Does it ever make you nervous to realize that our currency system is backed by a government that’s over $16 trillion in debt? Or what about the fact that the Federal Reserve gets to put money into circulation on a whim? Or have you ever wished — and please, stop reading and take your moral superiority elsewhere if you haven’t — you could print money on your own?
Well, at the end of Oct. 2008, an anonymous man calling himself Satoshi Nakamoto posted an academic paper online. The paper outlined the premise behind Bitcoin, an electronic currency system with no central bank or other authority — the strength of Bitcoin lay not in trust but in mathematics. Shortly after the release of his paper, Nakamoto released the first “Bitcoin client,” a computer program to implement the design he had described in his paper — an impressive feat given the enormous complexity and security concerns of the system. Bitcoin was born.
When you run the program, it first tries all sorts of adorably scrappy methods for discovering other computers running Bitcoin clients around the world. Think of this as dropping a goldfish in the middle of the ocean: eventually, with a little luck and a lot of perseverance, he’ll find a friend. Once the program finds the network of other Bitcoin clients, it can start working its magic.
Everything about Bitcoin works with the consensus of each program in the network. Each time a transaction occurs, all Bitcoin clients agree upon it and write it into a “block,” essentially a page in an enormous Bitcoin ledger. If a program tries to cheat by, say, spending the same Bitcoins twice, the rest of the programs will reject the transaction. The lack of a central bank or authority means no single body can defraud the system. If I want to send ten Bitcoins (popularly shorthanded to BTC), I tell a Bitcoin client, and that client tells all the other programs in the network. They all murmur for a second, nod their heads, and voilà — money sent.
But how are Bitcoins first introduced into circulation? Imagine a really hard math problem with tons of valid answers. (A simple example is finding a number that, when squared, equals four. Both two and negative two are solutions.) Each Bitcoin client is given the opportunity to solve one such problem (called a “proof-of-work problem”) and if all other programs agree that the solution is valid, whichever program solved it is allowed to create a certain number of Bitcoins for itself. This process, known as “mining,” is how Bitcoins are created. Since a solution is only accepted with the approval of the entire network, cheaters are quickly kicked out.
But, to counteract the ever-increasing speed of computers and the growing number of people using Bitcoin, this proof-of-work problem gets harder over time (with, of course, the approval of each program in the network). Initially, it was easy to create new Bitcoins. Now, it’s only viable with a cluster of specialized computers devoted to the task. (Interestingly, online rumors tell stories of people with such computer clusters being raided by the police — apparently the abnormally high power use and heat output of the computers looks a lot like an underground marijuana-growing operation.) Unlike a government printing money whenever it feels like it, Bitcoins can only be created in this way, and as it gets harder and harder, fewer and fewer Bitcoins are created, resulting in a stable and predictable number of coins in existence.
Because of this stability, the lack of a corruptible central bank and the strong mathematical basis, Bitcoins, against all odds, are being accepted and exchanged in place of real money. Currency has value if people are willing to use it, and some online merchants have accepted Bitcoin payments as a way to stand out from the competition. On the customer side, Bitcoin has been widely adopted both by geeky online communities enthralled by its computer science and cryptographic foundation, and by libertarians favoring a currency not controlled by any government or central authority. (Bitcoin also garnered a lot of negative press by being the only allowed currency on an online black market called Silk Road, where one could purchase drugs and firearms.) As a result, exchanges have been set up through which one can trade Bitcoins for dollars, euros, you name it.
That’s not to say Bitcoin is a perfect system. There is no such thing as “credit,” only cash. Any trading online guide will tell you that market prices tend to fluctuate a lot, and seem to be rising steadily over the long term. (In 2010, someone successfully traded 10,000 BTC for roughly $25 worth of pizza. Today, a single Bitcoin is worth about $12.50. You do the math.) And though the system itself is (reasonably) secure, many of the exchanges and so-called “wallets” for trading and storing the currency have been hacked into, with e-money worth hundreds of thousands of dollars stolen.
But, if you want to take advantage of Yale’s free electricity, why not try your hand at mining some Bitcoins? It’s unlikely to be fruitful with an average laptop, but after four years you may just be able to buy yourself some pizza.