Watching “Inside Job” last night, about the increasingly flamboyant greediness of the structure and process that culminated into the financial meltdown of 2008, I can say now that I finally understand what happened — at least in its broad strokes. I told my son Colin this, and he was delighted.

Actually, I had invited Colin to watch the movie with me, but he begged off. This morning he confessed that the movie would have put him into a furious rage, and he didn’t want to go there. He knows what the movie’s about. He’s been talking about the coming financial tsunami since before 2008, just doing his own internet sleuthing.

I remember the first time he brought the bankster ponzi scheme up. It was at the dinner table, Thanksgiving 2007, when he still lived in Massachusetts (he now lives next door to me) and we were all together with his brother Sean, and Sue and the kids. I took him aside and warned, in no uncertain terms, “do not spoil our holiday.”

A few weeks ago, I put up a post on a new type of peer-to-peer currency, the “bitcoin,” intrigued by its posibilities. Today Colin sent me a link from Rick Falkvinge that shows how this kind of currency works, and draws out the implications for both governments and banks. Fascinating. Here’s the latest article, but read the first two as well.

Why I’m Putting All My Savings Into Bitcoin

These past days, I have done a lot of thinking about bitcoin that ended up with me investing all of the money I had saved and all that I can borrow into the currency. Here’s why.

In two posts now, I have considered the effects of bitcoin on society. A lot of more thinking has been done than has been described in writing, and it has resulted in me putting all my savings into this currency.

Short version of what bitcoin is: it is a currency, but an entirely new kind of currency that can’t be seized or frozen by governments, one which is integrated with its transaction system where transaction fees are optional, and where you can transfer any amount anywhere instantly without any authority knowing or interfering.

I will demonstrate how it is used a bit further down in this article.

Here are the three key reasons I bet on bitcoin:

Past performance: the currency has increased in value one-thousandfold against the US dollar in fourteen months. Yes. Read that again: one-thousandfold, fourteen months. There is currently no indication it would stop or has saturated; quite the opposite.

Use case: the key advantage for bitcoin is that it does away with all bureaucracy, all transaction fees, and perhaps foremost, all transaction delays and gatekeepers in the financial system.

Key uptake drivers: doing the math, I predict that it has at least another thousandfold increase to go in the coming few years, and that’s counting conservatively.

Let’s look at these three considered factors one at a time.

1. Past Performance of Bitcoin

Normal currencies vary by a few percent over the course of a year. Not bitcoin. On March 30 of last year, somebody asked for $50 for 10,000 BTC (bitcoin) in the trading and wasn’t taken up on the offer. He got an offer of $25. Still, somebody claimed in the thread that the going rate was about USD 6,50 per thousand bitcoin. That’s per thousand. So while there are conflicting numbers between $2,50 and $6,50 as the rate for 1,000 BTC, let’s be conservative and go with the higher $6,50 per thousand BTC and compare it to today. As of midnight UTC on May 29, 2011, therate is USD 8,30 per bitcoin.

In the past month, the value has tenfolded.

In the past three months, the value has hundredfolded.

In the past fourteen months, the value has more than thousandfolded.

This can be hard to grasp. If you had changed 2,500 euros into bitcoin last spring, they would be worth more than two point five million euros today.

I challenge you to find one other commodity with this pace of appreciation. And there’s no indication it’s slowing down or saturating. Quite to the contrary: interest is picking up. It was only yesterday that the first article in mainstream media in Sweden was posted. (It sounded a bit like when the Internet was first presented: “thousands of people and shops are turning to a new digital currency…”)

Now, past performance is no guarantee of future performance. But I’ll be returning to that.

2. How Bitcoin Is Used

Bitcoin looks pretty much like any other computer program. It can be installed frombitcoin.org and is available for Windows, Mac, and Linux. If you didn’t know the underlying differences, you might think you were looking at your bank account. But you’re not connected to any bank — you’re connected to the bitcoin network, and what you are looking at is the money you have in a file on your computer, and only on your computer.

As long as you have this file, nobody can seize your money. Or look at your account balance, for that matter. You can make copies of the file. It is very wise to make copies, encrypt the copies, and store encrypted copies in many places. The money is in the file, in the form of cryptographic signatures recognized by the bitcoin network. (Copying the file doesn’t give you twice the money, but losing the cryptographic signatures will make you lose the money.)

So let’s say I want to transfer money to a friend in New Zealand. I hit Send Coinsabove, and enter my friend’s bitcoin address. In this case, I am picking it from the address book. I am choosing to send half a coin, roughly the price of a cup of coffee today.

As I hit Send, which I did right after taking this screenshot, my friend in New Zealand got this coffee money instantly, and it was deducted from my balance.

Sounds easy and straightforward, doesn’t it? It sounds just too easy. So just to illustrate, let’s take a look at all the normal things that didn’t happen:

• Nobody logged on to a bank of any kind.
• No bank page for complicated foreign transactions was loaded into any browser.
• No expensive foreign transfer fees were applied. In fact, no transfer fees were applied at all.
• No banks were holding on to the money for a couple of days. My friend had the money instantly.
• No bank holidays were relevant. I did this on a Sunday.
• No governmental economic blacklist was consulted. He could be a criminal under New Zealand law for all I care, but what matters to me is that he is my friend.
• Nobody got the chance to seize the money before my friend in New Zealand got it. Or afterwards.
• An alternative to a bank transfer would have been to use Visa or MasterCard. They did not get a cut, either.
• No tax authority saw the transaction or the money.

In fact, nobody knows that he got it except me and him. And he doesn’t know who sent it to him; he only sees the address he received it at. He’s probably a bit confused or surprised right now.

It’s not hard to see how this will replace the current financial systems, is it?

Of course, my friend doesn’t have to be in New Zealand. Just like when mobile phones arrived, I don’t have to know where he is, or care, for that matter. He could be on the other side of the planet, right here in Sweden, in Southeast Asia, or on the Space Station in low Earth orbit. It doesn’t matter. All I need is a bitcoin address and a net connection, as does he.

So why don’t you try installing the software? Then go to this page to get two bitcents for free, just to try it out.

3. The Key Uptake Drivers

So why am I so certain that the value will continue to grow? So certain that I bet all of my own money on it?

The supply of bitcoin is limited, and on a timescale of years, it is fairly constant. Nobody will issue more bitcoin to meet demand. This means that as more people exchange national currencies for bitcoin, the value of one bitcoin rises.

Usually, financial analysis is driven by financial analysts. This is something as unusual as a financial analysis from a civil liberties perspective.

To safeguard fundamental civil liberties for the entire population, the best bet is to guarantee the liberties for those who barely deserve it. The bottom of the barrel. But human rights do apply to all humans. If you manage to guarantee rights to the people who are despised, you have also guaranteed it for everybody else.

And in this case, it is just like that — it is the bottom of the barrel who are going to secure civil liberties for the rest of us with regards to our own money.

There is currently about USD 50 million in the bitcoin system, and just over six million coins in circulation, valued at $8 each. Up until now, demand has largely been driven by enthusiasts.

The value of a bitcoin can’t be held constant — if 12 more million dollars is exchanged into bitcoin, the value of a coin will rise to $10. The more people who want to use the system, the more people will need to exchange a portion of national currency for bitcoin, and the more money will go into the system. The more money there is in the system, the more a single bitcoin will be worth.

(UPDATE: As has been pointed out, the above paragraph is a simplification of the mechanics of a market.)

Some people have ridiculed the bitcoin currency because you can’t use it to buy a hot dog on the corner. The legacy banking system is much more suited to everyday tasks due to inertia and the networking effect. In this observation, they are entirely correct, and yet they are but a millimeter in that observation from drawing the conclusion why the uptake and value of bitcoin will skyrocket once people understand just how revolutionary it is:

The secondary uptake wave after enthusiasts is not going to come from those who use legacy banking daily and are comfortable with it. It is going to be people whodon’t want or are not allowed to use the legacy banking system for their everyday transactions.

The total money supply in the world is about 75 trillion US dollars. It varies a bit daily with currency fluctuations, but it’s on that order. Estimates say that between 5% and 30% of this supply is in the black market with illicit work and services. Let’s be conservative and pick 5%; let’s assume cautiously that four trillion US dollars worldwide is in the black market.

Most of this is arguably with local small-scale services — a craftsman who repairs your lawnmower and doesn’t give a receipt, an unlicensed taxi driver — but using the law of uneven distribution, we can assume that about 10% of this underground economy is of the large-volume high-tech variant. You know, the kind of economy that is capable of building undetectable submarines to smuggle narcotics, submarines so advanced that the US Navy isn’t able to detect them.

Let’s assume, again conservatively, that these high-tech operations shift 15% of their monetary transactions into this undetectable and untrackable financial system over the coming years, to try it out. That brings us to 15% out of 10% out of four trillion USD, coming to 60 billion USD that will enter the bitcoin system in cautious estimates.

The use case is undeniably compelling. But 60 billion USD that enters the bitcoin system in the coming years means that the value of a bitcoin will increase another thousandfold: the value of the system in total as of today is about 50 million USD.

At that rate, the money for a cup of coffee I sent above has become enough to buy a nice car instead.

Of course, this number assumes that nobody in Wall Street is greedy enough to want in on the value skyrocketing of bitcoin. In the real world, I am expecting investors to pump in more money into the system just to get their own share of that value increase. The sharks on Wall Street positively jump at the opportunity of seeing a 25% increase in their portfolio; we’re talking about a 100,000% increase here. Therefore, money from Wall Street and other investors will also boost the bitcoin rate at a proportion I’m not prepared to guess.

These two combined are likely to drive the uptake of bitcoin into normal daily commerce in a tertiary wave. Webshops first, then the physical world.

That’s why I’m putting all my savings into bitcoin now. In a best-case scenario, those savings can get three more zeroes after them in three to four years, based on these numbers.

4. Threats

I can bet a good deal of money that banks and credit card companies will lobby to have bitcoin outlawed, using whatever reasons they can dream up, as this technology makes them obsolete. But bitcoin is a peer-to-peer network. We have seen in the past twelve years how easy it is to shut down such networks, and governments stand to make as much a fool of themselves as the record industry did, if they go down that route.

I don’t think the prospect of looking like fools is going to scare many politicians, though. They’re kind of used to doing that. In any case, they’ll succeed about as well as the record industry did, i.e. not at all.

A more serious threat would be if somebody discovered a cryptographic weakness in the bitcoin network that allowed them to forge money. While the network appears resilient to this — the entire network is aware of the entire money supply, so you can’t pretend you have fake money and successfully pass it off — only time will tell if it really is. Until then, it is undeniably a bit of a risk. But it is one I am very prepared to take, given the potential payoff.

(UPDATE: As has been pointed out, an alternate threat is a competing cryptocurrency. But that’s not really a threat to cryptocurrencies as such; it may also strengthen the networking effect as long as there is interoperability.)

5. How To Buy Bitcoin

It’s a bit tricky to buy bitcoin. MasterCard and Visa are not very cooperative and refuse to service merchants who trade in bitcoin. It seems they don’t like it. (We file this fact under “No shit, Sherlock.“) But it can be bought anonymously.

Most people trade on an exchange known as MtGox, at mtgox.com. You can register a trading account anonymously there and buy bitcoin from equally anonymous sellers. But in order to get national currency into your account, you need to make a bank transfer to MtGox. I’ve done it using euro-based transfers. It’s annoying as the banks hold on to the money for a couple of days (bitcoin, anyone?) but the USD do end up in my trading account, and I am notified when this has happened. It works well.

The one annoyance may be that I am not allowed to transfer more than $1,000 worth of bitcoin per day to my computer from the exchange, due to US regulations. So I’ll have to transfer my portfolio in portions to my own computer in 24-hour cycles. But once that is done, they’re under my control. (Some other people may prefer to keep the bitcoin on the exchange. That would be their choice, and has its own set of risks.)

6. Finally, a Plea to the Developers

Bitcoin has appreciated like crazy, and as described, I predict it will continue to do so. There are already eight decimal places in the system. Please make it possible to use milli- and microbitcoins as soon as possible; bitcoin will continue to climb like crazy and may even accelerate. A currency where the smallest unit can buy you a small house is not practical for everyday use.

I would like to be able to use millicoins and microcoins. I know the system can handle it down to 1/100 of a microcoin; please make it possible in the interface as well.

Posted by Rick Falkvinge on May 29, 2011. Rick is the founder of the first Pirate Party and is a political evangelist, traveling around Europe and the world to talk and write about ideas of a sensible information policy. He is also a net activist, building tunnels and tools whenever and wherever. Filed under Headlines, Swarm Economy. You can follow the comments as an RSS feed.

Uranus square Pluto, millions of Davids running around all over the place, hanging out with each other, trading back and forth, ignoring the behemoth Goliath in their midst who, no matter how much he huffs and puffs, can’t even blow them away.