To borrow a phrase from "Seinfeld," it's a currency about nothing.
Bitcoins have no intrinsic value. But since they were introduced to the world in 2009 by inventor Satoshi Nakamoto (a pseudonym), they have turned into a billion-dollar market and have been designated a currency by the U.S. government. Since the days when stones and shells were recognized as a means of payment, currency has taken many forms. What makes bitcoin a currency is what it does, not what it is. "To the extent it looks, walks and acts like a duck, this 'duck' is a currency," says Sam Hamadeh, chief executive officer of private-company research firm PrivCo.
Here are some questions and answers explaining how bitcoin became a currency. The answers were supplied by Bitcoin.org, the Bitcoin Foundation, Hamadeh and the website of Mt. Gox, the largest marketplace for trading bitcoins.
What are bitcoins?
Nothing but a randomly assigned set of unique numbers, not encrypted or particularly complicated. They are linked to individual signatures to prove ownership. That ownership can be transferred between parties.
How are they allotted?
They can be bought second-hand on exchanges or "mined" as new bitcoins. Bitcoin prospectors who want new coins must solve math problems of varying complexity that are posed by members of the Bitcoin open-source consortium. Solving the problem gets you assigned to a pool that will be granted a number of the coins. Cracking the math problem, which requires a large amount of computing power and can take weeks, does not assure you will get any bitcoins, but puts you into a lottery that gives you a chance at winning one.
Why does it sound like a game?
There are overlaps in the gaming and bitcoin community. Super-fast gaming chips have been used by many bitcoin miners, and online game players have long competed for rewards like virtual money. But this time, it's serious.
What does it mean that bitcoins are "open source"?
In theory, the thousands of volunteers who review and approve bitcoin allotments provide a check on the system to make sure the supply is closely monitored and verified against a master list. While the algorithms, or computer codes, users must solve are secretive, the master list, known as the "block chain," is publicly viewable, just as the code for open-source browser Firefox is open. The theory is that the more eyes there are on a transaction, the more secure it is.
Other open-source groups have managed success using a similar open process. Linux, the widely used open-source computer operating system, was developed by thousands of users who contributed code and maintain the integrity of the software. Wikipedia, the online encyclopedia, works on the same concept. The ethos is as old as the Internet itself, which is carried by millions of computers in a peer-to-peer, decentralized network based on a set of common rules.
How many bitcoins are there?
Bitcoin's rules are based on a mathematical formula that will grow until the number of units hits 21 million, at which point it will shut down. In theory, the bitcoins may be broken into many smaller parts so the money supply can be expanded to meet growing demand.
How do bitcoins gain value?
Value is subjective. The bitcoin numbers themselves are worth nothing – just as gold is just a piece of metal until someone pays for it.
Initially, they were worth pennies. But speculators have bid up the value of a single bitcoin to as high as about $290. The overall value of all bitcoins in circulation is now calculated to be $1 billion, a sizeable figure but a tiny fraction of all global currencies. Vastly more currency is denominated in bank credits and accounts held by governments and individuals and estimated by the International Monetary Fund to be worth about $150 trillion.
How does "real" money gain value?
The piece of paper the dollar is printed on is worth nothing on its own. But banks allot credit to individual banking accounts regulated by government central banks. Their value comes from a government's backing, know as a "fiat," Latin for "let it be done." Every government has a fiat currency, even if it decides to peg its currency to U.S. dollars, as some Latin American, Gulf region and Asian countries do, and because the gold, oil and other global commodities are priced in them.