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Q&A

A bit(coin) confused? You’re not alone

Leeds
Gregerson

Unlike movieland mobsters, most of us don’t sit around counting our cash.

Indeed, many of us get paid by direct deposit to our checking accounts. In turn, we pay bills online with a few keystrokes and buy groceries and gas with the swipe of a credit or debt card. If we’re feeling old school, we’ll write a check.

We don’t need to see every dollar we own to know it’s real because we trust the numbers printed on our bank statements. If it weren’t for parking meters and vending machines, many of us wouldn’t carry cash at all.

So maybe it isn’t surprising that virtual currencies have sprung into existence. CoinMarketCap.com listed values for more than 130 digital currencies as of last week.

But one has been hogging the attention lately: Bitcoin. It’s recently been at the center of a Japanese currency exchange’s bankruptcy, hacker attacks and money laundering charges.

The question is: Can bitcoin outlast the drama to become a currency of the future?

Actually, that’s just one of many questions people have about bitcoin. Here are several more, along with some answers.

Q. What is bitcoin? Who created it?

A. Bitcoin is a virtual currency created in 2008 by a person – or persons – using the name Satoshi Nakamoto. Little is known about him or them.

In basic terms, bitcoins are lines of computer code that are traded from one person to another. With each trade, a unique digital code is added to that bitcoin to establish a trail. Because it all happens in cyberspace, some account owners have successfully concealed their identities.

The combined value of all 12.5 million bitcoins in existence was almost $7 billion on Friday morning, according to CoinMarketCap.com.

If it seems hard to believe that anyone would adopt an unseen currency, try this: Go to BlockChain.info and watch trade after trade pop up on your computer screen. Many of the trades are small, involving fractions of one bitcoin, but others involve hundreds of bitcoins, abbreviated BTC.

The currency’s name is likely a combination of “bit,” the smallest unit of measurement for computer data, and “coin.” Coin is used in numerous virtual currency names, including Litecoin, Auroracoin and Peercoin, three of bitcoin’s most popular rivals.

Q. Who issues bitcoin? Who regulates it?

A. No government issues bitcoin, although some – including the United States and Japan – are moving to regulate and possibly tax it.

Bitcoin’s creator(s) set up a system that generates new bitcoins every 10 minutes – the amount is now set at 25 – until a total of 21 million are in circulation. Although the currency is released six times an hour, 24 hours a day, the earliest that the last bitcoin will be released has been estimated at 2140, Bloomberg Businessweek reported.

Bitcoin’s decentralized network is operated by those who use it. Supporters say that having a public system minimizes the risk of fraud because it’s beyond belief that thousands – if not millions – of people worldwide could collude on a scheme.

The virtual currency is popular with libertarians and others who bristle under authority, including criminals.

Q. Let’s take a step backward. What is a currency?

A. In general terms, currency is the money accepted for payment in a particular economy. A country’s government typically issues paper notes and coins to make it easier for people to exchange goods and services.

Fiat currency – or fiat money – is a currency that isn’t backed by a physical commodity or reserve, Investopedia says. U.S. dollars are fiat money because although they are issued by the Treasury Department as legal tender, they are no longer directly tied to government gold reserves.

Bitcoin is also a fiat currency because it isn’t backed by a commodity, such as silver.

Q. If it’s not backed by anything, how do we know how much one bitcoin is worth?

A. Bitcoin, like most other things, is worth only as much as people are willing to pay for it. Exchanges allow bitcoin investors to buy and sell, with the price determined by supply and demand.

But compared to more common currencies, bitcoin’s value is especially volatile.

As of one year ago Tuesday, one bitcoin was worth about $42. By the end of December, they were selling for more than $1,100 each, according to CoinDesk’s Bitcoin Price Index.

But after the largest bitcoin exchange suddenly closed last week in Japan, the price plunged to less than $600.

On Friday, leaders of Tokyo’s Mt. Gox filed for bankruptcy protection and announced plans to reorganize and reopen the exchange. They confirmed that about 850,000 bitcoins are missing – probably taken by hackers.

Bitcoin’s detractors say bitcoin’s structure is unstable and bound to collapse. Supporters say Mt. Gox’s problems were of its own making, the result of inadequate management and security measures.

Q. If bitcoins’ value is so unstable, why would anyone buy them?

A. Because they hope to get rich quick.

Peter Leeds, the publisher of Peter Leeds Penny Stocks, said clients are interested in bitcoin because they are speculators.

As a result, the Toronto publisher has studied the virtual currency and concluded that it won’t survive.

“The fad is sort of on its downtrend,” he said Thursday. “It’s a great idea. It’s really not that great in practice.”

Leeds compared bitcoins to piles of dirt. If you bought a pile of dirt and then someone came along offering to buy it for twice what you paid, you might assume that you’re a savvy investor who should hold onto that dirt, he said.

Over time, you might even consider yourself rich as you reject increasingly higher offers. But, Leeds said, the day will come when everyone’s interest fades and all you’re left with is a pile of dirt.

Leeds, who doesn’t accept money from companies he analyzes and doesn’t invest in stocks he recommends, said about 5 percent of penny stocks are solid investment opportunities. But they are still a risk.

The publisher isn’t risk-averse. That’s not why he shuns bitcoin.

“I don’t pooh-pooh everything,” Leeds said. “But I pooh-pooh the stuff that is a bad idea.”

Q. Do any businesses accept bitcoin as payment?

A. Yes, a growing number of merchants and service providers accept bitcoin. Many are online, including Overstock.com, Gyft, WordPress and Reddit.

But some brick-and-mortar locations take it, too, including some restaurants and food carts in larger cities.

Any purchase less than the cost of a full bitcoin is conducted in decimal points. It’s like making change for a dollar – only each bitcoin is worth hundreds of dollars at this point.

The ranks of businesses accepting bitcoin is still small enough that a company can generate publicity by announcing the decision to accept it.

If the company’s client base is a tech-savvy crowd, it might be a significant marketing strategy that generates more sales.

If few customers use bitcoins, even better. That minimizes the company’s exposure to the currency’s volatility. Unless a business immediately converts bitcoins to U.S. dollars or another stable currency, it could end up with an unexpected loss if the value swoons.

Q. How are bitcoin transactions processed?

A. The currency’s supporters work together online to form the decentralized network that processes bitcoin transactions that take place directly from one person to another without a bank or credit card company handling logistics behind the scenes.

Bitcoin uses a public ledger, called the block chain, to record transactions. Anyone can log on and see the transactions happening as strings of numbers.

Bitcoin “miners” race to be the first to process those blocks of transactions. More accurately, their computer systems perform the complicated calculations involving mathematical algorithms.

The first miner who completes the task is rewarded with 25 bitcoins. A new race begins every 10 minutes.

But only the first-place finisher receives payment. If 1,000 computer owners are crunching bitcoin transaction numbers at any one time, 999 end up with nothing but a huge electricity bill for all the power used by the computers.

Considering that bitcoin miners are operating worldwide, there are probably many more than 1,000 competing at any one time.

Mining isn’t worth the investment, in Leeds’ opinion.

“It doesn’t make a lot of sense to me,” he said.

Q. Do banks see bitcoin as a legitimate currency?

A. Local and national banks are keeping a wary eye on bitcoin. If it gains steam, it could present serious competition for them.

But many believe that’s unlikely.

Karen Gregerson, STAR Bank’s chief financial officer, has asked younger co-workers whether bitcoin will become common locally.

“They tell me, ‘No, it’s not going to amount to anything. You don’t have to worry about that,’ ” she said.

Regardless, Gregerson added, “the payment system is being revolutionized.”

She was referring to how consumers pay for goods and services. Now, many people use debit or credit cards. Businesses typically pay 3 percent of the total transaction to the card issuer in exchange for processing the payment.

Credit card companies and banks – including Fort Wayne-based STAR – count on that interchange fee as an important source of income.

But bitcoin transactions bypass banks and credit card issuers. The network of people who process the transactions are paid in bitcoins.

“Where there is money to be made, there will be innovation,” Gregerson said, adding that it could be a future version of bitcoin that upends the existing system.

“I think it has the potential to evolve to be something that would compete with banking as we know it today,” she said.

Andrea Short, 1st Source Bank’s CFO, said the South Bend-based bank is concerned about any payment system that could harm customers.

Bitcoin is especially troublesome, she said, because it lacks oversight.

“When everything goes smoothly, everyone’s happy,” Short said. “But when there’s a dispute, there’s really no one to go to.”

Q. What’s this about bitcoin and money laundering?

A. Charlie Shrem, vice chairman of the Bitcoin Foundation, was arrested in late January and charged by federal prosecutors with conspiring to launder more than $1 million using bitcoin.

Shrem and Robert Faiella are accused of selling bitcoins to people who wanted them to illegally buy drugs anonymously on the drug trafficking website Silk Road, which law enforcement shut down in October.

Shrem was CEO of BitInstant, a bitcoin exchange company that stopped operations about eight months ago.

Bitcoin.org, the official bitcoin website, acknowledges that not all of the virtual currency’s transactions are legal. But, it says, that’s not a unique situation.

“Bitcoin is money, and money has always been used both for legal and illegal purposes,” the website says in its frequently asked questions.

“Some concerns have been raised that bitcoin could be more attractive to criminals because it can be used to make private and irreversible payments,” the website says. “However, these features already exist with cash and wire transfer, which are widely used and well-established.”

Q. Can you make money by investing in bitcoins?

A. Bitcoins are an investment and, like with most other investments, owning them is a risk. It appears that few local investors are eager to take that risk, however.

John Foxworthy, a certified financial planner with Phillips Financial, has been advising local investors for 10 years. He currently works with 40 to 50 clients.

None of them has asked Foxworthy to explain bitcoin or explore how they can invest in it, he said last week.

In fact, none of the locally owned firm’s 400 or so client families have broached the idea, as far as he knows. Phillips Financial manages $600 million in assets.

Foxworthy is reluctant to rule out bitcoin as a future investment option, but he’d firmly fall on the side of caution if a client asked.

“I would advise them to be very careful,” he said, adding that his concerns include security levels of websites that deal in bitcoins.

Q. So, should the average person buy bitcoins?

A. “Absolutely not,” said Leeds, the publisher who engages in some penny stock speculation with his own money.

He described bitcoin as a mania in the same vein as the dot.com and gold bubbles.

Based on those examples, Leeds predicted that more people will lose money than make money on bitcoin.

“I love the idea. The concept is great,” he said. “It’s just got too many structural flaws.”

sslater@jg.net

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