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Mike Caldwell, the founder of a small company in Salt Lake City that makes timekeeping software, considers himself financially conservative. He's also a geek, and couldn't help but get excited late last year when he heard about bitcoin, a new virtual currency. In February, on one of the handful of online exchanges that have appeared over the past year, he bought about $20,000 worth at less than a dollar per bitcoin. "I felt that maybe I would get a 20 or 50 percent return," says Caldwell, 33. By early June, when he sold the last of his stake, a bitcoin was worth around $30. Caldwell says his total return was well over 1,000 percent. "That magnitude was totally unexpected," he says.
For those who got in early, it's a gold rush. In the last few months this online cash has exploded in usage, notoriety, and value. Like dollars or yen, a bitcoin's worth fluctuates with demand, but in its short history it's gone mostly up. About $130 million worth of bitcoins are now in existence, and the value of that stash has grown more than 6,000 percent this year. Bitcoin partisans are breathless: "This is the biggest invention since the Internet," says Bruce Wagner, an entrepreneur who hosts a monthly bitcoin meet-up group in Manhattan.
The project was started in 2009 by an enigmatic programmer known as Satoshi Nakamoto. He always communicated electronically, never answered personal questions, and disappeared from online forums in December. The conspiracy-minded speculate that Nakamoto was actually a group of people, or a government cryptographer, or a pseudonym for Gavin Andresen, the Amherst (Mass.) programmer who took over the project after Nakamoto vanished. "I spoke to one guy who thought aliens might have come to earth to bring us this technology, it's so perfect," says Wagner.
Digital transactions normally require a trusted intermediary such as PayPal to credit and debit accounts properly and prevent cheating. With bitcoins, "there is no middleman, says Andresen or," more accurately, there's a distributed middleman. Individual transactions are encrypted, logged by a decentralized network running on thousands of home computers, and recorded in a public ledger. The system works similarly to peer-to-peer music-sharing networks in that files are shared among swarms of users, rather than downloaded from a central server.
Suppose you're in the market for alpaca socks, one of the few consumer items you can buy with bitcoins. Step one: Get some BTC—that's the symbol—at a currency exchange site such as Mt.Gox. Then download a desktop app from bitcoin.org, which will store your lucre (some use an online service such as Instawallet.org instead) and connect you to the decentralized bitcoin network. Next, find the alpaca farms bitcoin address, a string of characters also known as a public key. Click the send coins button.
The purchase is unconfirmed until a miner certifies it. Miners are power users who crunch numbers on behalf of the network, and some have racks of computers dedicated to the task. They're called miners because, just as gold miners increase the supply of gold, they create new bitcoins, at an algorithmically controlled rate. The greater their computing power, the more they generate for themselves. Once a miner's computer has processed a transaction, the alpaca farm gets bitcoins and you get socks. It's complex but fast: The bitcoin network has handled as many as 87 quadrillion calculations per second, 35 times more than the top supercomputer.
Bitcoins have all the advantages of cash—free to use, very hard to trace—as well as its disadvantages. That digital wallet is a file on a hard drive or online, and if it's lost or stolen there's no recourse. The currency is backed only by the faith and credit of its participants and outside the scope of any banker, politician, or the Federal Reserve. To a certain breed of libertarian nerd who grew up on cyberpunk, it's the Digital Rapture.
Bitcoin also resonates with those who have something to hide. "Any anarchist cyberscheme like bitcoin will rapidly attract the Four Horsemen of the Infocalypse: Mafia, drug dealers, terrorists, and child pornography," says author and futurist Bruce Sterling. The hacker group LulzSec, which has claimed credit for breaking into websites at Sony (SNE) and the U.S. Senate, says a donor recently sent in $7,000 worth of bitcoins. On June 5, Senators Charles Schumer (D-N.Y.) and Joe Manchin (D-W.Va.) urged federal law enforcement to shut down Silk Road, an online catalog for drugs, and spotlighted bitcoin's role as the only method of payment for these illegal purchases. Among the legit merchandise you can buy with bitcoin: organic gardening services, a bitcoin merit badge from NerdMeritBadge.com, and a smattering of tech products.
Merit badges and gardening are not the stuff revolutions are made of, but bitcoin's ascent has created a virtuous cycle: As early adopters see the value of their stakes rise, they have an incentive to entice new users and merchants. The number of people on the bitcoin network at any given moment has climbed from tens of thousands to hundreds of thousands since the start of the year, says Andresen. There are dedicated bitcoin currency exchanges, escrow accounts, and smartphone apps. In the planning stages are options exchanges, cash registers, and high-frequency trading programs.
In late March, Mark Suppes, a Web developer (who freelances for Bloomberg LP, parent of this magazine), bought a used ATM on EBay (EBAY) for about $400. In a Brooklyn warehouse, he's reprogramming it to accept bitcoin transfers from a smartphone and dispense U.S. dollars. Suppes is motivated by self-interest—"I own enough bitcoins that I'll be set if this works out," he says—and a desire to stick it to what he considers economic parasites. "If there's one industry that takes the most cream off the top and provides the least value, its finance," he says.
Bankers needn't worry at this point. The most common reason to hold bitcoins is as a speculative investment. "Any given day, it can move 20, 30, 40, even 50 percent," says Adam Cohen, a developer at startup Seatgeek who wrote a critical post about bitcoin on the Q&A site Quora. "That's scary. I wouldn't want to have a lot of my wealth tied up in it right now." Sterling calls bitcoins "a cousin project to WikiLeaks." For a glimpse of its future, he says, "find the half-dozen zealots who were core activists of WikiLeaks and ask them how their plan for massive planetary liberation has been going."
The skeptics are why Andresen evangelizes. After his last haircut, he persuaded his barber to accept payment in bitcoin. "I had to promise I would buy it back from him if it dropped in value," he says. "I insured his downside risk."
The bottom line: Bitcoins, a two-year-old virtual currency, have exploded in value since December as tech-minded speculators snap them up.