Welcome to the digital world of the 21st century…where cash is king. Except we’re not talking dollars or yen or Euros or rupees, we’re talking bitcoins. Bitcoins are an anonymous, algorithmically-derived virtual currency that has soared in value over the last few years.

Bitcoins

Part of the attraction of bitcoins is that they are more than a virtual currency. Bitcoins are a method of making payments, like PayPal or a credit card network. That means you you can spend and trade bitcoins almost as easily as sending an email or making an e-deposit at your bank.

Creating a virtual currency

Bitcoins were the brainchild of Satoshi Nakamoto, a pseudonym for an anonymous computer programmer or programmers. He/They developed the Bitcoin software for some years and released it publicly in early 2008. The bitcoin system was designed to run across a large network of machines that came to be called bitcoin miners, and these machines “discover” bitcoins by solving esoteric mathematical problems. The owners of these machines also collectively determine the rules of the system, and it requires the consent of a majority to affect changes.

The system is designed so that only a specified limited number of bitcoins are mined over time. This means that bitcoins cannot be inflated or deflated by central banks and are truly subject to the economics of supply and demand. One consequence of the finite supply of bitcoins is the extreme volatility in the value of the coins. Bitcoins were worth around $13 each in September 2010, and their value soared to over $900 in mid November of this year. On November 20, bitcoins lost almost one-third of their value, dropping from more than $900 to around $600 each.

Bitcoins: Regulatory quagmire

Bitcoins are a regulatory nightmare for governments across the globe. The fact that bitcoin operates as both a currency and as a payment system is what gives regulators headaches, and governmental responses are varied worldwide. The U.S. government has taken one of the toughest stances against allowing bitcoins to be formalized into the financial system. The U.S. Department of Homeland Security even went so far as to close down the U.S. bank accounts of Mt. Gox, a Japanese-based concern which is one of the world’s largest bitcoin exchanges.

Security concerns

Unlike traditional credit transactions, bitcoin transactions are not reversible. This means that once they have illicitly been taken, it is almost impossible to recover them. Each bitcoin exists as a private crypto key stored on the network, and are typically stored in digital wallets, so if someone hacks your digital wallet and gets your bitcoin keys, you have no real recourse.

There have been several digital wallet hacking incidents over the last few months. You can, however, totally eliminate this risk by keeping your bitcoin keys completely offline, such as storing them on a USB flash drive or a computer that is not connected to he Internet.