Meze Grille is a restaurant in midtown Manhattan only a couple of blocks from Fordham’s Lincoln Centre campus. The food there is great but this restaurant gains more attention for its acceptance of bitcoins – a digital currency. Meze grille is one of six restaurants in the world to accept this currency. So we ask, what is the Bitcoin?
The 2008 financial crisis left the world in chaos. The stock market crashed and corporations were exposed as confidence in the government and global financial system was severely eroded overnight. At this time, millions ran to protect their assets – the dollar was not as trustworthy as once thought. Enter Satoishi Nakamoto.
On November 1, 2008, Satoshi Nakamoto published a research paper on his new design for a digital currency he called the Bitcoin. Nakamoto seized the moment to expose us to a new currency that would forever revolutionize the idea of money.
The concept of digital currencies has been floating around since the birth of the Internet, but never has an individual or a group been able to design a model that was sustainable. The problem was that if a digital denomination was created, how then would it be controlled from reproduction through the copying and pasting of a code. It seemed that Satoshi Nakamoto had solved this problem. In his paper, he stated that a ledger was needed to record all transactions of this new currency to insure that a bitcoin spent once would not be able to be spent again by the same party. The ledger, however, had to be administered by a trusted third party in order to prevent fraud. Since there was no centralized organization backing this currency such as a government, many digital currency advocates were stumped. Nakamoto eliminated the third party altogether by publically distributing the ledger. The ledger, he stated, required common people to devote CPU power to running the ledger software. These people would be called “miners”. In exchange for this, the miners would generate bit coins as payment. The miners would solve cryptic puzzles in order to “mine” or create more bitcoins. Miners would have to solve complicated mathematical puzzles in order to produce said bitcoins. The algorithms of the program are encoded to release a set amount of bitcoins at a constant rate – that means the more miners that join the network, the harder the mathematical puzzles become. Also, the amount of bitcoins earned per puzzle decrease – all in order to release bitcoins at a steady rate for a total of 21 million bitcoins by 2140. The people only had to trust the mathematical algorithms of Nakamoto instead of a government that printed money at its will.
Since the nature of the currency is digital, it is extremely hard to track individuals trading the currency. This is an incentive for many who prefer to keep their anonymity while making transactions. Bitcoins can be transferred from one part of the world to another or from one person to another without any form of identity exchanged.
The bitcoin was first adopted only in the realms of cryptography, but as time passed and word spread, the bitcoin began to gain momentum. The bitcoin can be easily stored in a digital “wallet” on one’s computer or in a centralized service in the cloud. The Bitcoin grows by what is referred to as P2P or a peer-to-peer basis. The currency gains value depending on the demand for it. In the first few months of the currency’s adoption, there were recorded instances of people making purchases such as ordering pizza by transferring bitcoins to a person’s account. Said person would then use his credit card to place the order. The bitcoin held no real dollar value for most of 2009 and 2010; it functioned only due to its support from its users. Around 2010, the bitcoin gained traction as a mass currency and started trading at less than $0.14. At this time, many online vendors began accepting bitcoins as payment. Since the new currency was gaining momentum, many readily paid for bitcoins in dollars or pounds – essentially currency exchange. Interestingly, the bitcoin is not backed unlike other currencies. This creates instability in its value as the bitcoin to dollar or bitcoin to euro rate becomes extremely volatile. From late 2010 to 2012, the bitcoin has fluctuated from a value of $2 to $30 USD.
Fast-forward to today, the Bitcoin has been trading around $33. It has established itself as the first strong non-centralized digital currency. It is a startup currency – something that has never happened before at the mass level. It can be traded or transferred from person to person without the middleman. Its decentralized nature allows for security and freedom. The anonymity it provides adds to its allure and makes it a choice for many purchasing in the online world.
With new technology comes new regulation, however, the Bitcoin is currently functioning in a gray area. Since the currency has no central source that controls it, it really does not follow set regulations. Many of its adopters and supporters prefer it for this very reason as it provides more freedom. However, this has become an issue for government agencies across the world. Since the Bitcoin network allows for easy transfer without surveillance, it creates risks for all sorts of crimes such as the exchange of drugs, money laundering and easy access to money for terrorist organizations.
One of the most significant dangers is money laundering. On April 24, 2012, the FBI published a report titled “Bitcoin Virtual Currency: Unique Features Present Distinct Challenges for Deterring Illicit Activity” in which the FBI deems bitcoins as a paradise for exchanging illegal funds for legal funds.
Money laundering has three phases. First, there is placement, which involves introducing illegal funds into the financial system to enter the financial flow Second, there is layering which involves dispersing the funds in the financial system in order to exchange them for legal funds. The third and final step is integration, which involves the “dirty” money becoming clean. Laundering is harder for a physical currency but for a digital currency, it is as easy as the click of a button. Law agencies do not have control on the flow of money from the World Wide Web to the physical system. This exchange is difficult to track, making bitcoins particularly attractive to illegal entities. Recently, the bitcoin has started to stabilize in international marketing making it an increasingly legitimate financial instrument, which threatens the current currency system, turning it on its head. The fact that bitcoins gain their power from P2P exchange is alarming, as law enforcement agencies cannot control its production or legitimacy as a medium of exchange.
It is important to note, however, that although the bitcoin network makes it extremely easy and cheap to transfer funds, it does so at a high risk. A high amount of trust is required for the laundering to take place, as most times identities are not exchanged. In addition, the currency is not backed by much compared to currencies backed by national governments making the bitcoin prone to extremely volatile changes in value on the international market.
Other concerns involve the idea that bitcoins can perpetuate criminal activity. The currency makes it exceedingly easy to access any variety of illegal services through portals such as “The Deep Web” where one can hire hit-men or “The Silk Road” where one can purchase an assortment of illegal drugs.
Although government agencies have developed different ways in an attempt to track bitcoin users through IP addresses and electronic identities, tracking is hard as bitcoin accounts are easily opened and closed and proxies make detecting IP addresses close to impossible in many cases. Even if the government could track certain accounts, it cannot do much to stop the flow, as bitcoin accounts cannot be frozen.
Another concern is the threat to national governments. The Bitcoin makes it easy for rogue nation-states to gain access to money. This has been a major concern for the US government as the Obama Administration recently pressured the EU to cut Iran’s access to its banking system. The purpose of the move was to diminish transfer of funds to Iran from the outside. The Bitcoin becomes an obstacle as it eases the transferring of money. The FBI has identified this as a major concern regarding the Bitcoin network.
Although the bitcoin network has had many critics deeming it a bubble, the bitcoin network has experienced great success in the past years and continues to gain momentum. In times where economies are falling and countries are defaulting on their debts, it will be interesting to see what the future holds for this new form of money.