Online Cash Bitcoin Could Challenge Governments, Banks

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The Bitcoin digital currency also works a lot like cash in that it’s anonymous. When you go to a flea market and pay cash for an old Commodore 64, there’s no record of the transaction. You don’t have to know the seller’s name, and the seller doesn’t need to know yours. Digital currencies by contrast rely on accounts, and have to collect at least some information about you. Because Bitcoin employs no such accounts and instead relies on public key cryptography, there’s no way to know, just looking at the database of transfers, who sent money to whom.

A Revolutionary Concept

Bitcoin is potentially revolutionary for several reasons. For one thing, artificial currency inflation is impossible. In most countries, a central bank controls the money supply, and sometimes (such as during the recent economic crisis) it may decide to inject more money into an economy. A central bank does this essentially by printing more money. More cash in the system, however, means that the cash you already hold will be worth less. By contrast, because Bitcoin has no central authority, no one can decide to increase the money supply. The rate of new bitcoins introduced to the system is based on a public algorithm and therefore perfectly predictable.

More revolutionary perhaps is that because no intermediaries are needed for Bitcoin transactions, governments will have no intermediaries to regulate. And Bitcoin’s anonymity makes it difficult for governments to go after end users directly.

In his new book, Kingpin, Kevin Poulsen describes how hackers and fraudsters relied on e-gold for their transactions. While centrally run, the e-gold company didn’t require identification to open an account, making the currency somewhat anonymous. That was, until the FBI and Secret Service raided e-gold’s Florida offices and the company began to cooperate with investigators. Transaction information handed over by e-gold led to several arrests, and eventually the e-gold currency was itself shut down after executives were charged with money laundering.

Consider the same scenario with Bitcoin. Because Bitcoin is an open-source project, and because the database exists only in the distributed peer-to-peer network created by its users, there is no Bitcoin company to raid, subpoena or shut down. Even if the site were taken offline and the Sourceforge project removed, the currency would be unaffected. Like BitTorrent, taking down any of the individual computers that make up the peer-to-peer system would have little effect on the rest of the network. And because the currency is truly anonymous, there are no identities to trace.

The Implications of Bitcoin

Like any new technology, an anonymous and distributed virtual currency has good uses and bad.

The bad, of course, is that bitcoin could facilitate illegal activities, including the sale of pirated or counterfeit goods, stolen credit card numbers and passwords–even child pornography. And in perhaps a grayer area, bitcoin might allow consenting adults in the U.S. who want to place bets at legal UK gambling sites to do so without worrying about restrictions on payment processors.

The good, though, turns out to be really good. Law-abiding citizens can carry on their affairs without anyone snooping on them or telling them what they can and can’t do. Want to contribute to WikiLeaks or some other politically unpopular organization? No problem. Live under a repressive regime and want to buy a repressed book or movie? Here’s how. No wonder the Electronic Frontier Foundation calls Bitcoin “a censorship-resistant digital currency.”

Still in its infancy, the value of the Bitcoin economy is currently estimated to be only $5 million, but it’s growing. Exchanges where you can swap dollars for bitcoins and vice versa are up and running, and the number of vendors that accept bitcoins for payment continues to expand. If it catches on, Bitcoin might pose a threat not just to governments, but to payment processors as well.

And it’s a story that’s just getting started.

Jerry Brito is a contributor to TIME. Find him on Twitter at @jerrybrito. You can also continue the discussion on TIME’s Facebook page and on Twitter at @TIME.

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It's now 2013. BTC is at aroun $1000. Amazing how this flew under the radar back then.