Bitcoin is a digital currency that has the potential to revolutionize the monetary system beyond all recognition. Unlike traditional monetary systems Bitcoin has no central authority issuing the money and monitoring transactions. Instead transactions are collectively managed by a P2P network.

A P2P monetary system poses a potential threat to states and banks. Banks would lose their function as an intermediary between transactions and the transaction fees with it. And because it’s a global currency there are no exchange rates. States would no longer be able to determine the value of money and tweak the monetary system to their economic needs by inducing inflation. And because the transactions over P2P are untraceable the money can’t be taxed. The most radical of futuristic thinkers foresee a total collapse of states as a consequence.

So what are Bitcoins? They are actually files on a computer that can be exchanged over the P2P network.
Security is established by making use of public-key cryptography. All users have a public and a private key. When you want to send money to person X you put in his public key to indicate the money is meant for him. This transaction is signed by your private key. After that only the private key of person X can access the money.

In order to prevent double spending the information about the transaction is send to all the nodes in the network. When the network has accepted the transaction this is recorded and the previous owner can’t spend the coin again. Although the network keeps track of all transactions it does not keep track of the people executing the transactions. Accounts are not based on names but on the anonymous private keys. Therefore the money trail is untraceable. Moreover, bitcoin accounts can’t be frozen because there is no central authority enforcing regulations. This makes the monetary system immune to political interference.

But how does a file on a computer rise to the status of money? Bitcoin is based on three fundamental ideas: collective agreement, proof-of-work and scarcity.

Money has value by collective agreement. As long as everybody accepts euros, dollars or bitcoins as a trade for goods and services they can serve in system of value transfer. Such an agreement can be established by social engineering. The bitcoin community is accepting the coins as a means of value exchange and they are well on their way to accumulate critical mass.

Currency gets its value from the work that went into acquiring it (and from it being scarce). Marx defined money as ‘solidified labor’. The work going into creating bitcoins is making CPU-cycles available to the network. As described earlier, transactions are send to the entire network and need to verified. This takes up a lot of CPU-cycles and electricity. Anyone taking up this task is rewarded bitcoins (or transaction fees) in return. Analogous to gold digging this is called mining.

Scarcity is written into the bitcoin software. A fixed amount of coins are generated over time. Every ten minutes 50 bitcoins are awarded to one of the mining nodes in the network. To stem the amount of coins flowing into the bitcoin economy the reward is halved approximately every four years. By 2013 only 25 coins will be rewarded and 12.5 in 2017. The mining algorithm is fixed to release a maximum of 21 million coins. In 2140 the last bitcoin will be generated.

Whether bitcoin will overthrow governments and make banks obsolete is to early to predict. But this digital currency has qualities which could proof it is better equipped to serve the needs of the contemporary world than the current monetary system. There is hardly a time delay in closing deals. Transfers are done in the time it takes the network to verify the transaction: ten minutes on average. So there is no need to wait for banks to open and there are no more limitations when trading from different time-zones. And it’s a global currency which makes sense in a global economy.

It’s great for microtransactions on the web because there are no third-party intermediaries raking in transaction fees. People can be charged very small amounts for one-time services like listening to a song or reading a newspaper article. It could serve as an alternative to generating money out of advertising.

You can join the bitcoin economy by downloading bitcoin on Go there as well for more technical information.

Listen to an episode of Agorist radio explaining a lot about the technical details and social implications. Bitcoin Mania Part 1

Read the original paper Bitcoin: A Peer-to-Peer Electronic Cash System by founder Satoshi Nakamoto.