Understanding the Bitcoin Craze

Most likely you have already heard of Bitcoin, but like most people, you don’t have a clue what it is, or how it works. Let’s start with the basics: Bitcoin is a digital currency that is not governed or issued by any government or institution, but rather it is maintained in the “cloud” by a peer-to-peer network involving a universal ledger. If that is not sci-fi enough, wait until you hear about Bitcoin’s origins. In 2008, an individual or group of people, operating under the pseudonym Satoshi Nakamoto released a paper describing the Bitcoin protocol and in 2009 they released a software client, allowing people to mine bitcoins. The software is open source, so logically it set off a tech craze around the globe that has morphed into a multi-million dollar endeavor. Bitcoins have been compared to gold--they are not controlled by a central bank and they are electronically “mined” by powerful computers that solve ultra complex math problems. When the computers have successfully solved the problem, new bitcoins are minted. Once a bitcoin is minted it is electronically registered in a universal public ledger and encoded with a unique crypto-key to prevent it from being copied. The Bitcoin processor mints 25 new bitcoins for every block, or every problem that is solved. However, the client is programmed to stop minting coins after 21 million are in circulation, predicted to be sometime in the year 2140. So who can “mine” bitcoins? Anyone with a computer, although, your energy bill will generally outweigh the benefit of mining bitcoins and it could take up to three years for your computer to solve the algorithms. Nowadays, people join a mining pool via an online platform but even these pools are being outdone by super computers working around the clock in places like China. The average investor will just buy a bitcoin through an exchange, although the going rate is about $900 per coin. Ok, so where do we get a bitcoin without mining it and how do we use it? This is where venture capital meets cryptology. Early on, bitcoins were traded for hard currency on exchanges, think New York Stock Exchange. More recently, with big money from venture capitalists, like Andreessen Horowitz, start-ups are developing Bitcoin wallets. The wallets, act like banks, allowing people to store and trade bitcoins. Companies like Coinbase, akin to Pay Pal, allow individuals to open an individual account to buy and sell bitcoin and provide companies with a platform to accept bitcoins as payment. Venture capitalists are betting on Bitcoin wallets for future profits. The more companies that accept bitcoin, the greater the profit earned from transaction fees. Because the peer-to-peer network cuts out the middle man, Bitcoin has the ability to undercut credit card and global wire transfer fees, making Bitcoin an attractive option for businesses across the globe. Right now, Coinbase is offering no transaction fees for the first $1,000,000 in payment processing and just 1% to cash out. In the first weeks of 2014, Bitcoin has gained some high profile supporters. Overstock, the on-line shopping site, began accepting Bitcoin as payment, taking in $126,000 in sales on the first day. The NBA’s Sacramento Kings and some Las Vegas casinos are also accepting Bitcoin. It is estimated that Bitcoin’s market capitalization is now $10 billion. If you are risk adverse, Bitcoin is not for you, at least not yet. Volatility is par for the course for such a new currency, but for those willing to ride the wave, Bitcoin has delivered tremendous returns so far. At the start of 2013, the currency traded at $13.50. By November 1, it was at $211 and saw a high of $1,240 in early December. But Bitcoin is not all boom, there have been major bumps along the way, including ties to Silk Road, the on –line drug market that used bitcoins because of their anonymity. Regulators across the globe are also concerned with Bitcoin’s volatility and lack of transparency. China recently banned financial institutions from trading in Bitcoin and U.S. officials are requiring Bitcoin wallets to adhere to Anti-Money Laundering protocols. For its part, Bitcoin promoters are ahead of the game, they have already formed their own lobbying vehicle, the Bitcoin Foundation. Officials at a recent congressional hearing on virtual currencies seemed to take a positive but cautious outlook on Bitcoin but more regulation is sure to come. No matter how you feel about cryptographic money, Bitcoin is not the last we will see of this phenomena. As more of our transactions go global, digital currency makes a lot of sense. The good news is, for lawyers, Bitcoin poses an array of interesting legal questions, from banking law, to regulation, to privacy