You’ve probably seen them in the news and wondered what on earth a bitcoin is. Something about an anonymous online currency that you ‘mine’ for. What?

What are bitcoins? Bitcoins are an online currency. Founded in 2008 by a programmer under the alias Satoshi Nakamoto, they have quickly gained in usage and in popularity. You store your bitcoins on your computer using a bitcoin wallet and can send or request them from any other user around the world. Just like any other currency, you can convert your US dollars (or other currencies) into bitcoins. One bitcoin can be broken up into any denomination of smaller pieces.

How does the process work? There is no governmental authority or company out there that owns or manages bitcoins; it is all done peer-to-peer via the internet. As you’d expect, there has to be a very technical and accurate system of tracking all the bitcoin transactions that occur. Different from sending someone money via Paypal, you don’t have money in the bank to separately verify your transaction. Both the amount of bitcoins in your possession and any transactions you perform must be verified. As there is no one organization to do this, a complex peer-to-peer model has been set up to do so. People set up their computer to use its processing power to participate in this continually updating network to log and verify all transactions. There is also an element of a puzzle, miners must solve complex algorithms in order to continue to ‘mine’. After using your computer for a certain period of time to help maintain the log, you’ll be rewarded with a small amount of bitcoins.

Awesome – where can I download the software and start earning bitcoins? Mining bitcoins is an insanely difficult process. If you remember the movie “The Matrix,” picture that ‘geeked’ out even more. The average user like you or me wouldn’t be able to mine bitcoins. Some of my computer science major friends are still quite clueless about the process. It is far more difficult than just plugging your computer up to a network. People will often get together and pool their resources to mine. The algorithms that must be solved in order to continue to mine for bitcoins gets exponentially more difficult.

Where can I buy bitcoins and then spend them? Mtgox.com is one of the largest exchanges for bitcoins, so I’d start there. Most businesses accepting bitcoins are online, and a quick Google search will help you find them. The list will continue to grow exponentially as the popularity of bitcoins grows.

I still don’t get it – what’s the big fuss all about? There are two primary reasons that bitcoins are so popular. The first is the fact that no government controls them. The value of bitcoins are not subject to the mistakes or decisions of a government. Secondly, bitcoins offer the allure of anonymity. You can privately store up wealth and secretly purchase anything from around the world. Some people are using these features to a) hide wealth from the government so they don’t have to pay taxes and b) buy drugs, weapons and other illegal goods. For the programmers, the thrill of mining an increasingly complex algorithm keeps them coming back for more.

So, bottom line, what are your thoughts, Ben? I believe that for an investment to truly be worthwhile, it most hold some sort of intrinsic value. Stocks are actually ownership pieces of a company, and gold you can always make into jewelry. Although the bitcoin currency offers some practical benefits, e.g., you can actually use it as currency, the majority of bitcoin users are holding it speculatively, meaning they are holding it because they believe it’ll be worth more in the near future. This kind of an attitude is not sustainable. Check out this graph showing the value of bitcoins (in US Dollars) in the past month.

As you can see, this erratic fluctuation is a huge red flag. One day it’s hot, the next it’s not. Furthermore, despite the beauty of the bitcoin system, governments don’t particularly like competition when it comes to regulating a currency. Given all the negative aspects of bitcoins (hiding wealth and buying contraband), I believe it won’t be long before the government jumps in to regulate the market for trading bitcoins.

Overall, bitcoins are a fascinating concept, and I believe that if not bitcoins, another online currency will take its place. But for the average person like you or me, I think I’ll sit this one out and wait until the smoke clears.

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