Explaining Bitcoin without buzzwords

From Bloomberg:

Techies are trumpeting a so-called virtual currency called Bitcoin that they say could revolutionize global trade. Financial wonks are shouting from various corners of Wall Street about the regulatory pitfalls and the volatility, highlighted by a tumble in valuation that brought Bitcoin to the world’s attention.

Meanwhile, many of us don’t understand what a Bitcoin is, despite all the coverage. Bloomberg.com attempts to answer your questions, and we promise not to use the term “virtual currency” again here.

What is Bitcoin?

It’s like the U.S. dollar, the euro, or the Mexican peso — except that it’s not controlled by any country; you can’t hold one; and you can’t buy many things with it right now. Some tech-savvy companies are starting to accept payments in Bitcoin, most notably WordPress, which makes blogging tools.

While some enthusiasts have issued bills and coins that serve as physical proxies for the currency, Bitcoin was designed to be purely digital. You can’t go to an ATM and take out a Bitcoin, or put one in a cash register. Bitcoins live in online wallets, which are accessed via a computer. It’s more like an MP3 than a CD.

I’ve heard they can be used to buy drugs and other illegal items. How does that work? (Asking for a friend.)

Bitcoin transactions are not easily traceable. That means holders can trade them or use them to purchase things online anonymously. As a result, Bitcoin is becoming a popular vehicle for laundering money and buying illicit items on the Internet. Iranians have used Bitcoins to get around financial restrictions imposed by the U.S., and there’s a thriving online market where drugs are traded online.

Who created Bitcoin?

The identity of those responsible for inventing Bitcoin remains a mystery. A programmer or group of programmers going by the name of Satoshi Nakamoto published the original specifications for it. Bitcoin has been around since 2009, but it started as an obscure project that computer hobbyists experimented with.

How do you find Bitcoins?

In theory, anyone with a computer could “mine” Bitcoins through an automated mathematical process. You can unlock more of them if you discover a hidden series of letters and numbers that matches up with the Bitcoin security keys specified by Nakamoto.

Programmers have written software, which can run in the background on PCs, to rapidly check possible combinations of letters and numbers one by one in the hopes of stumbling on an unclaimed Bitcoin. If you’re planning to get rich by running the program in the background on your MacBook, don’t bet on it. All of the easy ones have been mined. Now, high-powered computer systems are needed. Serious miners have multiple computers running to team up on the task, and there’s even a computer virus going around that turns victims’ PCs into digital slave laborers.

The format, where it becomes more difficult and expensive in terms of computing power to discover Bitcoins over time, was designed to keep the currency’s growth rate — or inflation — steady and predictable. Currently, there are just more than 11 million Bitcoins in existence, and the instructions cap the total number at 21 million to be unearthed by the year 2140.

What is a Bitcoin worth?

Bitcoins now have a market value of about $1.04 billion based on supply and exchange rates, according to Bitcoin Charts.

There’s no control over how people value it against their own currencies. That, and a recent self-feeding cycle of public curiosity, explains how the value of Bitcoin in dollar terms has soared to more than $200 from mere cents at its inception. In the past week, the value has since slumped from as high as $266 to as low as $84, according to Tokyo-based Mt. Gox, the largest Bitcoin exchange.

Why is it so volatile?

It stems mainly from the lack of liquidity and a central monetary authority to make sure supply and demand are balanced. That, plus the absence of any large exchanges where buyers and sellers can find each other, makes Bitcoins vulnerable to manipulation and speculation.

Where do I buy some?

There are several upstart websites that act as Bitcoin exchanges, such as BTC-e and Tradehill. Mt. Gox has been halting trading periodically since April 11, citing difficulties with serving the high trading demand and cyber attacks on its system. The temporary closure also happened to come shortly after a drop in Bitcoin’s value. Maybe the finance folks have a point.

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