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Bitcoins: Widely known and widely misunderstood

Some people think of bitcoins as investment vehicles. Others see them as weapons against nefarious central banks. Both impressions are certainly wrong.

November 24, 2013|Michael Hiltzik
  • Bitcoin values are set not by a government authority but partially through a complicated mathematical algorithm and partially by what people think they should be worth at any moment.
Bitcoin values are set not by a government authority but partially through… (George Frey, Getty Images )

Back in the 1980s, when I lived in Nairobi, foreign residents had a simple way of obtaining Kenyan shillings.

They'd write a check in, say, U.S. dollars on their U.S. bank accounts to the Indian man who owned the ice cream store down the block. He'd pay over shillings at the current black market rate. Then he'd mail the check to his brother in Toronto, who would deposit it in the merchant's name in a Canadian bank account.

Presto! The expatriates got shillings to spend locally, and the shop owner spirited his profits out of the country for conversion to a hard currency, secure for his retirement. Everyone was happy (except possibly the Kenyan government, whose tax and foreign-exchange laws were being flouted.)

I've been thinking that the ice cream man would be a perfect customer for bitcoins today.

You've probably heard of bitcoins. They're a virtual currency, meaning they exist nowhere but on a network of ledgered accounts owned by people all over the world. The system is decentralized, so it's not under the control of any government or, arguably, any single authority at all. Bitcoin values are set not by a government authority but partially through a complicated mathematical algorithm and partially by what people think they should be worth at any moment.

As a result, their value has been highly variable — over just the last month the price of a single bitcoin has been quoted by Mt. Gox, a leading exchange agent, as low as $190 and as high as $900.

Bitcoins have been much in the news lately, not entirely for reasons that delight their promoters. One was the FBI's shutdown of Silk Road, an online marketplace where sellers peddled drugs, firearms and other illicit goods and services, taking bitcoins as payment. That pointed to how the relative anonymity of bitcoin transactions is supposed to be great for criminals, who obviously appreciate being able to evade tracking by law enforcement as they move assets around the world. (Silk Road's alleged San Francisco-based mastermind, Ross Ulbricht, was denied bail last week by a federal judge in New York.)

The other event that has put bitcoins on the map was a hearing last week by the Senate Committee on Homeland Security and Government Affairs. The session aimed to give federal regulators a chance to talk about how they're dealing with a medium of exchange that works outside of government coinage and the established banking system. Their testimony conferred legitimacy on the bitcoin simply by showing that the regulators are not especially inclined to outlaw it — in fact, to a certain extent they welcome it.

So bitcoins have reached that point in public awareness where their existence is becoming widely known, and widely misunderstood. Some people think of bitcoins as investment vehicles — an opportunity to get rich by getting in at the ground floor. Others think of them as weapons against nefarious central banks and their inclinations to debase currency. Both impressions are certainly wrong.

The only people who see bitcoins as opportunities to make a killing are insiders, of whom there are few, and rubes, of whom there are too many to count. A mutual fund for investing in the things has even been launched by the twins Cameron and Tyler Winklevoss, who got famous for claiming that they created the idea for Facebook and were mulcted out of their fair share of the spoils by Mark Zuckerberg. After observing that the offering's registration statement bristled with risk factors, the august Financial Times reported, "something tells us this is one Winklevoss-innovation Mark Zuckerberg won't be stealing."

As for the creation of an independent world currency outside the control of established governments, dream on — central bankers are not fools, and they're much more likely to co-opt the bitcoin system than bow to it. In fact, the co-opting process is already underway.

First, a quick history of bitcoins. They were invented in 2008 by a computer programmer or programmers using the pseudonym Satoshi Nakamoto. His, her or their identity is still unknown. The idea was to create a system of electronic cash operating outside the existing financial system. Bitcoins exist as entries in encrypted online accounts; you use them to pay or be paid by transferring them, or a fraction of them, from your account to your counterparty's account, with the transfer validated by computers on the network so that you can't spend more bitcoins than you own. (The validation isn't instantaneous, so even the smallest bitcoin transaction involves a 10-minute delay.)

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