The dazzling rise and fall of the virtual currency Bitcoin

Proponents call it a new currency for the virtual world. Critics call it a fantasy or, worse, a Ponzi scheme.

For Tyler Winklevoss and his twin brother Cameron, whose legal feud with Mark Zuckerberg over the origins of Facebook was depicted in The Social Network, it could be the next big digital thing – and they’ve dug deep into their pockets to back it, with an investment worth $11m as of Thursday morning.

One thing, though, is for certain: Bitcoin, the virtual currency launched by an anonymous hacker more than four years ago, has rarely attracted as much attention outside the technology world as it did over the past week, when its value gyrated wildly, striking a new peak before slumping precipitously. At one point, a Bitcoin was worth nearly $270. But at the time of writing, it equated to just over $73, according to MtGox, an exchange.

The sudden ups and downs sparked various theories, including the possibility that some investors spooked by the crisis in Cyprus had abandoned not just the country but the whole idea of conventional currencies for a virtual alternative, prompting the spike. The fall, then, might have been down to speculators cashing out as new investors logged on from Nicosia. The limited size of the Bitcoin market might explain the wild swings, as small trades in such markets often prompt big movements.

While the debate over this week’s swings continues among the currency’s supporters and detractors, for the rest of us, it was the first time we heard of Bitcoins. The virtual tender is the brainchild of a hacker using the online pseudonym Satoshi Nakamoto. He first mooted the idea in 2008, before Bitcoins began trading in early 2009.

Unlike dollars or pounds, say, Bitcoins are not issued by any government, nor is the flow of the currency managed by any central bank. They are also finite, in contrast to conventional currencies, which are theoretically limitless. And they don’t come in the form of notes or, despite the name, coins. Instead, the way to get your hands on Bitcoins is by acquiring a virtual wallet, a piece of software that allows you to store and trade in the currency. Wallets can be installed on computers and mobiles – or acquired via websites that specialise in the service.

That’s step one, and it gives you access to the Bitcoin network, which underpins the system. With no central authority, the network acts as a backbone for the currency, with the system working much like a peer-to-peer file sharing service, where users trade music and videos with each other.

The way to get new coins is to either buy them off someone else, or “mine” them by putting your computer to work at cracking a code that, once resolved, releases a preset number of Bitcoins into your virtual wallet. The amounts are automatically adjusted, ensuring that the network isn’t flooded with new currency. And the total inventory of Bitcoins is currently programmed to top out at 21 million by 2040 (currently, there are around 11 million Bitcoins in circulation, with a total value of around $1bn).

Who uses this virtual cash? Nobody knows for certain because the system is set up to ensure anonymity. We know about the people who’ve publicly disclosed their interest – like the Winklevii – but that’s about it.

There are few ways to spend Bitcoins. One is Silk Road, an online marketplace that, allegedly, is a virtual bazaar for drugs. The anonymity within the Bitcoin network, meanwhile, makes it hard to trace stolen currency. Then there are the question marks over the recent volatility. If Bitcoin is a real currency, the wild, unexplained swings certainly don’t bode well for users. Is this anything more than a bubble? To this, the Bitcoin Foundation, a body set up to maintain standards across the Bitcoin community, says not. Instead, the virtual money is “still finding its equilibrium,” Jon Matonis, a director of the foundation, told The Independent.

The Winklevii are also unfazed – for now. “It has been four years, and it has yet to be discredited as a viable alternative to fiat currency,” Tyle Winklevoss told the New York Times. “We could be totally wrong, but we are curious to see this play out a lot more.”

In numbers

$270 The peak worth of a Bitcoin during its rise over the last week

$73 What one Bitcoin was worth last night

11m Number of Bitcoins currently in circulation

Q&A: How do I get virtual hands on them?

Q. What is a Bitcoin?

A. You will never be able to put one in your purse or wallet, but Bitcoins are a form of currency which some hope could become a virtual equivalent of the pound or the dollar. A principal difference is that they do not exist as real coins, nor indeed banknotes, but merely as millions of unique online registration numbers which each represent one Bitcoin. Another is that they are not issued by a national government and they circumvent traditional banks.

Q. So who is responsible?

A. The project was started by Satoshi Nakamoto - at least that is his online pseudonym. There is much mystery over who he is. Now, the currency is promoted by the Bitcoin Foundation, which says it “standardises, protects and promotes the use of Bitcoin cryptographic money for the benefit of users worldwide”.

Q. Why would I want one of these things?

A. They can be exchanged for real goods – though there are very few conventional retailers, even online, that currently accept them – and their value in exchange for traditional money has spiked greatly recently. People who use Bitcoins are attracted by the fact it is outside government control and transfers of the online money are far harder to track or trace than normal currency. But that has led to accusations that they are perfect for criminals and drug dealers.

Q. So how can I get my virtual hands on some Bitcoins?

A. You can buy some in an online exchange, or you can “mint” your own. Essentially, the large numbers that make every Bitcoin unique are still being created, so if you can add to the vast computing effort required to create these numbers, you can claim part of their value.

Q. Are there any risks?

A. Plenty. There have been several large thefts of Bitcoins, and unlike traditional currency they are not protected by insurance. Being pretty much impossible to trace, the police cannot help track down the hackers either. Without being backed by years of trust or tradition or hard assets like standard currencies they also look potentially extremely vulnerable to investors losing confidence, which could leave the things worthless.

Q. Are there other online currencies to rival the Bitcoin?

A. There are several, Litecoin and Peer to Peer Coin among them. Even if online currencies become more accepted and reliable, it is yet to be seen if Bitcoin becomes the world’s virtual money of choice.

Rob Hastings