Wednesday, June 08, 2011

Converting Dollars to Bits the Right Way

As readers well know, BRT has written extensively about the foibles of the financial system. What has not been discussed is this blog's opinion about gold and silver as the support mechanism for same, something that was done for millennia prior to the central bank's recent success in turning money into a fiat entity created from nothing and backed by nothing. (Similar to religion but at least one has a fiat item in hand when buying a Starbucks or something else of intrinsic value. :))

Using gold or silver to back a financial system appears, on the surface, to be the way to go but other then quantifiablity and relative rareness of the metals in question, neither gold, silver or any other nobel metal does nothing of use unless used in tech, medicine or science, something to think about when attempting to create a financial system able to replace the fubar the central banking system has created for the world.

Enter Bitcoin, a system who's time's has come, hopefully.

What problem BitCoin solves:  Mathematically, the specific implementation of the bitcoin protocol solves the problem of "how to do all of the above without trusting anyone".  If that sounds amazing, it should!  Normally a local currency has to trust all kinds of people for it to be able to work.  So does a national currency.  And in both cases, that trust is often abused.  But with BitCoin, there's no one person who can abuse the system.  Nobody can print more money, nobody can re-use the coins simply by making a copy, and nobody can use anyone else's coins without having direct access to their keys.  People who break its mathematical "rules" simply end up creating a whole different system incompatible with the first.  As long as these rules are followed by someone, the only way BitCoin can fail is for everyone to stop using it.

This marvelous quality of not having to trust anyone is achieved in two ways.  First, through the use of cutting-edge cryptography.  Cryptography ensures that only the owner of the bitcoins has the authority to spend them.  The cryptography used in BitCoin is so strong that all the world's online banking would be compromised before BitCoin would be, and it can even be upgraded if that were to start to happen.  It's like if each banknote in your pocket had a 100-digit combination lock on it that couldn't be removed without destroying the bill itself.  BitCoin is that secure.

The notion of trusted entity being the driving force for finance is something almost totally overlooked by everyone including yours truly. :)

Whether or not payment processors ought to be telling us how to spend our money online, the fact is they can. We rely on third parties to transact online, and when government wants to restrict how we can spend money online, it's these intermediaries they turn to.

To transact online, you have to have an account with a third party like PayPal that you trust will follow your payment instructions. There's been no such thing as "online cash," no currency that could be exchanged untraceably between two persons without a third party intermediary--no such thing, that is, until now.

Bitcoin is the first online currency to solve the so-called “double spending” problem without resorting to a third-party intermediary. The key is distributing the database of transactions across a peer-to-peer network. This allows a record to be kept of all transfers, so the same cash can't be spent twice--because it's distributed (a lot like BitTorrent), there's no central authority. This makes digital bitcoins like cash dollars or euros: Hand them over directly to a payee, and you don't have them anymore, all without the help of a third party.

Bitcoin could be disruptive to the max, something the powers at be are probably laughing at just as IBM laughed at Bill Gates when he "innocently" asked IBM if it would be "OK" to sell the operating system IBM was financing to other computer manufacturers on a per processor license.

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