What's a Bitcoin and why would you want one?

By Woody Leonhard

You might have heard in recent weeks about Bitcoin millionaires — people who raked in vast sums of real money riding this relatively new form of currency.

Bitcoins offer both a fascinating, new approach to money and many potential pitfalls. Here's what you should know about this online phenomenon.

The history of money is fascinating. Ancient humans traded salt for fish, wheat for beer, and camels for wives. Around 9,000 BC, give or take a millennium or three, people started using an intermediary object — something they might not need but could exchange. For example, I'll take one bag of rice for my duck; I'll give you a half-bag of rice for that small clay pot or a whole bag for that big pot.

In Asia, cowry shells (considerably easier to carry than bags of rice, no doubt) were used long ago for bartering. But as trade expanded around the world, more sophisticated forms of "currency" were needed: bronze-cast knives in China, silver bars of set weights in Mesopotamia, gold bars in Egypt.

Around 700 to 500 BC, the first coins appeared — typically, stamped bits of naturally occurring silver/gold metal called electrum. Minted coins followed, their value dictated by the weight and fineness of gold or silver used. Coins from Athens, Persia, and China circulated all over the world.

Around the 11th century, paper money appeared alongside coins in China. In Europe, the first paper money was a sort of IOU used to document loans in gold. The IOUs gradually formalized into official banknotes.

In the 17th century, European governments (and much of the world soon after) moved into the business of issuing paper money, backed by deposits of gold and silver.

Skipping over centuries of hyperinflation, bank runs, and the end of the gold standard, we arrive at the monetary system in use today.

With the exception of cash and trade, every monetary transaction we make today goes through the same basic cycle: you offer to buy something with a credit card or check, a central record-keeping organization verifies whether you have sufficient funds or credit, the purchase is approved, and the transaction is posted to your account.

All forms of electronic money work the same way. You put through a charge using a credit card online, or you receive or send money via PayPal, or you tap your stored-value card or phone to make a payment. As long as you have enough money or credit, you're good. The system works because the currency used remains relatively stable.

Establishing an entirely different kind of money

Bitcoins are currency, but they're unlike anything most of us use today. They're a blend of new technology, old-style bartering, and free-market thinking. Although completely electronic, a Bitcoin's value is set by the open market — not by any government entity.

Like cash, Bitcoin transactions are untraceable. If you want to transfer significant amounts of money through traditional channels, it takes either suitcases of cash or at least one intermediary bank — along with all the required paper trails and fees. Not so with Bitcoins. Using some cryptographic magic and extreme redundancy, the Bitcoin network requires no central bank, no list of Bitcoin holders, nothing that can trace a person to a specific transaction. If that sounds like an ideal setup for money launderers, drug dealers, and/or fugitive prime ministers, you're on the way to understanding the early attraction of Bitcoins.

About four years ago, Bitcoins came to prominence as the preferred currency on the Silk Road website. As reported by the Guardian and other sources, the majority of sales on Silk Road involved drugs. Bitcoins made those transactions untraceable.

Today, Bitcoins are undoubtedly used for less sordid transactions. But their fluctuating value also gives them a commodity- or stock-like aspect. Through 2012, a single Bitcoin's value grew from U.S. $5 to about $13. This year, a Bitcoin cost $266 on April 10 and then fell to $125 the next day, prompting the crash of the largest online Bitcoin exchange, the Japan-based Mt. Gox (site). When the exchange came back online a day later, Bitcoins hit a low of $65. As I write this, a couple of weeks later, the value's almost doubled to $120.

Now that's what I call volatility!

Nobody knows for sure why the Bitcoin market soared, then crashed. One theory places the blame on Cyprus's banking crisis, where thousands of bank accounts received involuntary "haircuts" by a Cypriot government flailing for cash. Panicked depositors ran for alternatives — among them, Bitcoins. Others speculate that organized crime manipulated the market to buy low and sell high. (On April 24, Mt. Gox was also hit by a massive distributed-denial-of-service attack.)

Steve Forbes, no stranger to the subject of money and finance, put it succinctly in his op-ed article, "Bitcoin: Whatever it is, it's not money!" He states that the Bitcoin is too volatile to be "money" in any traditional sense of the term. "It has no fixed value. It trades like a stock or commodity."

To Bitcoin proponents, that's precisely the point. Bitcoins are kind of an anarchist's version of cowry shells — not beholden to any government, bank, political group, or individual trying to corner the market in a specific commodity.

How a distributed-currency system works

As mentioned above, Bitcoins are entirely electronic. At its heart, a Bitcoin is simply a number — like the serial number on a banknote. To use a Bitcoin, you sign in to your Bitcoin wallet, stored either at an online service or in an application on your personal computer or mobile device. The wallet shows your Bitcoin balances; it's also where you get Bitcoin addresses (essentially separate accounts), which you give to other Bitcoin users when transferring the currency. According to the "How does Bitcoin work?" page, the system is somewhat like a distributed email network.

Bitcoins also work somewhat like a typical online bank transfer but with important differences. For instance, there's no bank-like clearinghouse for Bitcoin transactions. Nobody has a list of all account numbers and owners. There is, however, an ongoing list of transfers: which accounts transferred how much to which other accounts. The list is public — it's stored in hundreds of different locations, on hundreds of different computers. (You can see every transaction going by in real time on Clark Moody's site.) Who owns the accounts is, on the other hand, private.

The technical details of Bitcoin transfers — how Bitcoins change ownership and how the system prevents transferring the same Bitcoin twice — involve public-key cryptography and some fancy computing techniques. Unlike a bank, the Bitcoin network doesn't keep track of your Bitcoins — only Bitcoin transactions. Which means you're responsible for protecting your Bitcoin wallet.

When you ask somebody to send money, you have to give them a Bitcoin address — essentially an encrypted public key. The Bitcoin software actually encourages you to generate a new address number for each transaction. If you get money from one person and then send that money to someone else using a different address, it's basically impossible for anyone other than you to know where the money came from or where it went.

There's some time delay on the transactions. Typically, it takes 10 minutes for Bitcoin transfers to take effect. The reasons are complex, but they're associated with preventing double spends — trying to spend the same Bitcoin twice, either intentionally or inadvertently. Since there's no central repository of accounts and balances, the delay is basically the price you pay for having a whole bunch of computers simultaneously verify the transactions.

If you're accustomed to bank wire transfers taking an hour, a day, or even a week to complete, 10 minutes doesn't seem like much of a hardship. And the Bitcoin verification runs 24 hours a day, seven days a week on hundreds of computers, making the system fairly reliable.

Incidentally, the first widely recognized Bitcoin transaction was the purchase of two pizzas. The buyer reportedly paid 10,000 Bitcoins — pricey even at early Bitcoin rates.

Where Bitcoins came from; where they're going

Bitcoins have a fascinating history. The originator of the concept, who went by the handle "Satoshi Nakamoto," has never been identified. I say "went" because Satoshi appeared out of the blue in 2008, published a few papers, never made a public appearance, and stopped answering emails in December 2010. However, the importance of Bitcoins doesn't rest in the person or persons who created it. The creation itself holds the answers to pressing money problems such as making private transactions without resorting to piles of cash.

If you want to keep your Bitcoin transactions private, there are two points of vulnerability to online snoops: when you buy Bitcoins using some other currency, and when you sell your Bitcoins. Once inside the system, you're anonymous. In other words, when you use Bitcoins only to pay for purchases, there's no traceable record. (One person recently sold his house with Bitcoins, another sold a Porsche.)

That obviously presents a problem for law enforcement. Because Bitcoins make investigations more difficult, law-enforcement agencies are leaning hard — sometimes with sanctions, sometimes with legislation — on the Bitcoin clearinghouses to provide information about transactions. Mt. Gox's sign-up page warns that if you try to access your account using the Tor network or public proxy servers (two common means of disguising your location), they might suspend your account and force you to submit anti-money-laundering documents. (A bitcoin.org page, on the other hand, recommends using Tor to hide your PC's IP address.)

Today there are approximately 11 million Bitcoins in circulation. The system is designed to let the number of Bitcoins increase at a very slow rate — by 2140, there should be about 21 million Bitcoins in circulation. If you want to learn more about Bitcoins, take a look at the official Bitcoin FAQ.

Bottom line: If you do become a Bitcoins user, keep in mind that the value of your Bitcoins can change rapidly and unpredictably. Whenever someone asks me whether I'd buy Bitcoins right now, my answer is a resounding "Hell no!" It's an interesting concept — a currency not tied to any country or financial institution — but the recent run-up and decline of Bitcoin pricing give me nosebleeds. Put your savings in Bitcoins, and you might make enough money to retire in the next year. Or you could lose 90 percent of your gamble — er, investment.

What are the best examples of people "cheating the system"?"

I learned this one from a friend's mom: How to get cheap long term parking at an airport by parking in an airport hotel garage... make sure the garage has a maximum fee for lost parking ticket, park your car and take the airport shuttle to and from the airport. Upon returning from your trip pick up your car and pay the lost ticket fee (usually like $20-30 total vs $15 - 20 / day)

Stretching postage dollars

A friend of mine used to have many Pen Pals when we were younger. At some point he started to send letters without a stamp, by writing the intended recipient's address as the sender's address, and his own as the intended recipient. The letters would then be delivered to the real intended recipient because the post office thought the recipient was the sender who forgot to put a stamp.

Arcade Claw Games are Rigged

The claw game (aka “crane games” or “fairground grabbers”) are pretty straight forward in appearance: put in your money, position the crane over a prize, drop the claw and hope your aim was good enough to bring home the prize.

But, winning a prize requires a lot more than skill. These machines are like slot machines, except children are allowed to play. Just like a slot machine, the operator can dial in how often the machine should pay out.
The crane game machine reduces the claw strength when the player is supposed to lose and increases its grip strength when the player is allowed to win. In that sense, they’re worse than slots because the player still requires some skill when the odds are in their favor.
The odds of the machine giving the claw enough strength to win a prize is regulated by some states and therefore varies. In California, the claw must have enough strength to win during an average of 1 in 12 games. In Nevada, it’s 1 in 15 games. In other words, during 1 in 15 games the claw will be strong enough to pickup a prize, but you still have to aim it well.
The following is an excerpt from a crane machine’s operating manual, indicating how two different knobs can be turned to adjust the claw strength in different ways. The full manual is available by clicking here (PDF).

If you really want to win, your best bet is to sit back and watch other people play. Count the wins and losses and put up your money when it’s due to grip again.
Alternatively, much older (less sophisticated) claw machines rely on spring tension and may be easier to beat if they’re calibrated with a decent grip. Also, be sure you aim the claw at the heaviest part of the prize, if the grip is tight this will make it easier for the claw to hang on.

* Foods that you don't realize contain meat

Creative tricks and tips

These creative tricks and tips are great ways to not only make life easier but to also make use of things we normally throw away or use items for more than one purpose.

Consumer Reports: Prepaid Card Fees Starting To Drop But Consumers Still At Risk Because of Poor Disclosure & Weak Consumer Protections

A new Consumer Reports analysis of prepaid cards has found that industry competition is beginning to help bring down fees, but fees aren’t always disclosed up front and can still add up quickly. Moreover, prepaid cards also offer weaker consumer protections than those provided by traditional debit cards.

Prepaid cards are reloadable cards that can be used to make payments similar to debit cards and are becoming the foundation of a second-tier banking system. Prepaid cards look like other plastic payment cards and bear the network logos of Visa, MasterCard or Discover along with the word “debit” on the front of the card. The Federal Reserve has found that prepaid cards are the fastest growing non-cash method of payment. That growth is expected to continue as the prepaid card industry works to attract the business of the estimated 60 million adults with limited or no access to bank accounts.

Consumers Union, the policy and advocacy arm of Consumer Reports, is urging the Consumer Financial Protection Bureau to require prepaid card issuers to improve fee disclosure and abide by the same mandatory protections consumers are guaranteed by law when using debit cards linked to their bank accounts.

“Now that so many households are relying on prepaid cards to manage their finances, it’s time for the Consumer Financial Protection Bureau to take action to protect consumers,” said Michelle Jun, senior attorney for Consumers Union. “We need new rules that require fees to be disclosed in a simple format so consumers know the costs before they purchase a card. Prepaid cards should get the same strong protections as debit cards so consumers have the peace of mind that their money is safe if their card is lost or stolen.”

Consumers can typically only find information about a few of the fees charged by card issuers before they purchase a card at a store. While some prepaid card issuers are providing direct links to fee schedules on their web sites, others make finding this information more difficult. Consumer Reports examined 16 different prepaid cards and found that issuers charged a variety of different fees to consumers:

Fees to Activate Your Card: 9 of the 16 prepaid cards reviewed charged consumers a fee to activate their card. Activation fees ranged from a low of $3 for the Walmart Money Card, nFinanSe card, and the Approved Card to $14.95 for some select RushCards. Some prepaid card issuers like NetSpend and Western Union are no longer charging activation fees.

Monthly Fees: 13 of the 16 prepaid cards charge monthly fees, ranging from $2.95 for the nFinanSe card to $9.95 for the Vision Premier card and the Univision card. Some prepaid cards, like the Bank Freedom card, will waive the monthly fee if the consumer makes a minimum deposit each month. Some cards, like the RushCard, give consumers the option of choosing the monthly fee plan or a per transaction fee plan.

Fees to Get Cash: 14 of the 16 prepaid cards examined charged a fee to withdraw cash from a domestic ATM, ranging from $2 to $2.50. This does not include the additional charge imposed by ATM operators. Consumers using Green Dot and Univision prepaid cards can get free access to Allpoint network ATMs, located in numerous retail locations. Otherwise they pay a fee to use a non-network ATM

Fees to Find Out Your Balance: 12 of the 16 prepaid cards impose a fee for checking balances at ATMs, ranging from 45 cents to $1 per balance inquiry. The ATM operator may charge an additional fee. Many prepaid card issuers provide other methods to check balances for free, such as by email, text message, or phone.

Fees to Get a Paper Statement: A number of prepaid cards no longer provide information about the availability of paper statements in their card agreements. Seven of the prepaid cards charge customers a fee to get a monthly paper statement detailing their transactions. Paper statement fees ranged from $1 for the Rush Card to $5.95 for the NetSpend Visa card. Many of the prepaid cards provide free access to monthly statements online or through email or text alerts.

Fees For Customer Service: Some prepaid cards enable all consumers to speak to a customer service representative for free. Other prepaid cards provide free customer service if the customer sets up direct deposit or only makes a limited number of calls per month. A few prepaid cards charge customers each time they make a call to customer service, ranging 50 cents per call for the NetSpend Visa card to $2.99 per call for the UPSide card.

Fees for Inactivity: 5 of the 16 cards charged fees when cards are not used after a certain period of time. These dormancy fees range from $2.50 per month for the H&R Block Emerald Card (after three months of inactivity) and the Western Union MoneyWise card (after 13 months) to $5.95 per month for the NetSpend Visa card (after 90 days of inactivity).

Prepaid card users can avoid some fees by taking a few steps. First, look online for the card’s fee schedule to find out all the different ways you can be charged. Your costs will vary widely depending on which card you get and how you use it. Make sure you understand those costs before selecting a card. If you decide to get a prepaid card, you may be able to reduce your fees by using direct deposit to load money onto your card. Avoid non-network ATM charges by getting cash back when making purchases and checking your balance online or over the phone.

Prepaid card users could end up losing money if their cards are lost or stolen and used to make fraudulent purchases. That’s because they are not protected by the same regulatory and statutory safeguards that enable debit card users to recover their money. If a debit card user contacts a bank about a lost or stolen card within two business days, liability is limited up to $50 (or up to $500 if the consumer makes the report after two business days). Prepaid card users are not guaranteed these protections since the contract terms could be revised or rescinded at any time.

In addition, prepaid card users may not have the same FDIC guarantee as bank account holders that they’ll be able to recover all of their money in the event of a bank failure. Even if the prepaid card web site displays the familiar FDIC logo, it’s not always clear whether the cardholder will be able to recover the full amount on the card or a portion shared with other prepaid cardholders.

Many prepaid cards are now offering new features to enable consumers to establish credit files or help those with bad credit to rebuild their credit record. But Consumer Reports found that information from prepaid card transactions is not useful to help a consumer build a credit record. Some prepaid cards also offer small lines of credit, which must be repaid within a short period of time. These short term loans are expensive and must be repaid quickly much like a payday loan.