Bitcoin: In math we trust

The origin of the internet-based currency Bitcoin is mysterious.

It seems most revolutions begin in secrecy. Leaders of political revolutions keep their identities hidden because those who wield power often kill to preserve the ability to wield it. Technological revolutions begin in secret because invention is a clandestine activity, and again, people in charge of the status quo may murder to defend it. Social revolutions often begin in secrecy because they start with an underclass that is forced into hiding by society’s prejudice.

All this secrecy is simply self-preservation on the part of the inventor—undermine the powerful opposition, and the opposition is very likely to kill or arrest someone. But what if the revolutionary gives over his or her revolution to the people without attempting to gain financial or political power from the revolution? You can’t decapitate something that has no head.

A few examples of humanitarian revolutionaries come to mind: Jonas Salk didn’t patent his polio vaccine. Linus Torvalds developed the kernel to the open-source operating system Linux and gave it to the world. Martin Luther King, Jr. certainly didn’t profit from his efforts on humanity’s behalf.

Bitcoin is a disruption to our current financial system, and it has the potential to devastate entire sectors of society. But its birth is also similar to humanitarian revolutions. Part of its launch was very public. In October 2008, someone—maybe an individual, maybe a group—published a paper under the name “Satoshi Nakamoto.” It was titled Bitcoin: A Peer-to-Peer Electronic Cash System. Check out the paper that launched a thousand chits here: http://bitcoin.org/bitcoin.pdf. Since Bitcoin is open-source, its code is available to and transparent to anyone who wants to examine or improve it—or who wants to seek vulnerabilities.

But only Satoshi Nakamoto knows Satoshi Nakamoto’s identity. There is, of course, speculation: governments, cryptographers, bankers, mathematicians, hackers—all manner of good and bad actors.

“Speculation” is in Bitcoin’s DNA. But speculation has another meaning: investment with the hope of gain but the risk of loss. And the second definition fueled a kind of digital gold rush to Bitcoin that had the word on the lips of some of the world’s largest financiers in 2013. And it was that speculation that took Bitcoin on one index from a value of $13.40 on Jan. 1, 2013, to $1,242 on Nov. 29, and back down to $757 on Dec. 31, 2013. At this moment, it sits at $856.34.

While words like “revolution,” disruption,” and “speculation” may make the timid dismiss Bitcoin as a flash-in-the-pan internet phenom akin to a dancing baby meme, this revolution is being televised.

Another thing about revolutions is they often begin in bars. And in Reno, the Red Rock Cell is ground zero for Bitcoin.

Aside from the obvious—an internet-based currency—in a word, Bitcoin is a dream. It's established upon nothing but people's willingness to assign and to agree to its value. But this is true for all money. Without everyone's tacit faith, that paper dollar in your pocket is just paper and ink, with traces of bodily fluids and cocaine. It has no intrinsic value. Even if it still had the backing of gold, and you could take that piece of paper to Fort Knox and get a dollar's worth of gold, the gold that would hypothetically back it probably has no intrinsic value to you. What are you going to do with it? Make a crown for your tooth? Make a computer chip that won't corrode? Make one ring to rule them all? You? Chances are, you personally couldn't even buy a loaf of bread at the correct weight. It's our social agreement that gold has value that makes it worth something.

Those mutually agreed upon rules of money are society’s very glue. You’ve got to trust somebody. Bitcoin simply asks the question, Are you going to trust a government or are you going to trust a worldwide system monitored and maintained by the individuals most concerned with keeping it stable and valuable?

Jay Yerxa, an IT analyst at Patagonia, has an easy answer to that question. He’s not going to trust government or bankers, both of which favor decisions made by individuals based on opinions, theories or corrupt interests. He’s going with the algorithm.

“We have to trust a third party right now, whether it be a government or the Fed (Are they going to raise interest rates?) or a bank (Is my credit card safe, am I going to get fraud or something?), we have to trust in these third parties. With Bitcoin, it’s a math-based algorithm based on, one, how many are created, and two, how these units are transferred from Point A to Point B.”

Think of Bitcoin as a distributed system of trust that grew out of decades of talk about a worldwide currency independent of government. It’s built upon the ideas of early crypto- and digital currencies. Geekier readers will recognize the underpinning concepts of BitTorrent, another peer-to-peer protocol used to exchange large files like movies or music.

Instead of being directed by an individual, like the Fed will be directed by Janet Yellen, it’s run by the millions of individuals who have an interest in seeing it run well and stably—those who use it.

“There’s a giant development community behind it, mostly volunteers, and then there’s a foundation,” says Yerxa. “The foundation [http://bitcoin.org] is the one that kind of listens to the community, but ultimately manages the official Bitcoin software client. They manage that whole process. … So it’s decentralized, but they have that central organization that makes these changes. The neat thing is that this organization can’t just make a change and push it out to everyone, the people have to look at those changes and go ’OK, I agree with that, I will download the latest version and comply with that.’ ”

There have been heated discussions, says the 30-year-old technologist. For example, at one point the community was trying to decide whether to “flag” certain Bitcoins that had been used for illegal purposes. (This was related to the Silk Road drug trade bust.) In Bitcoin, all transactions are public and traceable and stored on the Bitcoin network. Since transactions are attached to addresses, and addresses are attached to the wallets of the individuals—who, for example, present a Bitcoin payment for a Bud Light—there is only a veneer of anonymity. People who wish to preserve anonymity change their addresses with each transaction and keep different wallets for different purposes.

OK, great, but what is Bitcoin really?

Really, Bitcoin is an online ledger. Just as the money isn’t kept inside one of those big, green ledgers that you used to see at banks, this ledger only records transactions.

God, this stuff is geeky.

With something as complex as finance, there are practically infinite areas on which to focus and geek out. Simplifying complex Bitcoin concepts to the point of being intelligible to the unschooled risks oversimplifying for the informed. However, attempting to express nuances runs the risk of leaving Bitcoin in the hands of the elite, which is the opposite of what was intended by the currency's creators, and against the best interests of the system, which gains stability with increased buy-in. Suffice it to say, just as one doesn't have to know how a cell phone works in order to use it, Bitcoin can be used by anyone who can use a cell phone.

Unlike gold, which gets produced at a greater rate as its value increases, bitcoins are created in a fairly predictable arc, which actually decreases with time and use. As the plan stands, there will only be 21 million bitcoins created. At this moment, there are about 12.2 million bitcoins, which right now are equivalent to around US $10 billion. The last bitcoin is expected to be created in 2140. The curve of bitcoin creation is pretty easy to visualize: In the first four years, 10.5 million bitcoins were created. That number will decrease by half every four years, so 5.25 in the next four years, and so on.

“That’s the hard part,” says Yerxa. “It sounds like 21 million bitcoins is a very small number, but because it’s divisible eight decimal points, it’s actually over 2 quadrillion in the total units that can be created.”

Bitcoins are divisible down to eight decimal points (0.00000001 BTC). Since a bitcoin could theoretically be worth $10,000, the necessity for division is obvious—you wouldn’t want to buy a $10,000 beer, right? The divisions have vaguely metric names, like for example, 0.001 BTC can be called an mBTC or a millibitcoin or a millibit. But with the 24-hour volatility of the Bitcoin market, you’ll be paying a different price for each beer. It seems a careful observer could potentially decide whether to pay for his or her beers one at a time, or if the price is trending down, start a tab. In reality, though, the price is set—say $3 for a Bud Light—and it’s the Bitcoin number that changes; the value paid stays the same.

For those who want to get their feet wet by actually buying some tiny fraction of a bitcoin, the simplest way to get started is to join an exchange. Sources mentioned Coinbase.com several times, but that’s not an endorsement. Coinbase requires a link to a bank account, much like PayPal. That’s a little nervewracking, so use unique passwords, and put a layer between this account and main household accounts.

The biggest risk to the Bitcoin user is through the exchanges, where passwords may be hacked, and unscrupulous owners could steal the bitcoin data stored on their servers. Exchanges have even been hacked like Target, and there is no FSDIC to insure accounts, although there are Bitcoin insurance companies springing up. If that isn’t worrisome enough, another risk is the operating software—that there’s an unexploited bug waiting to hatch that could bring down the whole system. Risks aside, if you want to exchange bitcoins for American dollars, exchanges are one of the main ways to do it.

Much of the buying and selling takes place through cellphone apps. Various “wallets” with various features can be found at the usual places. Do some research. It’s money. It’s risky.

But if you really want to geek out on risk factors, Google the “51 percent attack” and “the greedy miner theory.”

In some ways, Reno can be considered an early adopter of this technology. Startups like Robocoin, https://robocoinkiosk.com, are reportedly taking their Bitcoin accepting ATMs to China. Mayberry Salon barber Josh Arias, www.barberarias.com, was featured in the story “8 things you can buy with bitcoins right now” on CNN Money. Storm 5, http://storm5.com, a cloud service provider is the only other one listed on the site, http://coinmap.org, which lists businesses that accept Bitcoin. There are some 29 in Nevada, including at least one casino in Las Vegas.

But national companies like Overstock.com have started accepting the currency, so you know the coffee shops, restaurants and retail stores are not far behind.

“When vendors start accepting it, that’s key,” Yerxa says. He’s a true believer, and probably Reno’s chief evangelist for Bitcoin. He got in when a coin cost less than $30, so he’s definitely got a dog in the fight. He’s even prototyping a machine to create a hardcopy receipt for Bitcoin transactions. “And that’s what brings me to places like Red Rock to talk to guys like Kevin [McGehee], to say, ’Hey, I think this is a really cool idea.’ I get motivated to talk to business owners because I don’t see it taking off unless businesses accept it. I don’t think we can all just trade it, just speculate. Eventually it’ll just collapse. But if businesses are accepting it, if families are sending money back to Mexico because it only costs them 3 percent instead of whatever Western Union is charging them [actually, that transaction is potentially free with Bitcoin through a shared account], I think those applications are real and help and are useful, and that’s why it’ll be successful.”

Yerxa points out that there are challenges for the retailer. It’ll create bookkeeping hassles of the sort experienced in countries where multiple types of currency are accepted. How are gratuities handled? Or what if someone bought $1,000 bucks worth of Bud Light when Bitcoin was at $1,000, and then Bitcoin drops down to $700? As might be expected, infrastructure like payment processors, analogous to Visa or Mastercard, have sprung up that transfer the Bitcoin into U.S. dollars at the moment of transaction in order to minimize risks. And, Yerxa says, Bitcoin transactions are cheaper than Visa or Mastercard. There is another benefit to retailers: there is no “credit card fraud,” with Bitcoin. If a transaction is made, the money is there; it can’t be reversed.

“At Red Rock, they have QR codes on the tabletop tents,” he said. “When it comes time to settle up, the bartender will tell you the total—the exchange rate is decided on the phone. The purchaser just punches the total into the phone, scans the QR code, and in a few minutes, the transaction is confirmed. It’s easy, but it’s not easy enough.”

Kevin McGehee, owner of the Red Rock Studios, is a recent convert, but nobody who knows him would be surprised by his conversion. An old-school fiscal conservative, he seems to fall square into the U.S. demographic that love the concepts that have buoyed up the e-currency (and its price). But, maybe surprisingly, it's Bitcoin's humanitarian and sociological underpinnings that really sold him on it.

“We started accepting Bitcoin in November,” he said. “It’s becoming more and more something that people want to participate in and be a part of. I believe in it. … To me, it makes financial transactions more humane. It’s not controlled by a central bank. I just think that banking has become such a corrupt instrument that nobody can manage it. It’s terrible. What Bitcoin does is it makes everything fair.”

It’s those kinds of ideas that probably predict conventional governments’ reactions: Currency is their sandbox, and they don’t want other kitties making messes. Canada ruled that Bitcoin is not legal tender. While the United States government is the largest holder of Bitcoin on the planet at around $28 million worth, it’s expected to make a general ruling on its status by the end of the first quarter. You can bet Uncle Sam will cash out his Bitcoin holdings for American if he decides to make the claim that the stuff is without value. Such a large dump on the market could give vigilant “investors” a big opportunity. China had a regulatory crackdown this month (although not the ban that mainstream media made it out to be).

McGehee says that none of this stuff is unexpected, and as is often the case, governments will have to be shown the proper response.

“You’re talking about creating a new financial instrument. Anytime you create something that is revolutionary or radically different from what came before, there’s going to be problems. I think it appeals to people who are willing to assume a little more risk to feel like they’re in the game.” But he finds safety in Bitcoin’s transparency: “Bitcoin is like a giant glass room that is completely secure and totally safe, and everyone can see what’s in the center of the room is the giant pink piggy bank. And everyone can participate and everyone can see it.”

Maybe this currency really does have a heart at its heart. Mark Pitchford, treasurer for the Reno Initiative for Shelter and Equality, www.renoinitiative.org, which helps feed and clothe homeless people in Reno, says while the thing called “Bitcoin” may pass, something like it will rise. He's another enthusiastic user and prophet. RISE is accepting Bitcoin donations, possibly the first nonprofit in Nevada to do so.

“Adoption is inevitable,” he said. “We’re not talking local, we’re talking worldwide. Bitcoin is not better than the dollar—the dollar is the world standard. Bitcoin is better than 70 of the 130 currencies out on the market. In Nicaragua or other Third World countries, their inflation level is about 30-40 percent. The grandfather who has been working all his life to have a future for his grandsons loses all that wealth in the matter of a year, matter of a decade, a matter of 15 years. When you’re talking about a worldwide economy that’s intermixed with every single other currency, [Bitcoin is safer because it] retains its value because it’s based on the dollar, it’s based on the yen, it’s based on the euro.”

But Pitchford, too, must return to the risky nature of a Bitcoin investment. There’s going to be a dotcom bubble with the Bitcoin, he says. It might have been the precipitous drop in November, or it may be a crash yet to come, “but it’s going to level out and then the utility and the ideas behind it and the consistency of its use will prove itself to the point it will be adopted and mainstream.”

He distinguishes between the currency and the protocol, the software framework, behind it. While this version of the currency very well may go away, as its weaknesses are parsed out and protected against, the next one or the one after that will be sustainable.

“Whether it be Bitcoin or whatever the future holds, the Pandora’s box has been opened,” he declares passionately. “There’s a need for this currency to exist and that’s not because the U.S. dollar sucks; it’s because 60 percent of the other countries’ money sucks, and they need to replace them. And this is the replacement, and it will actually hold wealth. This particular instance might not, but the next one will. And if that doesn’t, the next one will. Right now, in Third World countries, all you need is a cell phone and texting ability, and you can transact. Anyone with a text messaging ability can use the currency. … If you think this money is for the rich white people in America, you’re wrong. It’s for the poorest of the poor who lose the value of their money.

“Our first-world complaints about the Bitcoin: irrelevant.”

And that is what revolutions are made of.