economy worth around $50 million.
“The idea of money created and controlled by everybody instead of elite central bankers seems to strike a chord in a lot of people all over the world,” says Gavin Andresen, the lead developer of the Bitcoin project based in Amherst, Massachusetts. Bitcoin's origins are unclear: the original coder went by the name of Satoshi Nakamoto, but he is no longer an active developer. “I don't know anything about him, and have never met him,” Andresen says.
The idea of money created and controlled by everybody instead of elite bankers strikes a chord
While new miners adopt Bitcoin every day, its anonymous nature makes it impossible to know how many there are. At present, Bitcoin's P2P clients are crunching data at a rate equivalent to more than 50,000 high-end PC graphics processors. No one knows how many users that represents because some may be using exceptionally high-powered hardware.
Anyone joining to get rich quick by mining coins will find the system is designed to make this harder as more and more people join. This is because the difficulty of the bitcoin-generating task rises as the size of the P2P network grows. So even though there may be more client PCs taking part, bitcoins are still issued only once every 10 minutes. What's more, the quantity issued halves every so often, and the upshot of this is that there can only ever be 21 million BTC in existence. The cost of computer hardware and electricity needed to generate bitcoins may eventually exceed the expected return, but miners will still be able to make money through transaction fees.
If the value of the Bitcoin economy grows, so will the value of each bitcoin. But this shouldn't be a problem, as sums as small as 0.00000001 BTC can be traded. There is currently around 6.3 million BTC in circulation and the developers don't expect to reach the 21 million BTC limit until 2140.
“I've been living on bitcoins for more than half a year now,” says Nils Schneider, a Bitcoin developer who accepts bitcoins in payment for the web design and other services he sells. He converts some of his income to US dollars, using sites like MtGox.com, which is run by Mark Karpeles in Tokyo, Japan. Karpeles charges a fee of 0.65 per cent, and is earning $2000 per day, along with the equivalent in bitcoins. “All the income is reinvested into trying to get our company and bitcoins legal in as many locations as possible,” he says.
Legality is a concern for many Bitcoin users. If the system really takes off, governments are unlikely to allow the continued existence of an anonymous and non-taxable currency. “Bitcoin's legal status is still a mystery,” says Malmi Martti, a Finnish Bitcoin developer, but he believes banning Bitcoin won't be easy. “Even if running an exchange was made difficult, people will adjust. Peer-to-peer file sharing didn't really die with Napster.”
HMRC, the UK government's tax-collecting body, says people do not incur a tax liability when trading in bitcoins as long as they do not turn their profits into regular cash. Once conventional money is involved, however, the income could become taxable, HMRC told New Scientist.
What Bitcoin lacks is “a clear attribution of a guarantor for every unit of currency”, says Ashish Goel of Stanford University, who is developing his own peer-to-peer currency model. “In centralised currencies such as the US dollar, guarantors are governments. For P2P currencies, it should be individuals.”
“Money has never had intrinsic value, its value is determined by confidence,” says Josh Ryan-Collins, of the New Economics Foundation in London, who is cofounder of a local currency, the Brixton Pound. He says we are experiencing a global loss of confidence in state currencies that Bitcoin may be taking advantage of. But he would be “very surprised” if it became a global currency able to compete with state-backed funds.