Bitcoins are not mere drug currency.
Bitcoins are not failing.
Okay?
Are we clear about that?

Good.

The future of online commerce looks to rely less and less on the physical amount of money you have in your bank accounts and wallets and more on what you could call “digital” wallets: online reservoirs where you store money. Really, we already use some variation of a digital wallet, we just don’t easily acknowledge it. You work, you get paid via direct deposit, numbers change in your checking account, you use debit and credit cards to make transactions, you go back to work. Rinse, repeat. You hardly ever see cash unless you deliberately withdraw it from an ATM. Anymore, our money consists of strings of number values running through some computer located who knows where. We just confidently assume that all that money is actually staying or going where it should be staying or going.

While that describes our current model of commerce, it also serves as a fair portrait of Bitcoins, the emerging currency exclusive to the Internet.

If you’re familiar with Bitcoins and run an online business, how do you feel about accepting this form of currency? Cash currency has never kept somebody from getting ripped off, so what is the main hesitation for you and your business when it comes to accepting an exclusively online currency? If you’re unsteady about it right now, what would you like to see change with Bitcoins (or any type of online currency) before you were more comfortable with using it? Or, are you totally onboard with this form of currency already? Share your thoughts with us and other readers below in the comments.

Essentially, Bitcoins are an intangible currency, really no different in action than the numbers bouncing up and down in your bank account. Alternately, instead of representing sums of physical currency, Bitcoins are literally a majestic sequence of unique numbers that can be traded for goods. Instead of swapping wads of bound fibers and inks that are woven together into this germy thing we call cash, Bitcoins exist in a purely digital tapestry. It’s an experiment in decentralized currency, and while it’s been a good experiment and still has some growing to do, it doesn’t show any signs of disappearing anytime soon.

While it’s still got some time to really appreciate and grow stronger as a currency, a purely online currency will exist in one form or another. It won’t ever replace your tangible currency, but work alongside it for all of your online consumer decisions.

To find out more about the current state of Bitcoins and what will happen with them in the near (and far) future, I got in touch with Gavin Andresen, the Lead Core Bitcoin Developer, about the developments of the past year regarding Bitcoins and why this novel currency could feature prominently in the future of online commerce.

Bitcoins: A Primer

Money as an object is meaningless. It’s paper and and some inks and, thanks to people, lots of bacteria. It’s an arbitrary token that merely represents a commercial promissory value people can earn in exchange for goods or services that can then either be saved or spent on other goods or services. Dollars, euros, yen, pounds, rupees, tobacco leaves, rands – it doesn’t matter what object you invest value into, it’s the idea behind the currency that buttresses its value. The Bitcoin is no different.

The only difference is that, as opposed to physical money that you’ll stuff into your pockets and wallets, you will likely never actually hold a Bitcoin (yes, there are physical versions of Bitcoins if you absolutely must have a real version to thumb around in your palms). Just because you’re likely to never touch one, though, doesn’t mean that Bitcoins are any less valuable than the bills you have folded up in your right pocket. Instead, think of it like this: you are no more likely to hold a Bitcoin in your hand than you are to hold Pythagoras’ theorem in your hand.

What does distinguish this disembodied currency from its corporeal familiars, however, is that Bitcoins are not dependent on anything except the people who produce and use it. No governments, no banks, no organizations – just people. A truly anarchistic, peer-to-peer currency.

For a simplified explanation for how the Bitcoin market works on a consumer level, have a look at this video put together by We Use Coins.

The currency, however, doesn’t just fall into your lap like a prize from a cereal box, nor is it just magically conjured up from the imagination like the latest Internet meme. The production of Bitcoins is best explained through the simile of gold mining. Instead of boring through a mountain to unearth precious metals, new Bitcoins are generated by unlocking a mathematical sequence called a block chain and are doled out in increments of 50. The people that produce these Bitcoins, then, are known as miners (that’s actually the technical term for Bitcoin producers, too, not just a metaphorical descriptor). These miners, however, have traded in their helmets and pickaxes in exchange for loads of GPU firepower and very sophisticated software capable of deciphering the block chains. The software works in tandem across a network to solve these cryptographic proofs and the miner who is the first to solve the block chain will receive the 50 Bitcoins. Once a block chain has been unlocked, it is added to a ledger in order to prevent those Bitcoins from double-spending.

Eventually, as more blocks are solved, fewer Bitcoins will be generated because the block chains will be worth fewer new coins. Solving a block chain today is worth 50 new Bitcoins, but as of this December that reward will be reduced to 25 Bitcoins. Some time off in the future, it will be reduced again to 12.5. The gradual reduction in rewards works to mitigate the generation of new Bitcoins so as to avoid flooding the market, which would result in a devalued currency.

As more miners work to generate Bitcoins, the difficulty in unlocking the block chains increases so as ensure that a new block is generated only every 10 minutes on average. The increased difficulty of unlocking a block chain’s sequence is designed in such a way that, over time, the maximum capacity of Bitcoins that will be generated will be 21 million. Added to the multiplied difficulty of solving subsequent block chains, more and more computer power is required, which some have said could be a deterrent for would-be miners from working on the more difficult block chains. Andresen disagrees with the argument that hardware needs are becoming preventive. “Mining Bitcoins is becoming increasingly energy efficient,” he says. “Bitcoin miners want to pay as little as they can for electricity, so they’re constantly working to make mining more efficient.”

Energy requirements wouldn’t really matter in the grand scheme of Bitcoin production anyways, Andresen explains, as the Bitcoin production process is smart enough to adjust for variations in the miner work force. “The Bitcoin system adjusts itself so that the target number of Bitcoins are created about every 10 minutes, no matter how many miners there are.”

He adds, “The number of Bitcoin miners has almost nothing to do with how quickly Bitcoin transactions are processed, so it doesn’t matter to the Bitcoin system how much energy or how many miners are working – as long as there is one, the system will work.”

The production of Bitcoins isn’t infinite, though. In fact, there is a fixed amount that will ever be produced: 21 million. Although that peak Bitcoin mark isn’t expected to be reached until 2140, the number of Bitcoins generated will begin to taper off toward zero well before that, at which point miners will then be compensated with Bitcoin transaction fees. As the generation of Bitcoins decreases over time, the cost of a transaction using Bitcoins will increase, which these blocks exist to verify. In lieu of transaction fees, though, Andresen postulates that miners could also be compensated by a “more complicated arrangement between merchants that want their transactions confirmed quickly and securely.” One way or another, though, the monetary reward for generating Bitcoins will always be present.

As of this year, over 8 million Bitcoins have been generated. The first block of Bitcoins to be unlocked was completed by Satoshi Nakamoto, who could be considered the progenitor of Bitcoins. As Wired Magazine’s Benjamin Wallace covered extensively in a piece about bitcoins last year, Nakamoto might be best understood as the Tyler Durden of the Bitcoin culture. An effluvium of mystery envelopes Nakamoto as no one is certain of who he is or where he came from or, most intriguing, where he disappeared to following his last public communication near the end of 2010. It’s rumored the name was a pseudonym or that Nakamoto was actually a collective of developers. It’s even been suggested that Nakamoto was a nom de guerre for assorted bodies of the United States government. Nobody knows, and every major player in the Bitcoin industry denies being Nakamoto.

At this point, though, as the Bitcoin system is beginning to become more stabilized and the project is on the cusp of transcending any one person, does the origin of Bitcoins really matter anymore? It’s been around long enough to confidently assess that dealing in Bitcoins is likely not some kind of Faustian gamble. Besides, one of the prominent features of Bitcoins is its near-anonymity of the users who deal with it, a quality celebrated by Bitcoin proponents. If the currency users are mostly anonymous, why then shouldn’t the progenitor of Bitcoins be anonymous, too? If the shoe fits, right? We could all be Nakamoto and none of us would be Nakamoto. To obsess over the origin of Bitcoins threatens to belie the hard work that the currency’s current legion of developers are doing in order to bolster Bitcoins into a formidable, viable option for online commerce.

The Problem With Bitcoins

The Bitcoin has had a tumultuous twelve months. Perhaps its biggest mainstream debut to date happened in June 2011 when Gawker’s Adrian Chen published a piece about the underbelly of the Internet, the Silk Road, where you can buy, among other things, any fashion of drugs (drugs I didn’t even think existed anymore) one desires. Because of the anonymity that accompanies the use of Bitcoins, the Silk Road trades exclusively in the currency. As Gawker’s story was many people’s introduction to Bitcoins, the piece carelessly marginalized it as The Currency for underground drug trafficking on the Internet.

Regardless of Gawker’s oversights, Bitcoins blew up. The value of Bitcoins skyrocketed after Chen’s piece began to circulate and inspire interest in legions of new potential customers of Silk Road. Consequently, Senator Chuck Schumer called for a federal investigation into the Silk Road in order to hopefully shut it down. Now that the Bitcoin market had attracted the attention of the United States government, the popularity of the currency continued skyward.

The boom was short-lived, though, as it was not an organic and sustainable growth. It was an artificial trend born from a sudden onslaught of sensational media attention that ballooned the value of the currency. Being at the mercy of the public’s caprice, though, the value of Bitcoins crashed back to Earth a month later. By August, it had returned to its pre-Gawker levels.

Five months after the Gawker piece, Wired was preparing the toe-tags for Bitcoins, citing the currency’s sustainability problems and increasing lack of interest in the continued production of Bitcoins.

Andresen concurs that Bitcoins were pushed out onto the main stage long before the system was ready to handle that kind of attention. “We had a press avalanche last year,” he says, “Where the first couple of mainstream articles about Bitcoin caught the attention of other reporters, who in turn also wrote about it, which then triggered even more press.”

He continues, “That was both great and terrible for the project: great because it drew a lot more technical and business talent to look at Bitcoin and start Bitcoin-related projects, but terrible because when people realized that Bitcoin still has a lot of growing up to do, the speculative bubble popped.”

It’s misleading to say that Bitcoins failed because of that popped bubble. True, investing in Bitcoins currently isn’t as profitable as it was for a brief period last year, but that kind of inflation was artificially generated and really should never have happened in the first place. More, it’s probably not the last time the Bitcoin will encounter some heavy turbulence. “I think it is very likely the same thing will happen again sometime in the next few years as other parts of the world discover Bitcoin or it is re-discovered in Europe and the U.S.,” Andresen says. “I expect the wild price fluctuations to diminish over time as Bitcoin infrastructure grows up and speculators start to get a better idea of the real value of Bitcoin.”

That’s Money 101 for you, though: the potent volatility of supply and demand working upon, for better or worse, the unpredictable engines of human interest. Adding to the uncertainty is the fact that, most obviously, people already have a form (if not multiple forms) of currency, which has likely created an erroneous impression for the laity that Bitcoins are a second-class currency.

Then again, Bitcoins were never really intended to launch like an unstoppable money-missile into the future. Nakamoto, Andresen, and other Bitcoin developers have always cautioned investors that Bitcoins should at best be considered an experiment. “I tell people to only invest time or money in Bitcoin that they can afford to lose,” Andresen says. “There are a lot of things that could possibly derail it, ranging from some fundamental flaw in the algorithm that everybody has missed (he doesn’t see this as a likely possibility at this point) to world-wide government regulation (also unlikely, he says) to some alternative rising up and replacing Bitcoin.”

In a way, the story thus far of Bitcoins as an unpredictable investment is the quintessential story of the Internet as a whole. Every prominent company that currently claims a seat among the pantheon of technology giants – Apple, Google, Facebook, Twitter, IBM, et al. – has come into that position due to the rise and fall of previous online ventures. The lessons gleaned from the decline of previous companies like the Myspaces and Friendsters and Lycos is likely the only reason the current generation of tech leaders have managed to prevail for so long. In the end, the diminished presence of these companies is less a woeful tale of failure and more a triumphant testament to how resilient and efficient the evolution of ideas has been on the Internet, especially in such a short amount of time.

With Bitcoins, it remains to be seen if it will eventually be minted as a mainstay in online culture or merely serve as an early milestone in the continuing evolution of online currency. Andresen is optimistic, though, that Bitcoins are here to stay even in light of competing online currencies possibly popping up in the future. “I think to overcome Bitcoin’s head-start, an alternative will either have to have a large company or government backing it and marketing it. Or else, it will have to be radically better in some way,” he says.

“There seems to be a perception that Bitcoin is in a winner-take-all race against other currencies; either everybody in the world will be using it for all of their online purchases in 50 years or it will not exist. I think the online payment world will like our current world of currencies – different currencies used in different places. The online payments won’t be divided by geography, though it might be divided by language or culture or social network.”

As it were, the currency network’s public image may have taken a bruising last year, but the reports of Bitcoin’s demise appear to have been exaggerated.

The Currency of the Future?

For now, the Bitcoin experiment appears to have weathered the Great Media Blitzkrieg of 2011. Bitcoins’ value is once again growing at the organic rate it was intended to grow at. So… to 2140 and beyond, right?

“I’m not even going to try to predict what will happen in the year 2140,” Andresen is quick to say. His focus is more attuned to the more immediate future of Bitcoins. “In December of this year, the Bitcoin will be 4 years old and the number of new Bitcoins produced will be cut in half. I think we will learn a lot when that happens and that will give some insight into what will happen over the years as Bitcoin production slowly drops to zero.”

Like any model of currency, it’d be a risk to really put all of your eggs into the Bitcoins basket. The currency could have long-term staying power. Then again, it could exist as a prototype that ends up producing a more advanced model of online currency and eventually be supplanted by something like a Bitcoin 2.0, for lack of a better term. Either way, some version of Bitcoin will continue to grow and become a part of our future experience with online commerce.

“I think there will eventually be one dominant currency that is used for 80% of worldwide online transactions,” Andresen predicts, “but I think there will always be alternatives. The most likely outcome in my lifetime, the next 40 years or so, is most people will use their national currencies when purchasing goods and services from other people in their own countries but will use something else for international payments.”

Naturally, as Bitcoins continue to evolve, developers like Andresen are working hard at ensuring the private security of Bitcoin users. Andresen says his past six months have been spent building “multi-signature transactions” for the Bitcoin network. He explains the multi-signature security feature as thus: “They are kind of like if you took all of the paper money in your wallet and then tore it in half and put half in your safe deposit box and kept the other half in your house. A robber would have to break into both your house and your safe deposit box to steal your money.”

You’d be hard pressed to find that kind of security with your current stash of cash if for nothing else but because it would be ungodly inconvenient for the consumer, to say nothing of the ambitious thief. Andresen says that’s one of the major advantages Bitcoins will have over our current terrestrial currency: you can conjunctively store your Bitcoins in two places at once so that in order to use them, a person would need access to both storage sites. One location where you might store your Bitcoins could be a secure website run by a bank which acts as the proverbial safe deposit box for Bitcoins whereas the other could be your computer or smartphone.

“To steal your Bitcoins, thieves would have to break into both your computer or smartphone and your bank. And, it would be impossible for anybody at the bank to steal them without first breaking into your computer.”

The infrastructure for this multi-signature security technology is still in production, he says, but he expects that by the end of this year “there will be easy-to-use, incredibly secure and convenient solutions for storing and spending Bitcoins.”

With that kind of unprecedented level of security, it’s even possible that in the future Bitcoins might become a wise means for stashing your savings.

While the security advances will likely be a strong draw for future Bitcoin investors, perhaps of equal importance to the gradual growth of Bitcoins will be its acceptance as a form of payment with more online businesses, but that’s all in due time. As the reliability and legitimacy of Bitcoins is developed over time, don’t be surprised to see more online businesses begin accepting it. For now, though, the goal is to nurse the Bitcoin economy to a level where it will persevere the next blizzard of media attention the developers anticipate in the coming years. It’s possible Bitcoins may endure another “rise-and-fall” inflation in the future, but hopefully it won’t so easily shake the faith of the masses, at least as badly as last year’s roller coaster appears to have done.

In the meantime and in-between time, reconsider what those figures in your bank account really mean to you. You might see dollars or whatever your country’s currency happens to be, but the reality is that what you’re using these days intrinsically isn’t so far removed from Bitcoins. The Bitcoin experiment may or may not survive to 2140 but even if the Bitcoin itself were to disappear, the very idea of it is powerful enough that the development of an online currency will undoubtedly continue.

So now that you know a little bit more about Bitcoins, what do you think? Still wary about it or would you give it a try? If you’re still uncomfortable with the idea, what would allay your anxiety with using Bitcoins? Why wouldn’t a standard currency used exclusively for online purchases across the globe be a good idea? Again, let us know what you think.