Everything you need to know about Bitcoins in 2013

Bitcoin Everything you need to know about Bitcoins in 2013

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Bitcoin: the bits and pieces

You may have heard of it in the media. Bitcoin is the new, hot “virtual currency” that is not only attracting the attention of millions of individuals, but banks, the federal government, state governments, and a number of national governments. And importantly, the attention of venture firms – companies like Andreessen Horowitz, Lightspeed Venture Partners, and Union Square Ventures, which have all recently invested in Bitcoin-based start-ups.

Oh yea, some of you are busy. Before continuing with the hype of Bitcoin, here is a summary of the things you should know about It.

  • Bitcoin is a secure digital currency, created by computers “mining” complex mathematical problems.
  • There is a mathematical limit of 21 Million Bitcoins that can EVER exist
  • Even though there are already over 11M Bitcoins mined in the last few years, there is diminishing marginal return on mining, and so experts expect it will take another 100 years before all 21 Million of then are mined out.
  • Because Bitcoins can be permanently lost, hence destroyed, (and it happens regularly on accident), the existing Bitcoins will never be close to the 21 Million max.
  • Almost ALL kinds of businesses are trading with Bitcoins now, online and offline: from gambling sites to your local barber or dentist.
  • Due to true scarcity, diminishing marginal returns on mining, and a growing sense of trade ubiquity, it is quite possible for a Bitcoin to be worth $10,000s or $100,000s in value. (Of course, it is also possible for it to drop to $0)

Okay, back to the hype story of Bitcoin

In April Tim Draper, founder of Silicon Valley’s Draper Fisher Jurvetson, led a seed-funded investment in CoinLab, itself a Bitcoin business incubator. Shortly after it secured a series A round of $6.11M. Winklevoss Capital Management (yes, the twins from the Facebook story), submitted a filing with the SEC in July, in a bold step to launch the first Bitcoin ETF (exchange traded fund). Estimated to own 1% of all Bitcoins, the twins plan to commit the entire stash to the fund, establishing a roughly $13,000,000 base. And now, even Google Ventures has entered the fray with its small seed investment in OpenCoin, the developer of an open source payment system for virtual currencies.

Bitcoin promises to be the democratic currency for the common man, yet a great investment vehicle (not without unpredicted risks) for those “smart” VC’s in the Valley and other investors around the world. At the same time Bitcoin millionaires have been created, who are naturally interested because their accounts cannot be frozen or seized, at least for now.

Bitcoin icon.sm  Everything you need to know about Bitcoins in 2013

So, What is Bitcoin?

Bitcoin is a virtual (digital) currency network, though more specifically a “cryptocurrency” network, where the creation and transfer of value is based on an open-source cryptographic protocol that is independent of any central authority. The term “bitcoin” also refers to the basic unit of currency within this system. Born in 2009, the network is global – allowing currency to be moved between countries almost instantaneously without involving government regulation or control by traditional banking systems.

Bitcoins are generated from a process of mathematical mining, which is used to secure the network. However, instead of yielding a unit of gold or silver, this process yields an encrypted string of data, known as a hash, equal to a unit of virtual currency. All bitcoins are generated (mined) and all transactions are tracked (secured) by a global network of peer-to-peer computers using standard Internet protocol.

Bitcoin icon.sm  Everything you need to know about Bitcoins in 2013

Why Bitcoin is special.

There are a number of fundamental features which make bitcoins and the Bitcoin network attractive to users. Some reflect the characteristic qualities of the more traditional “quality” currencies, while others are distinctive to cryptocurrencies. Here are some of the more compelling features which make Bitcoin unique:

Decentralization -
Instead of traditional government oversight and banking control, the Bitcoin economy is monitored and maintained by its global network. This global network provides a means to support, verify and secure the comprehensive public ledger of all Bitcoin transactions. No government, company, or organization runs the Bitcoin network – it is fully distributed among its users.

Anonymity -
Though all transactions are public, they are not tied to one’s identity. Therefore, each and every transaction is not only secure but anonymous – the user controls anonymity and traceability. They protect their privacy.

Security -
The system is highly encrypted and secured by a global network of computers which check every transaction for uniqueness, to insure that no coin is reproduced or double spent. This essentially makes bitcoins impossible to counterfeit.

Public -
There is a comprehensive public ledger which tracks all transactions – the “block chain”. While this enables every transaction to be viewed in public, the parties involved remain undisclosed.

Stability -
The supply of bitcoins is predetermined and coded into the encrypted network. This prevents the random or indiscreet “printing” of money into the system. This makes Bitcoin more attractive as a long term store of value, or eventual investment vehicle.

Convenience -
Bitcoins are carried in a digital wallet. These wallets can be located on your computer, smart phone, an iPod Touch, or in the cloud. The amount of bitcoin is not restricted by physical size. You can carry thousands of dollars worth of bitcoins onto a plane or dining out without a problem. And they are invisible.

Frictionless -
Point to point transactions are, in general, free of any charges. Individuals can use Bitcoins in direct exchange for products and services – no transaction fees or bank charges. In this sense it’s like cash. For large transfers, online retail purchases, or exchange services – such as purchasing dollars with bitcoins, the service fees are normally a small fraction of what banks and money handling institutions would change for Fiat currencies. In these cases, bitcoin is essentially frictionless.

Market Growth -
Last but not least, Bitcoin has exploded in the past year, from a market cap of some $50M in 2012 to over $1.4B in 2013. Exchanges rates for bitcoins were as little as a few cents per coin in 2011 to $20 in 2012, and are now hovering around $120 in 2013. Though the future is still unpredictable, the bitcoin has shown increased price stability with time.

Bitcoin icon.sm  Everything you need to know about Bitcoins in 2013

 

 

 

What makes Bitcoin special among virtual currencies.

Typically we can think of virtual currencies in two classes – company-based virtual currencies and true cryptocurrencies. In the first case, the virtual currency is intrinsic to a single entity and therefore limited to its exchange for products and services offered by that entity. Think of Linden Dollars used in Second Life or Amazon Coins, which can be used for purchases within the Amazon stores. Outside of the their parent entities, these currencies offer little if any exchange options. For supporting purchases and transactions in the global digital world, Bitcoin is vastly superior.

In the case of the true cryptocurrencies, Bitcoin was the first and is the current darling in the virtual currency world. Though Bitcoin is a viable purchasing currency for online products and services, it is also beginning to gain acceptance by restaurants and stores in the physical world. Many professionals will now take bitcoins in exchange for their services. (You can even have dental work done on your teeth, but right now you’ll have to fly to Finland to do so.)

In general, only Bitcoin has gain a reasonable level of public acceptance. Though there are a least two dozen notable cryptocurrencies, only a handful have gained even a modest level of traction. Litecoin, which is actually based on the Bitcoin protocol, is set up to have 84 million coins mined. Currently about 20% of these have been mined, with a total market value of $50 million. Unlike Bitcoin, there are no physical merchants that are currently accepting Litecoin. However, there are a growing number of online services that do accept Litecoin.

Bitcoin icon.sm  Everything you need to know about Bitcoins in 2013

Where is Bitcoin on the Hype Cycle?

The Bitcoin hype may not be over. In fact, it may still be growing. At a recent MIT/Stanford Venture Lab (VLAB) event on virtual currencies, moderator Kashmir Hill of Forbes indicated that the “hacker community” was actually excited about two technologies and weren’t certain as to why. First was 3D Printing, and the second was Bitcoin. You may be familiar with other technologies that have “excited” this community – like the World Wide Web and Social Networking.

At the same VLAB event, Cameron Winklevoss stated that he felt that most people probably know about Bitcoin by now. However, statements about technological awareness from the high tech centers often over estimates reality. What might seem like common knowledge in Silicon Valley, LA, New York, Boston, or Austin, may not be the norm for the rest of the country. Or the world for that matter, though Europe and parts of Asia and South America seem to lead Americans’ awareness in the case of Bitcoin.

A recent June YouGov/Economist poll of 1000 US residents found that only 30% responded yes to the question “Have you ever heard of Bitcoin?” This seems to contradict Cameron’s statement, though one could argue that the sample size may have been too small or that it weighed rural areas too heavily. He may have also been implying a more global awareness.

Another poll of over 22,000 U.S. consumers was taken on Bitcoin in May by the survey firm On Demand. They found that only about one quarter (25.3%) of Americans had heard of Bitcoin. In comparison to the company’s surveys taken in Argentina and the UK, Americans seem to lag in awareness of the virtual currencies. Results in those countries were closer to one third – 37.9% (on a sample size of 760) for Argentina, and 32.3% (on a sample size of 2,731) for the U.K. For the Bitcoin-aware responders, the trust of the currency by Americans (62%) also lagged that of the Argentinians (73%) and the British (69%).

It is debatable on where Bitcoin is in terms of the Gartner hype cycle. For those unfamiliar with the Hype Cycle, it is a visual tool used by analysts to help evaluate the maturity, adoption, and social impact of specific technologies. Typically, a new technology goes through a phase where there is great excitement, leading to inflated expectations. This is followed by a subsidence phase, and a subsequent maturing and recovery, in becoming a viable product or service.

Some may argue that the Bitcoin system and technology is approaching the “Peak of Inflated Expectations” as it continues to garner an increasing number of stories in the news. Some might say it is already descending from the peak, which might become more apparent in hindsight, a few months into the future.

 

Gartner Hype Cycle.2 300x195 Everything you need to know about Bitcoins in 2013

Others, the optimists among us, probably feel that Bitcoin has passed the inflated expectations stage and negotiated the “Trough of Disillusionment”, and is now moving up the “Slope of Enlightenment”. They point to rapid mid-year rise of Bitcoin daily trading in 2011, from volumes around $10,000 to a peak of over $250,000. This is illustrated in the two year daily volume chart for Mt. Gox (Chart reproduced courtesy of bitcoincharts.com). The chart presents the daily volume in US dollars. With the accompanying decline, the resulting profile did approximate a rough early Hype Cycle profile.

MTGox2yvolchart 300x111 Everything you need to know about Bitcoins in 2013

Mt. Gox Daily Volume in Currency – USD from Aug 31, 2012 to Aug 31, 2013. BitcoinCharts.com.

 

The subsequent rise in trading did suggest that Bitcoin could actually be on a trajectory that might seem like a slope of enlightenment in nature. However, fitting Bitcoin trading data to a Hype Cycle is more an art than a science. Can you see how the period from March through August looks like it might be exhibiting Hype Cycle characteristics? Well, try harder. Alas, predictions will only be validated after a substantial amount of time has passed. We may have to wait awhile until we know where Bitcoin is on the Hype Cycle.

In terms of daily transactions, Bitcoin has risen over the last year from typical days of 30,000 transactions to typical days in excess of 60,000. At the same time estimated transaction volume has increased from $5M to $30M. Both trade volumes and transactions continue to rise.

Though it is impossible to know the actual number of people involved in daily transactions, the number of unique digital wallets used can be tracked. Typically 30,000 unique wallets were used a year ago. The current daily wallet numbers are near 70,000, with occasional days where the number exceeds 100,000. If we were to assume that there is an approximate 1 to 1 ratio of people to active wallets involved in transactions, this data would indicate overall adoption is steadily rising.

BC Rnd 64px.1 Everything you need to know about Bitcoins in 2013

Who and what accepts Bitcoin.

All types of online services accept payment in bitcoins – from computer hosting and Internet service providers to online merchants selling everything from electronic supplies to nerdy tee shirts. You can even buy flowers through a growing number of online florists.

Online casinos, travel agencies, professional services, gift shops, software suppliers, and of course, many porn sites use Bitcoin. Some notable companies have adopted Bitcoin early on, such as WordPress – which started accepting bitcoins in late 2012. The Internet Archive, the non-profit foundation which historically preserves websites through the Wayback Machine, started to accept donations in Bitcoin in early 2013. Not only accepting bitcoins, but paying its employees in bitcoins if they prefer. This organization is becoming a Bitcoin trend setter, not only for foundations, but possibly all businesses in general.

 

De Waag Bitcoin 300x225 Everything you need to know about Bitcoins in 2013

Slowly but surely restaurants and cafes are beginning to accept Bitcoin. Draper University in San Mateo, CA is now accepting Bitcoin for tuition payments and course fees, and other institutions may follow. Similar to their online brethren, some consulting services are beginning to adopt a Bitcoin-friendly business position. And of course, their are those dental services in Finland. As adoption becomes more prominent in the US, this may lead to a trend in American dental services. And if dentistry, why not plastic surgery and other elective medical services?

Bitcoin icon.sm  Everything you need to know about Bitcoins in 2013

How Bitcoins are produced and circulated.

There are a number of mathematical features in the design of the Bitcoin system, which provide rather unique desirable qualities. First, the total number of bitcoins that will ever be produced is set at 21,000,000 coins. Currently there are a little over 11,000,000 bitcoins in existence.

The actual generation of new bitcoins comes as a bounty or reward for closing the ledger, roughly every ten minutes. The production of bitcoins decreases over time, as the reward value is halved every four years. Originally the reward value started at 50 coins – producing 50 bitcoins every ten minutes. Currently it is 25 bitcoins, in 2017 it will be 12.5 bitcoins. At this rate the total 21,000,000 bitcoins will have been produced by the year 2140.

Concurrently, the difficulty in mathematically solving the cryptographic problem which is used to verify the transactions and secure the network, will increase. This increased difficulty will require more computing resources and electrical energy to be invested. As such, the reduced rate of production and the increased computing investment is part of what gives Bitcoin its value. (Not gold, silver or the good faith of governments.)

One should be aware that the total number of Bitcoins in circulation will never be 21,000,000.

“Wait, didn’t you say that a total of 21,000,000 Bitcoins will have been mined?”

That is true, but Bitcoins can also be destroyed. This is because some people will lose their wallets. Without the wallet and the private crypto key, the Bitcoins inside can never be recovered. Similar to losing cash in a fire, but without insurance to cover the lose, and without new printed money replacing old and offsetting the effect on circulation.

It is also speculated that some users have accumulated large sums of Bitcoin, with the intent of holding them for the appreciation in value. This effectively removes them from circulation, essentially creating a condition of pseudo-destruction. If the user meets with an unfortunate situation, such as chronic memory loss or demise, without provisions for a suitable execution of assignment to another individual or entity, the state of the coins is that of permanent destruction. Kiss them goodbye.

All in all, these Bitcoin characteristics – theoretical limitation on the total number of coins, the increased difficulty in mining (production of coins), the decreasing reward for mining coins (and securing the network), and the residual destruction of coins, create anti-inflationary forces. These forces will make it hard for Bitcoins to decrease in value over time. They may also have a stabilizing effect on the coins in the exchange markets.

 

Bitcoin icon.sm  Everything you need to know about Bitcoins in 2013

 

Types of Bitcoin Businesses/Companies.

There are many types of Bitcoin-based companies. Most are normal, legal businesses, but a few are illegal, or at least somewhat notorious. The great majority are services, retailers or markets, while a few deal with actual Bitcoin products – the Bitcoin miners. We’ll touch on a few here.

Marketplaces -
There are two marketplaces which use Bitcoin for transactions, Bitmit and Silk Road. Bitmit is an online auction site that conducts its sessions in dollars and bitcoins. Bidders and sellers can post their orders in either, and the updates will be displayed in both. Like eBay, there are “buy now” options where the purchase price is given in both dollars and bitcoins. For each transaction a 1.9% service fee is charged, whether in bitcoin or dollars. Though these fees are far from frictionless, they are seen as reasonable in exchange for the convenience of purchasing products with bitcoins.

Silk Road (established in early 2011) is a rather infamous online “black market” site known for supporting the purchase and sell of drugs. Though users can purchase legal goods and services, an estimated 70% of the products are drugs. All transactions are conducted with bitcoins. This takes advantage of the anonymity that Bitcoin provides to protect the identity of the clients.

Financial Services -
On the financial services side, there are a number of Bitcoin monetary exchanges, led by the largest – Mt. Gox. Based in the Tokyo district of Shibuya, Mt. Gox was established in 2010 and trades bitcoins for dollars, yen, euros, and other currencies. Mt. Gox typically charges a fee up to 0.6% on each trade. Typical trading volumes are around $15M a month. Other exchanges include BitInstant, Virwox, BTC-e, and BitStamp, who together represent about a third of the volume of Mt. Gox.

One precious metals exchange is based on bitcoin – Coinabul, a two year old company based in Wyoming. The company sells gold in bars or coinage, and silver coins, for bitcoins. Once payments are received through the network and secured in the Coinabul digital wallets, the purchased gold or silver is distributed from its centers in California.

Another financial service for Bitcoin is Bitpay, the automated payment processing service for bitcoin. Bitpay enables online merchants to accept bitcoin payments in exchange for a 1% service fee. As Bitcoin gains acceptance more merchants will utilize Bitpay as a purchase option for their customers and take advantage of the lower service fees – relative to credit cards and other charge services. In the future an similar system is expected to support physical stores and merchants who would like to offer their customers the option to make bitcoin purchases.

Gaming -
When it comes to Bitcoin gaming sites, most are gambling sites or have substantial wagering features. The leader is SatoshiDice, the online Bitcoin site which started in January of 2013. Since then a number of gambling parlors and casinos, such as Bitcoin Video Casino have been launched which feature wagering in bitcoins. Many existing casinos have opened up their wagering options to include. One unique feature of some Bitcoin gambling sites is the acceptance of very small bitcoin bets, typically on the order of a few cents in value. It’s a good way to test the waters before going in too deep.

Like the standard online game universe, MMORPG’s, puzzles and gameboard games are beginning to appear. It appears that most are retools of existing games, but featuring Bitcoin purchase options. In time this segment of games may catch up to the gambling segment

Mining Hardware -
A number of Bitcoin miner companies have developed in the last couple of years. These hardware-based companies build the computers which secure the Bitcoin network and solve the math to compete for the coin reward that is generated every time the ledger is closed. Since these computers must compete to see which can close the transaction ledger first over each ten minute interval, those with greater computing power are more likely to win.

In the early days of the network desktop PC’s and laptops could be used. The faster machines, with the more powerful CPU’s would be highly competitive. Soon GUP cards were installed and tapped to do the mining, outperforming the machines which used their CPU’s. Shortly thereafter people would build rigs which utilized multiple GPU cards. These rigs would generate “hashing solutions” much faster, but would also consume large amounts of electrical energy. They also produced excessive amounts of heat – good for the winter, but not the summer.

In the past year, specialized mining rigs (advanced miners) based on advanced chip designs have come to market. One type uses application-specific integrated circuit (ASIC) chips to do all the heavy lifting. Another type uses field-programmable gate array (FPGA) chips to do the number crunching. Both types offer major jumps in performance over GPU-based rigs, with ASIC machines being the fastest for now. However, the cost of designing, developing and manufacturing these rigs can be substantially higher than just purchasing a fast PC and loading it with hefty graphics cards.

All of the advanced miners are either project builds – developed and supported by user groups, or start-up companies, such as Butterfly Labs, Avalon, and Avnet. But the start-ups are not without controversy. Many purchasers have experience delays in delivery, or uncertain fulfillment – orders placed and funds committed, with product put on hold. Customer support has been characterized as unpredictable.

Six Advanced Miner Companies

FPGA – based miner companies: Avnet, Butterfly Labs, Lancelot
ASIC – based miner companies: Avalon, Bitforce, Block Erupter

Mining Pools -
Another type of Bitcoin business based on miners comes in the form of mining pools, which take various forms. In one form, individuals that own miners can join a grouped pool, where all rigs work together over the Internet, in a combined effort to win the bitcoin reward for solving the blockchain (transaction ledger). Since the combined computational power of the pooled network is much more substantial, the likelihood of winning is proportionally greater. If the pool wins, the Bitcoin proceeds are stored in a pool wallet and distributed to each member proportionally, based on the amount of computing power they bring to the pool.

Mining Contracts -
Another form of pooling is offered through pool contracts. Companies like Cloudhashing use powerful clusters of bitcoin miners to do the mining and sells contracts to both individuals and companies. As the cluster produce bitcoins, the contract owners are paid out based on the level of their contracts. This eliminates the need to own expensive hardware, configure and maintain sophisticated software, and supply the electrical power to run the equipment. It also provides the essential on site monitoring and maintenance around the clock, which insures that mining is always being performed.

Bitcoin icon.sm  Everything you need to know about Bitcoins in 2013

What is the Future for Bitcoin

It appears that we are entering a new era for the world’s currency systems. In the beginning currencies were commodity based. Items and materials of perceived value became accepted in exchange for other items (products) and services. Eventually gold and silver became the accepted common backing for most societies.

Subsequently commodity based systems were replaced by the politically based systems, where the “good faith” of governments became the backing. In the twentieth century the US dollar replaced gold as the basis of all currencies. Everyone knew that the good faith (and power) of the American government backed the dollar – so it had to be like gold. In theory, it was the US Fiat currency that helped to supported other Fiat currencies.

But today the US dollar is more virtual than it has ever been. Most of an individual’s wealth is the form of electronic records stored in their accounts with various financial institutions. Many more transactions and simple purchases are made through electronic services than through the physical exchange of cash or coin. The virtual nature of money is ever increasing.

So, as the “usage” of bitcoins continues to increase, while the creation rate of bitcoins continues to decrease (a few years to mine half of the coins, and over 100 more years to mind the other half!), at some point in the future each bitcoin could be worth hundreds of thousands of dollars!

Still, there are inefficiencies and expensive mechanisms which prevent many of the advantages of a virtual currency. The developers and supporters of Bitcoin believe that the new digital currencies will help solve the remaining problems, with Bitcoin leading the way.

At its current rate of adoption, Bitcoin is expected to become a viable alternative to Fiat currencies in the next ten years. Sooner, if adoption does not stay somewhat linear, but takes on a more typical exponential rate. It already exceeds the total value of the currencies of some smaller countries, such as Niger, Sierra Leone, Bhutan, Samoa, and Liberia.

Some critics have accused Bitcoin as being a network of Ponzi schemes, while others have claimed it will be a refuge and vehicle for criminals and money laundering. But the same arguments can be placed on the Fiat currencies and their supporting financial systems. Yes, Bitcoin might be used for money laundering, but have you ever thought of how much money goes through Wells Fargo to be laundered?

What Bitcoin does bring to the table is a highly secured transaction network that can globally transfer money faster than Fiat-based systems. And a system that protects an individual’s privacy, which is a very sensitive and hotly contested subject on its own.

In conclusion, we can look back at the history of the last forty years. In the early seventies IBM executives felt that small home computers weren’t a viable concept – “no one would want a computer in their home”. Two young men from Silicon Valley felt differently.

Though computers had been linked together, exchanging data since the late 1960′s, no one thought it would have much practical benefit for society in general. When we learned to do the same thing without wires in the 1980′s, it was still viewed as a novelty. But along came the 90′s and the world became different, in a connected sense.

Networks, social networks, mobility, entertainment and education, among others, are evolving to make lives more dynamic and effective. But as far as our currency systems have advanced, they are still slow in evolving – especially in security and privacy. Virtual currencies may be the solution, or part of the solution. And Bitcoin, with all the debatable issues, appears to be poised in leading the way.

(Special Thanks to Jerry Fuqua, the Bitcoin expert, for tremendously helping out on this post and making it possible!)

5 comments
HiSocial
HiSocial

mmmm, do not click the previous link, just copy it. Your commenting system it's not displaying the right url

HiSocial
HiSocial

Try this onehttp://www.microsofttranslator.com/bv.aspx?from=es&to=en&a=http://www.salaimartin.com/randomthoughts/item/589-la-burbuja-del-bitcoin.html

My 2 cents:

On the offer site

- We don't know for sure, that offer will remain scarce. It could be for exampled hacked or the bitcoins creators could have a secret way to create new bitcoins

On the demand site,

- The demand could grow or...drastically decline. Imagine for example that governments  outlaw the bitcoin


Yu-kai Chou
Yu-kai Chou moderator

Hmm, not sure why, but Livefyre has been dropping comments...Here's a comment I got from @HiSocial:

"Hi Yu-kai,

Bitcoins are a very risky business, you should read this article from Xavier Sala Martin (Columbia University Macroeconomic Professor, and probably a Nobel Prize in the near future). Here you have the translation

http://www.google.com/translate?hl=en&ie=UTF8&sl=auto&tl=en&u=http%3A%2F%2Fwww.salaimartin.com%2Frandomthoughts%2Fitem%2F589-la-burbuja-del-bitcoin.html"

Yu-kai Chou
Yu-kai Chou moderator

And then my response to myself -_-....

Hey HiSocial, thanks for the comments. There are definitely risks to Bitcoins, but due to the scarcity, if it grows in demand, the value will grow quite tremendously. 

The link you included here does not work....can you help out?