The market capitalization of the Bitcoin ecosystem crossed 1 billion US dollars recently. As the value of the each Bitcoin nears 100 US dollars, many have begun to take notice.
One likely source of this sudden interest is the Cypriot banking crisis. As depositors scramble to hedge their investments, the steadily growing notoriety of bitcoin raises some interesting opportunities. The two most alluring aspects that make the Bitcoin economy unique are the concept of mining and, interestingly enough, the automatic limits on mining.
Unlike other forms of currency, bitcoin users can create new money. By solving complex math problems users, or miners as they are often called, create new bitcoins where there used to be none. This operation is not strictly free “as in beer”. Miners need to invest time, electricity, and equipment into the endeavor. Profit is also not guaranteed. The nature of the math problems being solved mean that a single miner may never create new bitcoins on their own.
This self-limiting aspect of Bitcoin creates a fascinating set of contradictions. First there is a hard limit. There will never be more than 21 million bitcoins in circulation. It is important to note that each Bitcoin can be divided almost ad-infinitum. Some software only supports fractional bitcoins to 8 decimal places, but there is no hard limit in the Bitcoin system itself. Once all bitcoins have been mined it is expected that the value will increase as smaller and smaller fractions are transacted.
Block mining serves two functions. First, it cements a set of bitcoins transactions into the distributed record called the block chain. Second the miner who solves the problem and successfully signs the block is rewarded. The reward today consists of 25 bitcoins plus any transaction fees. Transaction fees are small quantities of bitcoins left over (intentionally by the requestor) from any submitted transactions. The reward changed from 50 bitcoins to 25 towards the end of November 2012. Bitcoin is designed such that this halving of the reward should automatically occur approximately ever 4 years, until 21 Million bitcoins have been created and the reward becomes 0. At this time, the transaction fee will become the only incentive for continued mining operations which are essential for the continued success of Bitcoin.
Its distributed, non-regulated nature has also raised the ire of regulators. The United States Treasury Department’s Financial Crimes Enforcement Network announced on March 13 new guidelines on how to apply existing regulations to people involved in the transacting of virtual currencies. This announcement was aimed at the prevention of money laundering via Bitcoin; at the same time some saw it as adding legitimacy to the growing Bitcoin economy.
One last attribute of Bitcoin that I will mention in this post is called “difficulty”. This is actually adjusted based on the overall speed of mining. If blocks are being mined at a rate faster than expected (due to an excess of mining capacity) the difficulty level increases automatically. This is intended to prevent one actor from applying excessive capacity in hopes of gaining an unfair advantage. Judging by the current up-swing of difficulty, I think it is safe to say that the popularity of Bitcoin is on the rise.
No one can say for sure what is on the horizon for Bitcoin. However I think it is safe to say there will be more to see soon.