The billion-dollar Bitcoin roller coaster

In December 2012, Tom, a husband and father with a heavy load of student-loan debt, applied for a $30,000 interest-free loan from a credit card company. Over the next month, he used the entire sum to buy up a hoard of the nearly five-year-old virtual currency known as Bitcoin.

The $30,000 amounted to the combined value of Tom's retirement and savings accounts. If Bitcoin failed, he would have to declare bankruptcy or wipe out his nest egg. But after reading news articles, Tom had become fascinated with Bitcoin's potential. Something clicked. He bought as many as he could, as fast as he could.

"This is not a leap of faith. I have done my research. I feel the projects surrounding Bitcoin right now are revolutionary," Tom (not his real name) wrote in an anonymous post on Reddit. "Perhaps I will go to my grave in debt. Perhaps not. That is part of the fun of this little experiment."

Bitcoin, first proposed by an unknown computer programmer in a theoretical 2008 paper as "electronic cash" that could function without banks, has crashed into the mainstream. Investors from both coasts have poured money into PayPal-like businesses that plan to smooth Bitcoin purchases, and its designers have caught the attention of the Justice Department, Treasury Department and Central Intelligence Agency.

Its future likely lies somewhere between the ideals of its promoters and the ridicule of its detractors, tied to evolving government regulation, angry debates in its far-flung network of architects and the interference of hackers exploiting still unknown weaknesses. For investors as well as speculators like Tom, the currency carries very real risks and rewards, but its mechanics and uses remain incompletely understood, even by some of its adopters.

Bitcoin employs complex mathematics, but it might be most easily understood as an innovative way to prove that money has changed hands. Those who use it do so not because its value is based on a scarce metal, like gold, or upheld by an army to enforce its use, but because of its programming. It approaches the libertarian-hued ideal of a "trustless transaction" — a particularly desirable notion in a digital age — that allows two people who don’t know each other to exchange money and goods with no bank and minimal need for third-party guarantees.

Bitcoins exist almost entirely in the electronic world. They are generated by a decentralized network of more than 20,000 computers owned by Bitcoin users — all employing enormous number-crunching power to finish math calculations that yield bitcoins when solved. This process is known as mining, and those who own the computer systems are called miners. Bitcoins are exchanged between anonymous addresses that users can create, if they wish, every time they want to make a transaction. Buyers and sellers using cash and bank transfers to barter bitcoins congregate on large online exchanges, where the value of single bitcoins has been known to fluctuate by hundreds of dollars within a single day of trading.

Companies like Coinbase, among those that Tom used to invest his credit card loan, function as full-service "wallets," selling consumers bitcoins they've bought from exchanges and offering them software to hold them on their computers. Bitcoins can now be used to buy beers in New York City bars and withdraw Canadian dollars from Vancouver ATMs, in addition to a host of small online businesses that have started accepting the currency. But despite a recent surge in public attention, the Bitcoin network remains comparatively small: The total value of all bitcoins is slightly more than $8 billion, while PayPal processed $145 billion in payments in 2012 alone. There are nearly 12 million bitcoins in existence, and there will never be more than 21 million, according to rules designed by Satoshi Nakamoto, the pseudonymous creator of Bitcoin and author of the foundational 2008 paper who has never been identified.

The staying power of Bitcoin has inspired an outpouring of enthusiasm among devoted programmers, venture capitalists and hard-core libertarians alike. Proponents envision wide and beneficial uses, sometimes obscuring the doubts that linger over the currency's faults. Because Bitcoin can survive only as long as a large, dispersed group of people share faith in its stability, such weaknesses — and exploitation by hackers — are a constant threat to the billions of dollars at stake.

In March the network stumbled onto such a flaw: A miner using a new version of the Bitcoin software, developed by a corps of top volunteer programmers, compiled a list of transactions that was too big for the old software. Users split between the old and new paths, threatening to cleave Bitcoin into two currencies. Several groups of the most dedicated miners stayed on the old chain, and the lead programmers asked those using the new software to switch back. The process returned to normal, and users breathed a sigh of relief.

"It isn't actually a democracy. It's whoever controls the most processing power, which is really about how much money you have put into hardware for mining, so it's not exactly democratic, and it could cause problems in the future," says Gareth MacLeod, a founder of the small Canadian company Tinkercoin, which aims to provide a streamlined process for average consumers to buy small amounts of bitcoins.

The crisis was averted when the Bitcoin community worked together, but there is no guarantee that another split would end the same way. Francois Velde, a senior economist at the Federal Reserve Bank of Chicago who wrote a policy briefing on Bitcoin in December, described its programming as a "remarkable conceptual and technical achievement" that may be adopted by banks and governments, but he warned of its intentionally leaderless structure.

"Should Bitcoin become widely accepted, it is unlikely that it will remain free of government intervention, if only because the governance of the Bitcoin code and network is opaque and vulnerable," he wrote.

Among Bitcoin's benefits is its fluidity. It is essentially an online version of cash, and many governments have yet to decide how to regulate the way users exchange bitcoins or convert them into hard currency. People traveling abroad could carry no money and, using a website like LocalBitcoins.com, exchange their bitcoins for cash with local residents or with any number of online buyers willing to send payments through services like PayPal and MoneyPak.

Bitcoin eliminates most transaction fees and allows for nearly infinite self-division, unlike denominated dollars and cents. Micropayments of a few cents per article, long the dream of newspapers hoping to wring revenue from a brutal online ecosystem, could be normalized by Bitcoin. Some farmers in the United States and Argentina, faced with 3 percent transaction fees if they sell produce to consumers using credit cards, are taking payments in bitcoins and converting them to local currency at a lower rate. Expatriates in the United States could send bitcoins home at no cost. (An 80 percent reduction in transaction fees since 1999 saved Mexican immigrants about $12 billion from 2001 to 2010, according to The New York Times.)

Bitcoin's privacy could provide a way around the stigma and risks associated with certain payments. A political dissident in China could receive an anonymous Bitcoin transfer to fund his efforts, and someone visiting a psychiatrist or seeking an abortion could pay in bitcoins to ensure her privacy. After Western Union, PayPal and major credit card companies stopped dealing with WikiLeaks in 2010, the secret-exposing group set up a Bitcoin address that has received over 3,700 bitcoins and shows a balance of 1,111, which amounts to more than $600,000 in today's prices.

"Sure, it may enable terrorists or other abhorrent entities to move their money when a traditional checking account would likely be frozen," Tom, who asked to remain anonymous to protect his accounts, wrote to Al Jazeera. "But perhaps that is a reasonable price society must pay in order to prevent the damage big banks have caused this world and will continue to."

Trumpeting the usefulness of Bitcoin sometimes overshadows uncomfortable facts, such as its susceptibility to hacking and the comparatively limited number of people using bitcoins for legal purposes. In fact, much of the activity on the Bitcoin network may not be what it seems.

Earlier this year, researchers from the University of California at San Diego and George Mason University attempted to establish the identities of as many anonymous Bitcoin users as they could. As they traced the flow of transactions, they discovered that fewer than half the bitcoins in existence were in circulation. And most of the activity, the researchers claimed, was in gambling.

They found that 64 percent of all bitcoins were still sitting in "sink" accounts that had never been touched since the currency's inception. Only 4 million bitcoins were being spent or moved around. The team also found that Satoshi Dice, a massively popular gambling service that returns instantaneous winnings at variable odds based on an algorithm and the amount of the bet, accounted for about 60 percent of the Bitcoin network's daily activity.

They also showed the ease with which anonymous Bitcoin addresses could be exposed. The researchers followed transactions from unknown accounts as they were sent from user to user until they reached one of the major exchanges, like the Japanese-based Mt. Gox, where they would probably be cashed out. These prominent exchanges, which are coming under increased scrutiny and generally adhere to money-laundering laws, almost always require proof of identity. They're also among the only places to reliably convert large amounts of bitcoins into hard currency.

If bitcoins could be seen flowing to a major exchange from a suspicious account believed to belong to an illegal business — or a dissident — authorities could issue a subpoena to see where the money went when it entered the real world.

The ability to unmask Bitcoin users has not deterred thieves, and major services have fallen victim to hackers by committing basic mistakes. Bitfloor, possibly the largest Bitcoin exchange in the United States at the time, shut down in September 2012 after a hacker broke into the owner's computer, found the private code to access his address and stole 24,000 bitcoins. Earlier this month, hackers accessed old email accounts that belonged to the owner of Australia's Inputs.io, a service that provided users with software to manage their Bitcoin addresses, and stole 4,100 bitcoins, or nearly $1.6 million.

Its owner, who explained that he was "not much over" 18 years old, had been storing large amounts of his clients' bitcoins in an account connected to the Internet rather than one that was disconnected and encrypted on his hard drive. "I know this doesn't mean much, but I'm sorry," he wrote in a post on the website after it closed.

Despite Bitcoin's volatility, weaknesses and unanswered questions, people keep buying. On Monday the currency traded above $800, its highest value ever. It has been known to gain or lose half its value in the span of days.

After investing his credit card loan last winter, Tom tracked every dip and jump in the market. Some nights, burdened by the knowledge that much of his family's finances depended on a barely tested currency invented by someone who had never appeared in public, he would lie awake or cry himself to sleep. Once, after a precipitous fall in value, he tried to sell all his holdings at a loss, only to find his online exchange disabled. The next morning, they returned to their previous price.

Tom's family and closest friends, the only people he had told, "smiled and nodded" when they heard of his plan, he told Al Jazeera. Reddit users were harsher: "Your family should sue you, then leave you at the side of the road," one wrote.

By April 10, the price of a bitcoin had jumped from $12.50 to $266, then the currency's highest spike, ballooning the value of Tom's holdings. The value fell 68 percent over the next five days, but Tom sold 150 near the peak. He repaid his credit card loan and quit his job a month later.

Feeling "invincible," he started playing on gambling sites and investing in failed Bitcoin businesses, losing "several hundred" bitcoins. He spent more than $10,000 buying computer processors to mine his own bitcoins, then realized they would never be powerful enough to pay for themselves. When Bitcoin dipped to $76, he sold 100 in a panic.

But now, with the currency climbing again, his remaining holdings, which he would not discuss in detail, likely amount to several hundred thousand dollars.

He told Al Jazeera, "Viewed from the perspective that I had nothing 11 months ago and now I have enough to put one of our kids through college, I am happy with what I have and am taking much less risk at this point."