What are Bitcoins?

The concept of digital money is not new. But one of the most recent incarnations, Bitcoin, is gaining widespread appeal.

Launched in 2009, it is a type of crypto-currency which exists as computer code and is not tied to any physical currency or commodity.

The system has no central bank or issuer and no disputes service, and once a transaction is completed it cannot be undone.

Users of Bitcoins can remain anonymous, making the currency popular for trade in illicit drugs, weapons and other illegal activity.

There is also no public face to the currency, which is run and administered entirely by the online community.

In New Zealand, a Customs officer charged with drug offences was caught earlier this year using a hidden website called Silk Road, which allows users to buy illegal drugs using Bitcoins.

But it is also touted as an alternative to the government- and corporate-controlled world of banking for people who just want to buy everyday things.

One of the currency's early adopters used his Bitcoins to buy pizza.

Nearly five million transactions using the currency have taken place so far this year, more than double the number processed in 2011.

But the system has been the victim of hackers who have stolen hundreds of thousands of dollars worth of Bitcoins over the past year.

The Bitcoin Foundation was recently established to rebuild their reputation and distance the system from the dodgy, underworld-type business it is associated with.

But can it survive? Is it secure enough? And does it have the potential for mainstream appeal?

What are Bitcoins?
The term Bitcoin is a bit of a misnomer because it is not a coin it all as it has no physical properties.

It is a string of computer code which represents a specific amount of the currency.

Bitcoins are generated by computers belonging to a network of its users' computers.

An algorithm releases 50 new Bitcoins into the network every 10 minutes, with the pace halving in increments until about 2140, when the number of Bitcoins will reach the pre-determined limit of 21 million.

Computers which generate Bitcoins are called "miners".

They "mine" Bitcoins by cracking increasingly difficult puzzles, which require enormous computer power.

This limits the number of people, and computers, which can issue Bitcoins and prevents the market being flooded with them – this would apparently cause hyperinflation.

Bitcoins can be bought through online exchanges such as Mt. Gox, whose listed exchange rate as this story was published was $US11.90 per Bitcoin.

Bitcoins can be stored in digital "wallets" on users' computers, on portable media such as flash drives or on cloud storage systems.

Buying something using Bitcoins is as simple as sending an email.

The price a user pays for Bitcoins depends on the market value of them on any given day, much like any other currency market.

What are Bitcoins used for?

Just like physical money, Bitcoins are used for a range of legitimate and illicit purposes.

WikiLeaks, for example, used Bitcoins as a way to receive donations after major credit companies such as Visa and MasterCard refused to process its transactions in December 2010.

The major advantage of using them is anonymity.

Users of the hidden website Silk Road use Bitcoins to buy all kinds of illegal and legal drugs. The goods are then posted internationally with fake return addresses.

When the New Zealand customs officer was caught using the site this year he denied it was to buy drugs.

A Dunedin university student was also caught using it to get 165 Ecstasy pills mailed from the Netherlands.

Mainstream use

The key to growth is to get mainstream merchants on board, and according to Scientific American this seems to be happening.

Tony Gallippi's company Bitpay provides mobile checkout services to companies which accept Bitcoins.

He says they had 100 merchants in November 2011, which has grown to about 1100 now.

Stores selling anything from clothing, musical instruments, and alpacas accept the currency.

Last year, Manhattan eatery Meze Grill famously accepted bitcoins as payment for food.

It is becoming easier for people to buy them through exchanges such as Mt. Gox, and retailers like it because it makes fraud all but impossible.

A Bitcoin transaction can never be reversed because of the complicated way the network's ledger is edited, so a retailer never has to be concerned about charging a stolen credit card, for example.

Fluctuating value

Eighteen months ago Bitcoins were relatively unknown. Media coverage by companies such as Forbes helped raise awareness, which in turn raised their value.

From April to May 2011, the going rate rose from US86 cents to $US8.89, but then skyrocketed to about $US27 by June after technology website Gawker published a story about it.

A Tennessee man, known as KnightMB, who held 371,000 Bitcoins, suddenly was worth more than $US10 million, becoming the richest man in the Bitcoin community.

Florida programmer Laszlo Hanyecz used 10,000 Bitcoins to buy two pizzas back when they were worth just a few cents.

If he'd held on to them, they would have been worth $US272,329 after the June 2011 boom.

But he was philosophical about it, according to Wired. "I don't feel bad about it," he said. "The pizza was really good."

Cleaning up the image

The Bitcoin network, while gaining in popularity, has become tarnished after several large thefts by hackers.

In the past few months, Bitcoin exchange Bitcoinica lost $US400,000 worth of the currency.

Another exchange, Bitfloor, had to close after having $US250,000 worth of bitcoins stolen.

That is why the group of Bitcoin loyalists set up The Bitcoin Foundation.

It is modelled on the Linux Foundation, a non-profit group designed to promote the popular open-source operating system.

Whether the Bitcoin's underworld image can be revived, however, remains to be seen.

To many, it is seen as a scam – a Ponzi scheme. Others view it as a way to buy illegal goods without being caught.

To most, however, it is likely to remain a mysterious and complicated initiative, inaccessible to people with limited knowledge of the internet and computer coding.

Bitcoins, argue some, were introduced because of problems associated with traditional currency, such as fraud and traceability.

But those problems are unlikely to be so insurmountable as to bring Bitcoins into the mainstream.

For most people, a dollar works just fine. 

callison@nbr.co.nz