Bitcoin and the Blockchain

Utah Software Engineer Mints Physical Bitcoins

Bitcoins introduced a lot of people to the idea of computerized money. Now the digital currency, which set off a minor frenzy when it broke into public consciousness in 2013, is trying to grow up. Utopian fantasies have subsided as consumers remain unconvinced of the value of swapping their cash for bitcoins, or using them to buy goods and services or for transferring money. Sharp price swings have shown that owning bitcoins isn’t a sure path to riches — the currency lost half its value over the course of 2014, a worse showing than the ruble. But the currency’s underlying technology, known as the blockchain, is a different story. In its simplest form, the blockchain is a public online ledger in which transactions are recorded and verified. Silicon Valley startups and established Wall Street firms are all exploring whether such a decentralized system could become a launching pad for major changes in finance and other industries.

The Situation

Startups with names such as Chain.com, Ethereum and Colu are trying to use the blockchain for everything from voting to selling merchandise. They think of the virtual currency as just the first of many applications of the blockchain, and one that won’t be that widely used. Developers are currently split over proposed software changes that could either make bitcoins more useful or lead to a slew of competing versions. There’s also uncertainty surrounding how bitcoin-related businesses will be regulated. The U.S. Internal Revenue Service ruled that bitcoins would be treated as property, not currency. In September, the Commodity Futures Trading Commission said that bitcoin is a commodity, just like crude oil or wheat. Meanwhile, arrests for Ponzi schemes using bitcoins and mysterious spikes and drops in the currency’s value show that it has yet to overcome an early reputation as a tool for selling drugs and laundering money.

Source: Bloomberg
Source: Bloomberg

The Background

Virtual currencies aren’t new — online fantasy games have long used them — but the development of a secure digital currency without a central issuer rightly turned heads. The pseudonymous creator of the bitcoin system, Satoshi Nakamoto, solved a problem central to any currency: how to control its issuance, i.e., prevent counterfeiting. But Satoshi did it without relying on government’s central authority. He also solved one specific hurdle for digital money — how to stop users from spending the same unit of currency twice. His breakthrough idea involves the blockchain, a publicly visible online ledger that records every single bitcoin transaction, one maintained by a network of bitcoin “miners” whose computers perform the calculations that validate each transaction, preventing double-spending. The miners earn a reward of newly issued bitcoin. The pace of creation is limited, and no more than 21 million bitcoins will ever be issued.

The Argument

A bitcoin boom early in 2014 led some to call it a bubble with no intrinsic value. But entrepreneurs in the field say that focusing on the price of bitcoins is missing the point — the currency’s value as the basis of a new kind of payment system not reliant on third parties like governments, big banks or credit-card companies. Dreams of replacing the dollar aside, putting bitcoins to work is a matter of applying enough time and money, they say. Convincing applications of the bitcoin system include moving money abroad, signing contracts, clearing complex financial transactions and as a medium for micro-payments in emerging countries. The idea of the blockchain as the center of new businesses got a boost when Blythe Masters, a former JPMorgan Chase banker who helped develop the market for credit default swaps, joined a blockchain startup. Will bitcoins themselves be left behind in the blockchain rush? Even some of the currency’s canniest boosters realize there is no guarantee that it will ever break into the monetary mainstream. Mike Hearn, a member of the core team that updates the bitcoin software, said that the “most plausible outcome” is that it retains only a niche appeal.

The Reference Shelf

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First Published Oct. 3, 2013

To contact the editor responsible for this QuickTake:

John O'Neil at joneil18@bloomberg.net