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What is bitcoin and how to invest in it

You may be hearing a lot of chatter about Bitcoin lately and find yourself wondering what exactly it is, does, and means. We at PCMag have been having the exact same internal dialogue, so after combing the farthest corners of the Internet to find out more, we had a conversation with ourselves about what we discovered.

Bitcoin is an open-source P2P digital currency, and a protocol that enables instant peer-to-peer, worldwide payment transactions with low or zero processing fees.

Unlike typical currencies, Bitcoin operates with no central bank or authority; managing transactions and issuing bitcoins is carried out collectively by the network. The software is a community-driven, free, open-source project, released under the MIT license. Basically it uses cryptography to control its creation and transactions.

The currency is both highly fungible and untraceable (like cash) and theoretically inflation-proof (like gold).

That’s interesting from a geek perspective, I guess. But why am I constantly hearing about it all over the Twitterverse right now?
Most people are linking the recent spike in Bitcoin interest to the Cypriot government’s recent proposal last month to “tax” (i.e., confiscate) up to 10 percent of every deposit in Cypriot banks in a desperate bid to save its bankrupt financial system. Appropriatingcustomers’ deposits has been off the table since the Great Depression, and Cypriots disabused the government of that plan’s viability quicker than you can say “where’s my pitchfork?”

Wait, I’m not sure I see the link between the two.
Because of its inherent design there’s no way a government can seize bitcoins or make more of them (causing inflation). So if your government or central bank starts acting irresponsibly with its national currency, Bitcoin is a way of avoiding the taxman, arbitrary confiscation, capital-flow restrictions, and the inflation-monster.

That could come in handy in somewhere like Zimbabwe or one of those bankrupt Eurozone countries then.
You catch on quickly.

Sounds like it was invented by some kind of paranoid genius.
You’re right, it does sound like a scenario out of a manga comic. Bitcoin was invented during the deepest, darkest throes of the financial crisis by a shadowy developer (or developers, nobody knows exactly who) going under the pseudonym Satoshi Nakamoto. Fast Companytried to uncover Nakamoto’s identity in 2011, and discovered circumstantial evidence indicating a link between an encryption patent application (filed on August 15, 2008 by Neal King and Charles Bry of Munich, Germany with New Jersey-based Vladimir Oksman) and the bitcoin.org domain name (registered 72 hours later). The patent application (#20100042841) contained networking and encryption technologies similar to Bitcoin’s. Textual analysis revealed the phrase “…computationally impractical to reverse” was found in both the patent application and bitcoin’s whitepaper. All three inventors explicitly denied being Satoshi Nakamoto. Circumstantial evidence also indicates that Jed McCaleb—a P2P evangelist, eDonkey founder, and founder of MtGox, the first and largest Bitcoin exchange market, could be Nakamoto.

Regardless of his or her true identity, a comprehensive New Yorker article notes that “Nakamoto was very clearly motivated in this effort by the fallout from the 2008 financial crisis…from the first, Bitcoin was devised as a system for removing the possibility of corruption from the issuance and exchange of currency. Or, to put it another way: rather than trusting in governments, central banks, or other third-party institutions to secure the value of the currency and guarantee transactions, Bitcoin would place its trust in mathematics.” Nakamoto outlined his proposal for the crypto-currency in a whitepaper in 2008; the first bitcoin was “mined” in January 2009.

Hold up a second! How on earth do you “mine” a virtual currency?
Mining was a term deliberately chosen because of the way the creation of bitcoins is meant to mimic the act of mining gold, with a finite supply and diminishing returns the longer you mine. Bitcoins are generated at a predetermined rate by an open-source program which runs on a massive peer-to-peer network of 20,000 independent nodes, generally very powerful (and expensive) GPU or ASIC computer systems specifically optimized to compete for new bitcoins. The network will increase the money supply as a geometric series until the total number of bitcoins reaches 21 million bitcoins (BTC).

Bitcoin releases a 25-coin reward to the first node in the network that solves a difficult mathematical problem requiring a certain amount of brute-force computation. Everyone in the network is then notified of the solution, and competition for a new block and its 25-coin reward renews. Currently 25 bitcoins are generated roughly every 10 minutes.

As of March 2013 more than 10.5 million of the total 21 million BTC had been created. Theoretically all bitcoins will be generated by 2140, with the last one consisting of fractional parts. To ensure granularity of the money supply, each BTC unit can be divided down to eight decimal places (a total of 2.1 × 1015 or 2.1 quadrillion units).

Math is hard. I’m getting bored.
How about a kitteh?

Ok, I’m happy again. That was a good tactic.
Welcome to the Internet.

This all sounds great, but no doubt the Feds are poised to swoop in and spoil all the fun. It’ll be just like our guns!
Well yes and no. The Financial Crimes Enforcement Network (FinCEN), the federal agency that enforces laws against money laundering, actually released a statement on March 18 which classified some Bitcoin exchanges as Money Service Businesses.

This basically means the Feds accept Bitcoin as legit, for the moment at least. The Bitcoin Foundation’s chief scientist and lead developer Gavin Andreson was somewhat relieved by the announcement:

“In my opinion, the FinCEN guidance is fantastic news: it gives Bitcoin users and businesses clear rules on how they will or won’t be regulated,” he said to the New Yorker.” It is great for ordinary users, because FinCEN said that using bitcoins to buy products or services is perfectly legal. And, long-term, it is great for businesses, because they now know how FinCEN will classify them and what regulations they must obey here in the United States.

“That said, it might cause problems for some smaller U.S. bitcoin-based businesses, who might have been hoping that they wouldn’t be regulated at all. The bigger bitcoin businesses have been anticipating this for a while, so I don’t think it will affect them.”

This is actually starting to sound like a good investment.
That depends—how do you fancy your ability to ride a bubble and get off before it bursts? Bitcoins were basically worthless at birth: about five cents each. While trucking along at a value of around $10 for most of Bitcoin’s four-year existence, they’ve been extremely volatile. Since the beginning of this year the value of a bitcoin has exploded from $35 to reach $100 two weeks ago, before more than doubling again in the last week to $260, thencrashing down to $75 in the last few days.

This is the definition of a bubble. Geek.com warns that you should have seen the crash coming. Financial blogger Felix Salmon points out in a great backgrounder that “bitcoins are an uncomfortable combination of commodity and currency. The commodity value of bitcoins is rooted in their currency value, but the more of a commodity they become, the less useful they are as a currency.”

The Financial Times‘ Alphaville blog goes into further detail explaining how Bitcoin’s speculative value means that as it becomes more expensive it loses its usefulness as a facilitator of exchange. Because the Bitcoin economy is currently in the throes of hyperdeflation, the rapid rise in the value of a bitcoin causes people to hoard, rather than spend their bitcoins, exacerbating the bubble and making it ever less useful as currency. Put it this way: with the price skyrocketing, why would you buy anything with your bitcoins today when their price trajectory just doubled in value in a week?

So yes, people are hoarding bitcoins.

Bear in mind that the value of bitcoins has closely tracked fluctuating media interest in Bitcoin, and Business Insider has some advice on six things that could cause Bitcoin prices to crash.

If you’re still intrigued by the opportunity to make free money(!), TechCrunch has a good primer on how to mine your own bitcoins. Hint: it’s not easy.

On second thought, now sounds like a good time to cash out. Where can I use my bitcoins?
Well there’s this guy called Jeff Berwick, a self-described libertarian anarcho-capitalist who says he’s going to install a Bitcoin ATM in Cyprus, and that he has orders for 300+ machines in 30+ countries.

SpendBitcoins has a large, disorganized list that’s about as easy to search as an encyclopedia handwritten by a four-year-old. There’s a much more useful wiki for places that accept bitcoins, and there’s even a bar in midtown Manhattan that now accepts them.

Anonymous digital marketplace the Silk Road is the most infamous of venues accepting bitcoins, and for good reason. People use Silk Road to buy drugs, weapons, and child porn completely anonymously. Because it’s so dodgy we’re not going to walk you through how to access it, but if you take 10 minutes using the Google, you’ll figure it out.