What Are Bitcoins And Why Should You Care?

Hey, remember these guys?

No, not those guys. These guys.

The Winklevoss twins, most notable for trying to lay claim to much of Facebook’s profit, has invested a lot of money in Bitcoin. That may not seem like such a big deal, but Cameron and Tyler Winkelvoss didn’t just lose out on Facebook billions and go back to Olympic rowing like the Double Trouble meatheads they were depicted as in The Social Network. (By the way, the two did win $20 million in cash and $200 million in shares from Facebook.) Instead, the twins have been busy investing in startups, most recently in Bitcoin. Over the last year, the Winklevii have been salting millions into this enigmatic virtual currency. A large $11 million, to be precise, as of last week when trading was briefly suspended following a flash crash of about 60 percent. This left a single bitcoin worth $70, and the whole bitcoin market worth over $1 billion.

Lately, bitcoin has been attracting a lot of attention.

Google Trends see use of the search term bitcoin go up, down, and then WHOA.

A group of venture capitalists, including Andreessen Horowitz, FF Angel, and Lightspeed Venture Partners, have announced they too are entering into the bitcoin domain with OpenCoin. OpenCoin will most likely die the death of a thousand cuts, but for now, the new currency seeks to compete with bitcoin on a much wider playing field. OpenCoin’s virtual currency claims to be able to not just work with bitcoins, but also yen, dollars, euros, and pounds.

Hedge fund companies are also starting to get into the act. Exante have bought 82,000 bitcoins, which equals around $10 million. Bitcoin is a libertarian hedge fund and futures marketer’s wet dream. A currency that — like their trading devices —  is in no way beholden to any form of reality. Bitcoin has no yield, credit, or debt instruments.

Other people who aren’t Silicon Valley venture capitalists are also getting in on the act. One guy spent $20,600 to buy a Bitcoin Mine on eBay. That’s 1,333 percent more than the actual hardware is worth. Companies like Avalon are building devices solely devoted to solving the complex algorithms that create new bitcoins. It’s unlikely these machines will run Bioshock Infinite or Call Of Duty.

Oh, and that guy on eBay didn’t even buy the hardware. In actuality, the buyer purchased a place in line for a machine that will be delivered next month.

Where do bitcoins come from?

Bitcoins were first created in 2009 by anonymous programmers, that is if you’re a lazy journalist at the New York Times. Prior to bitcoin’s creation, Satoshi Nakamoto was indeed, anonymous, but he is the name behind the whole scheme.

Apparently, Satoshi is in his 40s, lives in Japan, and codes and writes in flawless British English. Satoshi hasn’t been heard from since April 2011, having “moved on to other things,” but he may possibly be Neal King, Vladimir Oksman, and Charles Bry. Each of those people have denied being Satoshi. Mount Gox, the main Bitcoin trading company is based in Japan though.

How do bitcoins work?

It’s all handled by the Gnomes of Zurich and the Bavarian Illuminati. I wish to God that that was true. That would make more sense than how bitcoins really work. It’s a horribly, horribly complicated process that I shall attempt to understand and hopefully help others to comprehend along the way.

You have a virtual wallet on your computer. These are files that link to multiple bitcoin addresses, rather like a bit torrent (hence the bit in bitcoin). Each address has a balance of coins, and this gives you an infinite wallet with infinite pockets, each one containing change.

When you want to initiate a transaction, you create a new address, or pockets. This increases privacy and anonymity, which is one reason why the bitcoin is popular. Money transfers into the merchant’s pocket, and the transaction ends.

Meanwhile, this is where the miners come in. Every 10 minutes, all transactions are bundled into blocks. A miner’s computer uses brute force computing power to work out small, randomized computations based on the blocks to verify transactions. No miner has any control over the computations the machines perform or the outcome.

The more transactions that occur, the more information is created, and the more computing power is needed to confirm it all. Miners are rewarded with new bitcoins for completing the block of computations.

As computational power goes up, the reward halves every four years. Currently, the reward is 25 bitcoins. Given that a bitcoin is currently worth roughly $70, that works out to about $1,750 for every 10 minutes.

This method is on the verge of replacing the SETI project for people with more computational power than World of Warcraft deathmatches.

What’s to stop Donald Trump turning Indonesia into a giant solar-powered server farm to mine bitcoins until the rest of his hair falls out? A difficulty metric, that’s what. With every 2016 blocks that are calculated, the calculations get increasingly difficult, to keep the pace of block mining regular.

Is it worth it? Remember that bitcoin that was worth $70? It dropped from $266 and is up from $22 at the start of the year. This is a volatile process. If you like volatility, go for it.

There are now federal regulatory frameworks in place for miners now that the U.S. Treasury has caught up to the internet.

A user of virtual currency is not an MSB [Money Service Business] under FinCEN’s regulations and therefore is not subject to MSB registration, reporting, and recordkeeping regulations.

However, bit miners are liable for regulation and are expected to collect information about customers.

…[A] person that creates units of convertible virtual currency and sells those units to another person for real currency or its equivalent is engaged in transmission to another location and is a money transmitter.

I’ve bought, like, a million bitcoins. What can I do with them?

For one, you can buy drugs. Drug dealers will take any kind of currency. Cash, grass, or ass. Nobody rides for free.

Seriously.

One of the biggest bitcoin traders is Silk Road, an online black market that specializes in the trade of illegal drugs. Half a bitcoin buys you a gram of MDMA, otherwise known as ecstasy. And that’s just the tip of an immense iceberg of illegality. No wonder the person who runs Silk Road goes by the name The Dread Pirate Roberts. Of course, dealing drugs is small fries compared to simply doing nothing.

In a Forbes piece about Silk Road, one buyer and small-time drug dealer with the name Joey Terrifying writes that he used the site to buy a gram of Molly, a form of ecstasy, with the intention of quickly selling it to his own customers. By the time Mr. Terrifying had sold the drug three weeks later, Bitcoin had risen in value so much that it dwarfed his profits from the drug sales.

“I would have more money now if I had just done nothing at all,” Terrifying laments.

Websites do exist that will take your bitcoins and convert them into real-world currencies. For a price, of course. Nobody rides for free. One such place is the Bitcoin Store, which sells electronics at discount prices. At Spendbitcoins, you can buy army surplus gear, sexual hypnosis courses, delicious baklava, and e-cigarettes, which is all perfect for your frosty blonde Petrograd girlfriend.

The frosty blonde Petrograd girlfriend you can pick up on OK Cupid, which has started taking bitcoins.

The future of bitcoins?

With people with way too much money pumping millions of real-world assets into bitcoins and using the currency as a form of tax-free savings, it looks like it’ll be around for a while. Increasing scrutiny in countries like the UK over companies like Starbucks and Amazon offshoring their operations to avoid paying taxes could make the prospect of virtual offshoring seem increasingly appealing as tax havens start diminishing and disappearing.

In fact, libertarian organizations like Fre33 Aid have used bitcoin to get around paying their 2012 taxes.

TechCrunch asked a few economists to talk about bitcoin’s future. Some anticipated the new currency being superseded by better iterations, using its cryptography and brute-force number crunching to become the basis for a future currency. Others urged for caution, comparing its rise with the NASDAQ explosion of 1995 to 2000 or the value of a pack of smokes in a prison.

And if not, I’m sure the Winkelvii could interest you in some sexual hypnosis and e-cigarettes.