Permanent Address: http://www.scientificamerican.com/article.cfm?id=3-years-in-bitcoin-digital-... oney-gains-momentum 3 Years in, Bitcoin Digital Money Gains Momentum The digital currency exchange network now includes more than 1,000 merchants and at least tens of thousands of unaffiliated users, as it tries to solve barriers to participation By Morgen Peck | Monday, October 8, 2012 | Nowadays Bitcoin adopters are providing some clues about the benefits of a decentralized, anonymous, digital currency. For instance, independent merchants use it to receive online payments directly from customers, WikiLeaks uses it to dodge financial barricades, and drug users use Bitcoin to shop anonymously on the Internet's black market. But not everything works smoothly. The system lacks a quick way for people to trade in their physical cash for Bitcoins. Foreign currency exchanges don't deal in Bitcoins, and finding someone to sell them in person remains a huge challenge. A few of the online exchanges that do exist have lost huge amounts of their customers' Bitcoins to hackersba combined sum now worth over one million dollarsbwhereas the more stable ones require users to self-identify in a way that undermines the network's anonymity. And although the number of merchants using Bitcoin is growing, one still can't find very many places to spend them. At a conference this month in London, Bitcoin's core developers and many of those who are building applications to make it more user-friendly confronted the currency's setbacks of the past year and planned a course forward intended to elevate it from a niche technophile currency into one that competes with physical money on all levels. "'It's a challenging project, but it's one that's going to change the world. So that's why we're all here,"' said Jeff Garzik, one of Bitcoin's lead developers. How it works Imagine sending money over the Internet as easily as sending an e-mailbany amount, any time, to anywhere in the worldbjust as though you're standing next to a person and handing them cash. This was never possible before Bitcoin. The name, Bitcoin, is slightly misleading as there are no real coins involved. In fact, it's a publicly shared ledger that keeps track of transactions among different accounts. The task of updating the ledger falls to whichever computers (referred to as nodes) happen to be running the Bitcoin software at any given timeba role that is completely voluntary. Anyone can participate at this level once they've downloaded the Bitcoin software and purchased "coins"busually from an online exchange. The price they pay for them depends entirely on how the market values them from one day to the next. When Bitcoin users want to transfer their money to another account, they send an encrypted request to the network, identifying the involved parties by random strings of letters and numbers rather than by name. In order to verify the transaction and update the ledger, one of the nodes must come up with the solution to a difficult mathematical problem called a "'hash function,"' which takes the raw data from the transaction request and reduces it into a new string of data with a shorter, fixed length. A computer can only settle on the solution by trial and error, making multiple random guesses until it works. Once completed, this work is prohibitively difficult to reproduce and, in effect, time stamps the transactions as they come in so that no one can work backward on the chain. The first node to solve the puzzle broadcasts its solution to all of the other nodes, which then agree on the new version of the ledger. In this way, control over the ledger is spread over the entire Bitcoin network. To the network, all of this looks like a long chain of transactions, reassigning ownership of an arbitrary unit called a Bitcoin. What users see depends on which applications they run to access the Bitcoin network. In general, the interface allows users to open any number of new anonymous accounts and then receive and send Bitcoins to and from any other account. A person who owns Bitcoins really just owns a cryptographic key used to access a specific account. The computers that maintain Bitcoin guzzle electricity, enough so that many people admit to running them at work instead of at home to shift the cost (many people rely on specialized GPUs and multiple units to run the software, such that power bills can noticeably increase). They are driven by an incentive. Every time a computer seals a block of transactions with a hash function, Bitcoin software creates 50 new coins and assigns them to the ownerbs account. This is how new currency is issued in the first place. Given that Bitcoin transactions occur in public, it's easy to measure the level of participation. According to Garzik, Bitcoin is expanding faster than it ever has since its birth three years ago. More than 60 trillion Bitcoins bounced between accounts since the beginning of this year, constituting nearly five million transactions, which is more than twice the number of transactions processed in 2011. Ever so slowly, merchants seem to be warming up to Bitcoin, according to Tony Gallippi, whose company, Bitpay, provides mobile checkout services to companies that want to accept Bitcoins. "I went to the Prague conference in November 2011 and we had about 100 merchants," he says. "We have about 1,100 now." Very few merchants deal only in Bitcoin. Mostbfor example, a massage therapist in Vancouver, a guitar shop in New Hampshire and 18craftsmen in the Etsy marketplaceblist Bitcoin alongside the standard payment options. When they finalize a deal in Bitcoin, they do so knowing that the transaction can never be reversed. The Bitcoin network doesn't edit its ledger. As such, merchants no longer have to worry whether they are charging a stolen credit card. "'The fraud mitigation is big for Internet merchants, because they are all handling card-not-present transactions. And the business has to eat the loss if the payment is reversed later on,"' Gallippi says. "'Using Bitcoin, a business can receive a payment from any country on the planet, instantly, with no risk of fraud."' Underworld and legitimate uses For others, Bitcoin has become a lifeline. In December 2010, soon after WikiLeaks uploaded 251,287 leaked U.S. embassy cables to its site, VISA, MasterCard, PayPal, Bank of America and Western Union united to embargo the group, refusing to carry out its transactions. According to WikiLeaks, the blockade, which continues today, choked off 95 percent of its donation stream. The activist group has been able to restore donations, in part, by accepting Bitcoin. As of September 30 WikiLeaks was holding the equivalent of $12,000 in its public Bitcoin address. "'It's important to them. At least they have one way of getting donations,"' says Birgitta JC3nsdC3ttir, a member of the Icelandic parliament and a co-producer of the WikiLeaks's Collateral Murder video (which chronicles two 2007 U.S. Army helicopter air strikes in Baghdad that killed two Reuters war correspondents and several probably unarmed men), who spoke in favor of Bitcoin at the conference. It would seem that Bitcoin has a little something for everyone: You can send money overseas to your kid in college without paying wire fees. You can anonymously fund activist institutions. You can buy drugs (legal and illegal pharmaceuticals as well as recreational ones). But first you have to have some to spend. And right now, getting a hold of Bitcoins is much harder than the people who advocate the currency would like it to be. Many of the smaller online exchanges where customers purchase their account value have fallen prey to hackers who broke in and stole the Bitcoins users were storing on the site. This summer Bitcoinica lost over $400,000 in Bitcoins to hackers, and early this month another exchange called Bitfloor closed down as it sought to rebound from $200,000 in stolen funds. The large exchanges that remain have responded to the crises by collecting personal details from their clients as a defense, a practice that many in the community say undermines the whole point of having an anonymous currency. Frank Braun, an IT security consultant and self-described privacy extremist, confronted the problem by urging people at the conference to open new over-the-counter exchanges. But it may also be possible to build an exchange that is as anonymous and decentralized as the Bitcoin network itself. In his talk in London, Mike Hearn, another core Bitcoin developer, proposed a peer-to-peer currency exchange that would link trusted buyers and sellers online and then leave them to sort out payment details amongst themselves. The system would require no central repository of money, eliminating the target for hackers. Nor would the system collect private details about the users, working from the same string of letters and numbers as the Bitcoin protocol. But perhaps most consequential for the future of Bitcoinbin order to shut down a peer-to-peer currency exchange, one would have to terminate every node on the network. The few lawyers who have studied Bitcoin all agree that the currency inhabits a legal gray area. No one really knows how governments would react if it gains traction, but many consider the exchanges to be the easiest target for people who want to regulate Bitcoin. Decentralizing the exchanges would make that job nearly impossible. Bitcoin developers are quickly proving that they can design decentralized alternatives to even the most sophisticated financial institutions. But some are building applications that use money in ways that had never before been possible in the digital world. Chris Raggio, a programmer in Mississippi, is working on a digital alternative for the common tip jar. The collection "vessel" would be a wall poster embedded with an NFC (near-field communication) chip, which could be programmed to accept Bitcoin donations. Unlike similar payments with PayPal or credit cards, one could make small donations without a fee, right on the spot, just like throwing a quarter in a jar. "'We hear all this talk that we're going to a cashless society," Raggio says. "Maybe we are and maybe we aren't. But if we are, we're going to need something like this to protect that money jar."' Similar applications are being built to facilitate micro-payments on the Internet and, if successful, they could reduce the extent to which content providers now depend on advertising revenue. Such applications could aid in inviting new users to participate in the Bitcoin economy. None of them have arrived yet, but many people are writing them, often quitting steady jobs to do so. At the end of his speech, Garzik rallied for the currency and asked for patience over the long haul. "'How long did it take to create the euro, implement the euro, widely distribute the currency, widely distribute the cash registers, point-of-sales systemsball of that stuff,"' he asked. "'It took years and years. And so one cannot reasonably expect Bitcoin to be an immediate success in two years."' --Michael