Online Cash Bitcoin Could Challenge Governments, Banks

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Late last year, after WikiLeaks began releasing its trove of State Department cables, many individuals sought to show solidarity with the group by making a donation. They found, however, that many payment processors would not remit money to WikiLeaks, some say as a result of U.S. government pressure. PayPal even froze the group’s account so it couldn’t access funds already collected.

“Hey, Visa, Mastercard, Paypal: It’s MY money,” media critic Jeff Jarvis tweeted at the time. “How DARE you tell me where I can and can’t spend it?”

Intermediaries as Choke Points

Whether or not payment processors ought to be telling us how to spend our money online, the fact is they can. We rely on third parties to transact online, and when government wants to restrict how we can spend money online, it’s these intermediaries they turn to.

Online gambling and sports betting is perfectly legal in countries like the UK, Ireland and Australia, and a resident of the U.S. will have no problem reaching the websites of gaming sites from those countries. Placing a bet is another matter, however, because the Unlawful Internet Gambling Enforcement Act of 2006 requires payments systems to block transactions to online gambling sites.

Similarly, Congress is considering a law like the proposed Combating Online Infringement and Counterfeits Act (COICA), which would not only allow the Department of Justice to seize the domains of sites suspected of selling counterfeit and pirated goods, but would also require payment processors to block transactions to sites placed on a black list.

To transact online, you have to have an account with a third party like PayPal that you trust will follow your payment instructions. There’s been no such thing as “online cash,” no currency that could be exchanged untraceably between two persons without a third party intermediary–no such thing, that is, until now.

True Digital Cash

Bitcoin, an open-source project created in 2009 by Satoshi Nakamoto, is the world’s first distributed and anonymous digital currency. That’s a mouthful, but it’s not difficult to understand.

Since the web has been around, digital currencies have come and gone. Think of Facebook Credits, a digital currency that allows you to buy virtual goods on Facebook applications, or Microsoft Points, the currency of the Xbox Live Marketplace and Zune store. You exchange dollars for them just like you might exchange dollars for euros, then use them to buy stuff from sellers who’ll take them, say a patisserie in France, or FarmVille in Facebook.

The web has also seen all-purpose digital currencies, from defunct dot-com bubble start-ups Flooz and Beenz, to the slightly more successful e-gold. Unlike cash, however, digital currencies to date have had a third party intermediary monitoring transactions. That’s because digital cash is different from physical cash in one very important way: If I hand you a 100 euro bill, I no longer have it. You can’t be as sure of that, however, when the cash is just 1’s and 0’s. So it’s been necessary to have a trusted intermediary deduct the amount from the payer’s account, and add it to the payee’s.

Bitcoin is the first online currency to solve the so-called “double spending” problem without resorting to a third-party intermediary. The key is distributing the database of transactions across a peer-to-peer network. This allows a record to be kept of all transfers, so the same cash can’t be spent twice–because it’s distributed (a lot like BitTorrent), there’s no central authority. This makes digital bitcoins like cash dollars or euros: Hand them over directly to a payee, and you don’t have them anymore, all without the help of a third party.

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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