This article is written to address a peeve of mine/ I keep reading/hearing “bitcoin is anonymous” and warnings about how terrorists and drug dealers can use it for bad purposes. While this is true, they are far safer doing illegal activities with cash. If you are somehow unaware of Bitcoin, check out the wikipedia page for a good overview.
Basically, bitcoin is like PayPal except it uses its own currency (bitcoin) instead of U.S. dollars. You have to have internet access to transfer funds (just like you do with PayPal or a credit card). Without an internet connection, you cannot send or receive bitcoin. (Just like PayPal, and just like credit cards, though with credit cards a business could use a paper imprint of the card and run that through later, trusting the buyer. I am not sure if there is any way to do this offline with PayPal or bitcoin.)
Unlike PayPal, bitcoin is decentralized. If PayPal goes down, you can’t use PayPal. Bitcoin works like peer-to-peer file sharing services do. There is no master bitcoin server. Instead, thousands of bitcoin servers are running around the world, creating a vastly redundant network with no central point of failure.
You earn bitcoin just like you earn U.S. dollars — you can do work for someone who pays you in bitcoin, or, you can exchange/sell stuff for it, like how you might give someone a table for cash. In my case, a few years ago I gave some U.S. dollars to a company and they gave me some bitcoin for it.
But how does someone get bitcoin in the first place?
If you trace the U.S. dollar back far enough, you find it originated as paper notes representing some supply of precious metal (see the wikipedia entry on the U.S. silver certificates). At some point, we unlinked our dollar from silver, and now paper is just a virtual currency, not really tied to anything. We accept the value because we can trade/exchange it for goods and services. Our banks don’t even have enough dollars to match what we have in our checking or savings accounts. See the wikipedia entry on fractional reserve banking.
Just like U.S. dollars originated from mining precious metals, bitcoin originated by virtual mining. Bitcoin is a mathematical creation, with a finite amount that can be created through some complex mathematical formula. In the early days, bitcoin miners ran software to decode/discover the bitcoin. They might then use it to buy a pizza (which may have been the very first bitcoin transaction for goods in 2010). And thus it begins.
Over the years, mining has become less and less popular. The fewer bitcoins there are to find, the harder and longer it takes to find them. Just like the gold rush, early miners found plenty, and those who showed up years later had to do much more digging.
At some point, the electricity cost to run the bitcoin mining computers is more than what the bitcoin is worth. But, just like gold, if the value of bitcoin goes up high enough, it might be worth mining it again. (It’s much like the oil industry. If gas goes to $4/gallon, suddenly it’s worth it to do more work on those old U.S. oil fields. When it’s $1/gallon, it’s cheaper to just import it.)
Bitcoin is NOT Anonymous
And now … the point of this article. Bitcoin is not an anonymous currency. Every bitcoin ever created is recorded in a ledger. This ledger (see the wikipedia entry on block chain database) is replicated on the thousands of systems running bitcoin software. Every transaction (sending or receiving bitcoin) is recorded in this ledger, thus every virtual penny of bitcoin is traceable.
Just like every U.S. dollar has a serial number on it, every bitcoin has a serial number. Just like with cash, you can spend a portion of a bitcoin — like giving a store $10 for an $8 item, and receiving $2 back in change. As bitcoins split up, new entries in the ledger are created. It is possible to track the movement of every piece of a bitcoin ever spent back to its original full bitcoin that was created through the mining process.
It would be as if every business wrote down the serial number of every cash bill they ever received and then shared this information with every other person who uses cash around the world. In the real world, this would be impossible, but in the digital world, the Internet and distributed computing makes it easy.
What this means is if you have ever been identified as owning a bitcoin (or portion of one), it would be possible to see where you spent it. Since the entire ledger is public, if the receiver of the bitcoin has ever been known, you could now trace the transactions and know that Bob just sent Dan $5 worth of bitcoin.
In order to stay anonymous, users can create disposable wallets for each transaction, and split up bitcoins in to many small pieces and exchange them through anonymizing services making it much harder to track down. Think of it as exchanging serial numbered U.S. dollars to un-serial numbered coins, then turning those coins back in to dollar bills later. (Except, in the case of bitcoin, every fractional penny of bitcoin is still tracked.)
Cash is More Anonymous than Bitcoin
Because of this, cash is far more anonymous than bitcoin. There is no master ledger for cash. There may be a record of where brand new bills are delivered, but once they leave the bank or ATM machine, they are out in the wild. Tracking bills can be done, of course:
…but it’s far from a complete record of every place those bills have been. I expect anyone using bills for illegal purposes probably didn’t take the time to log their bill’s serial numbers in a public database.
“Bitcoin is the new MP3”
MP3 files and peer-to-peer systems were initially associated with illegal music piracy. Today, many see bitcoin along the same lines. Yet, it’s no different than any other piece of technology. Cash can be used to buy a carton of milk, or a bag of illegal narcotics.
The convenience of being able to near-instantly transfer bitcoin anywhere in the world without government oversight is both a benefit and concern. It is a far superior way to move value around the world without anyone being able to stop you. Since cash is completely anonymous, you could buy bitcoin with cash and then move that bitcoin around in ways cash never could — something you could never do though a bank transfer. (You would have to physically smuggle out suitcases of cash to do the same thing with paper currency, and hope it doesn’t get stopped at the border during an inspection.)
Just be aware that somewhere in the ledger is a record of you transferring bitcoin for that carton of milk you just bought.
Bitcoin is being accepted by places like Dell, Overstock.com and ProXPN. Maybe you’ve heard of them. To them, it’s just another form of value — much like a company dealing with different world currencies.
It will be interesting to see how bitcoin evolves. Maybe it will be huge in the future, or disappear completely like so many other amazing technologies have.
Until then, I’m willing to do work for bitcoin so let me know if you ever need any custom Arduino programming or audio/video work done.