The internet created a new money that exists only in cyberspace. We call this money
Bitcoin, where bit refers to the computer term – a piece of information, either a one or zero.
This money has other names including virtual money or cryptocurrency.
No central bank or government issues Bitcoins, and 11.75 million Bitcoins were circulating
in the world in October 2013. Bitcoins’ supply continuously grows until 2140, stopping at 21
million Bitcoins. Furthermore, cryptography plays a key role in Bitcoins. Every Bitcoin has a
unique, encrypted number that only a Bitcoin operator can decrypt.
A person opens an account
or wallet and can buy Bitcoins from online vendors. A person can store his Bitcoins on his
computer or cellphone or use an online wallet.
A person does not have to reveal his identity. Then he or she settles transactions by sending
the other party his Bitcoin information. As a buyer completes a transaction, software encrypts
that person’s private key into the transaction along with the Bitcoin number. A private key is
like a person’s bank account number. Ensuring people do not spend the same Bitcoin for
multiple transactions, a miner completes the transaction. A miner decrypts the transaction and
records it in a ledger. Then it re-issues the Bitcoin to the seller.
A miner can earn transaction
fees and receives newly created Bitcoins by clearing transactions.
Miner is not the proper terminology. A miner functions as a clearinghouse.
A clearinghouse can be a large bank that helps member banks transfer money between them. Then
member banks have accounts at the clearinghouse. For example, you buy $500 in clothes from
an internet store and send a check to the seller. Next, the seller deposits the check into his or her
bank account. Seller’s bank sends information about the check to the clearinghouse and the
clearinghouse checks with your bank. Your bank checks your balance ensuring you have enough
funds in the account to pay the check. Once your bank approves the transaction, the
clearinghouse reduces the account for your bank by $500 and adds $500 to the account for the
seller’s bank. Then your bank reduces your account by $500 while the seller’s bank adds $500
to his or her account, thus clearing the transaction.
Bitcoins have four drawbacks that would prevent wide scale adoption.
1. People who deposit their savings into banks have deposit insurance. If their bank fails, the
deposit insurance guarantees the depositors will not lose their money. The Federal Deposit
Insurance Corporation insures bank deposits up to $250,000 for U.S. banks. However, no
government agency insures Bitcoin or protects people from losses.
2. Hackers can break into online wallets and steal the Bitcoins. Since all transactions are
electronic, they can erase history, and people may not recover their stolen Bitcoins.
3. Price of Bitcoin fluctuates greatly between $80 and $1,000, which we show in Figure 4. For
people to use and accept money, people must know the money’s value. Some investors
purchased Bitcoins, hoping to buy at a low price and sell for a high price.
Bitcoins provide three benefits. First, buyers and sellers do not have to reveal their identities
to each other. They can remain secret. Second, people can use Bitcoin to launder or smuggle
currency outside a country. A buyer would purchase Bitcoins in one country and withdraw the
Bicoins in another country, circumventing currency controls. Finally, buyers and sellers use
Bitcoins to settle transactions in the underground economy that is hidden within the internet. We
call this the deep internet where most internet users would never see. The deep internet allows
buyers and sellers to communicate with each other without revealing their location or identities.
Bitcoin is evolving into the currency of the black markets on the internet. Buyers and sellers
use Bitcoin like the numbered Swiss bank accounts.
For example, they open a numbered account at a Swiss bank that contains no personal information. Then they can use the account to
settle transactions secretly. For example, a person pays for an illegal service. This person
contacts the Swiss bank and asks the bank to transfer the bribe amount from his bank account
into the seller’s bank account. This person gives the banker a code (or private key for Bitcoin) to
approve the transfer. Consequently, the transaction remains secret because no one has revealed
his or her identities.
4. Few sellers accept Bitcoins as payment.
U.S. federal government is cracking down on the internet black market and is closing down
Bitcoin operators. Agents believe that if they can shut down the money, they can eliminate the
black markets operating in the deep Internet or prevent the funding of terrorists. For example,
the U.S. Department of Homeland Security shut down Mt Gox, the largest Bitcoin operator in
the United States in May 2013 although Mt Gox did not participate in illegal activities. U.S. law
requires all money exchangers to register with the Financial Crimes Enforcement Network.
Unfortunately, the federal government will fail because people can use Bitcoins anywhere in the
world.
Bitcoin continues to flourish despite its drawbacks and U.S. government crackdown.
Bitcoin ATMs are cropping up in Hong Kong, New York City, and Vancouver, and more stores
and vendors are accepting Bitcoins for payment.
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