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Rise of the e-currencies

How bitcoins and their ilk could save — or destroy — the world
By JEFF INGLIS  |  February 12, 2014

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Bitcoins, and other e-currencies along similar lines, are all the rage these days — and everyone’s talking about them as if they know what bitcoins actually are, or do, or something. It won’t surprise you to learn that most people know only part of the picture, and most of those hardly understand the part they know.

In fairness, bitcoins are a challenging concept to understand. But we here at the Phoenix are always up for a challenge, so we’ll break it down for you. First, we’ll have an explanation of what bitcoins are, what they’re not, and what they make possible. Then we’ve assembled a set of arguments that explain how and why bitcoins are both the end of the world as we know it, and the next step to saving the world we love so well.

A useful point to start is to note that the word bitcoin, when used with a lowercase b, refers to the units of currency; when capitalized, Bitcoin refers to a software and the Internet-based communications methods used to track and exchange them. There are also other e-currencies, such as litecoin; all of them use the basic structure and concepts underlying the Bitcoin system, and differ only in the most arcane of technical details. They’re also not nearly as popular, nor as widely accepted — in part because bitcoins got there first.

Something from nothing

During, and in the wake of, the 2008 financial crisis, the institutions we had relied on to ensure economic stability turned on us. Several deeply concerning and fundamental facts about the world’s currency became widely apparent:

* Banks can’t be trusted Not only are they often working in opposition to their depositors’ best interests, but they gambled with other people’s money, lost, and then asked for government bailouts to pay off the debt.

* Governments can’t be trusted Rather than protecting their people’s interests, governments sometimes see their citizens as just another cash source. In March 2013, faced with an impending economic collapse, the government of Cyprus confiscated 10 percent of all the money held in accounts in that country’s banks.

* And anyway, money’s value is imaginary Governments, including the United States, can create massive amounts of new money out of thin air, and give it to whomever they want (usually the banks, as opposed to the people). This has always been true, but politicians and other financial experts no longer seem to worry that regular people object.

* Still, money is an inescapable, integral part of our daily lives It’s a very flexible medium of exchange, which I can accept in remuneration for (to pick an example) my reporting and writing and spend in a grocery store in exchange for food.

Some people had expressed those concerns long before the 2008 meltdown; afterward, more people understood them much more clearly.

Out of these problems came a seemingly simple solution: Create another currency, not beholden to a government, and find a way to store it safely without banks.

Of course, it turns out those are two very hard things to do, while still preserving the confidence and security we expect from a monetary system. The most difficult problem is how to prevent counterfeiting — which is of course far easier with a digital item than a physical one (as the movie and music industries have learned, to their dismay).

Government currency — and even most other alternative currencies (such as time-dollars) — have a centralized authority that can verify the authenticity of money. In the United States, it’s the Federal Reserve. Replacing this system with another one that also required central authority and verification made the whole exercise moot. The real goal was to decentralize verification, while still ensuring nobody copied e-currency and, effectively, spent it twice.

In late 2008 and into 2009, a person or group going by the name of Satoshi Nakamoto proposed a system called Bitcoin, offering a solution to the double-spending problem that was ingenious for its simplicity: The central authority keeping track of transactions should be the public at large, and the ledger should be available online to all who asked.

But that created another pair of questions: How to get the hundreds, even thousands, of different computers storing their own copies of the ledger to agree on when to update it, and what changes to add when updating?

Bitcoin offered an elegant solution to this problem, too. Whenever anyone wants to spend a bitcoin, they broadcast that intent to the network of ledger-keepers via the Internet. As each request comes in, each ledger-keeper computer checks its copy of the official record, to ensure that the spender’s identity is valid, that she actually has the correct amount available, and that she hasn’t spent it elsewhere already. If it looks good, each ledger-keeper adds the transaction to its own list of approved transactions that need to be added to its ledger in the next update. The ledger-keepers communicate about their individual approved lists; if a majority of them agree, the transaction is finalized and added to the shared official ledger. These checks and updates happen in computer software and encrypted communications across the Internet, and take only a few minutes.

Adding strength to this system is the fact that anyone can install the software on their computer to make it a ledger-keeper, receive their own copy of the ledger, and contribute to validation and verification of transactions. The ledger itself is fully public, showing which accounts sent how many bitcoins to which other accounts, and when.

Of course this raises the question of privacy. One of the things people like about physical cash is that it’s not particularly traceable. Bills have serial numbers, but most people don’t pay attention to those details, and it would be terribly hard to track any substantial sum. (See wheresgeorge.com for an example of trying to track dollar bills’ physical movements.)

Because it’s so central to our lives (we don’t typically want to broadcast which doctors we go to, how often, nor how much we pay them, for instance) privacy is also a cornerstone of traditional electronic payments: We trust the merchants and banks to keep our information away from wrongdoers. (The recent, and ongoing, revelations about card-system hacking at Target offer a warning against being too trusting that way.) At the very least, though, merchants and banks don’t publish their transactions online for all to see.

But that is exactly what the Bitcoin system proposed doing.

Satoshi Nakamoto had a solution for this, too: Every account would have a pseudonym in this new currency system, and everyone could create and use as many accounts (and pseudonyms) as they wanted. The ledger would store the pseudonyms of the sender and receiver (not their real identities), and the ledger-keeping software would confirm through secure encrypted communication that the people using those pseudonyms were the people who had created them, by comparing digital signatures stored when the account was created against the digital signature presented during a transaction. (For those who wish to dig deeper into how a publicly available ledger can store a signature in a way that is truly secured so only one person can sign it, look into public-key cryptography. There’s enough reading online to occupy the rest of your days.)

This seemed to solve all the problems that had faced digital currency: quick and easy transaction approvals, protection against counterfeiting and double-spending, privacy protections for buyers and sellers, and avoidance of a central authority that could steal everything on a whim.

The next trick was getting people to actually use it.

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