Virtual economy looms as digital cash grows up

Virtual economy looms as digital cash grows up
Virtual economy looms as digital cash grows up

IF THE price of gold halved overnight while the cost of mining equipment ballooned, the global economy would be plunged into chaos. This scenario is about to play out in the online peer-to-peer currency Bitcoin, but rather than disrupting the digital money supply, it could be what Bitcoin needs to be taken seriously.

Bitcoin is maturing rapidly. Last week blog host WordPress.com announced it will now accept Bitcoins, adding blog themes to the list of things you can use the currency to buy online, which already includes T-shirts, jewellery and illegal drugs.

Bitcoin has no central bank or authority. Instead users running the Bitcoin software form a decentralised network that processes transactions. At the same time, their computers attempt to be the first to calculate the results of a difficult and regularly changing puzzle and so receive a small amount of Bitcoins as a reward (see “How to be a Bitcoin miner”). These can then be spent or converted into cash. The process is called mining because of its similarity to striking gold.

The mining reward was initially set at 50 Bitcoins by the currency’s mysterious creator, the pseudonymous Satoshi Nakamoto, but to prevent inflation it is designed to halve every four years until the total number of Bitcoins is fixed at just under 21 million, double the current number in circulation. It is impossible to predict exactly when this “halving day” will take place as it depends on the computing power of the Bitcoin network, although it is thought that the first is due on 29 November.

No one is sure what the effect of halving will be, but with 1 Bitcoin currently valued at around $11, miners look set to take a significant hit to their profits unless the exchange rate adjusts.

“Seeing what happens to the price of Bitcoin will be interesting,” says Gavin Andresen, lead developer of the Bitcoin software. “Everybody knows when it’s going to happen, so if we assume everybody is purely rational, economic models tell you that nothing will happen because everybody will have already anticipated that change.”

Another looming shake-up complicates matters, however. Calculating the Bitcoin algorithm is like entering a lottery and the more powerful your computer, the more tickets you get. Early adopters simply used the central processing unit of an ordinary desktop computer, but mid-2010 saw a shift to using more powerful graphical processing units (GPU). The Bitcoin algorithm is designed to adjust to changes in the computing power of the Bitcoin network by altering its difficulty every two weeks, equivalent to changing the odds of the lottery, which keeps the supply of new coins roughly stable.

But these GPUs will soon be outclassed by application-specific integrated circuits (ASICs). As the name suggests, this is hardware designed to do just one thing: compute the Bitcoin mining algorithm. “They are the endpoint of Bitcoin mining,” says Josh Zerlan of Butterfly Labs in KansasCity,

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