Cryptocurrencies could change the nature of transactions forever.
LATE LAST YEAR a man walked into a San Francisco library, headed to the science fiction section and quietly turned on his laptop, one of many people using the internet available there that day.
However, unlike the others, he then was rugby tackled by half a dozen FBI agents.
The man was Ross William Ulbricht. It is alleged that Ulbricht is also Dread Pirate Roberts, the figure behind Silk Road, an online drug marketplace where people can use the near-anonymous Bitcoin to enable people to buy and sell illegal substances.
Ulbricht’s arrest triggered a 20% drop in Bitcoin’s value, just one of the stark fluctuations experienced by the digital currency in 2013. Since then its value climbed and fell on the back of every new headline written about it.
Its value peaked at $1,250 in November not long after a US Senate hearing in which virtual currencies were described as a "legitimate financial service", before plummeting to around $421 after China restricted trade in the digital cash in December.
Today a single bitcoin stands at $832, after bullish endorsements from Wall Street analysts and gaming companies like Zynga, which have started accepting it as a form of payment.
While aficionados believe it could even hit $10,000 in 2014, Bitcoin is the frontrunner of a pack of cryptocurrencies collectively referred to as altcoins – alternatives to fiat-based mediums of exchange.
How does Bitcoin work?
Bitcoin was created in 2009 by a developer working under the pseudonym Satoshi Nakamoto, and its units are best thought of as virtual tokens rather than physical coins.
As with sterling, the dollar or the yen, Bitcoin’s value is determined by what people are willing to exchange it for, but unlike such fiat currencies, it is not controlled by a single entity such as a central bank, whose responsibilities include controlling supply by doing things like printing more cash.
Instead bitcoins are produced by a method known as ‘mining’ or ‘hashing’, in which computers use processing power to solve difficult equations. Whoever solves the problem has successfully ‘mined’ a new block of bitcoins.
To compensate for users who acquire more processing power in an attempt to solve these problems faster, and thus mine bitcoins more quickly, the difficulty of the equations is adjusted to ensure that a steady stream of 3,600 new bitcoins are produced each day.
That means no sudden influx (the equivalent of a bank printing lots of money) can devalue the currency.
That number is halved every four years, and once Satoshi’s limit of 21 million bitcoins is reached, no more will be produced – but that won’t be for another 143 years.
The bitcoins can then be sent to and received in electronic bitcoin wallets, which basically store strings of letters and digits, which are your own personal key to your bitcoins.
Just as if you lose your real wallet you lose the cash it contained, if you misplace your virtual wallet you lose the keys to your bitcoins, too.
While Bitcoin’s value fluctuated wildly last year, Jonathan Turrall, CTO of MetaLair, a startup developing currency exchange software, believes it is ultimately more reliable than fiat currencies.
"When I found out about Bitcoin I took all my ISA, personal savings, everything, and moved it straight into that," he says. "Everyone thought that I was nuts. [But] it’s a finite resource, something which time has shown, like with gold or silver, causes a greater level of stability.
"Since we went fiat in the last 30 years, it’s just gone insane in its valuation and the level of inflation that’s happened since the dollar was divorced from the silver value."
Turrall is as optimistic about Bitcoin as he is pessimistic about fiat, believing that we will see the digital currency reach far higher heights than $10,000 by the end of 2014.
"There’s a figure that one company put out that if Bitcoin hits 5% of the gold market you’re looking at $25,000 per bitcoin. The gold market in my mind is quite small so I think that’s easily achievable."