What is bitcoin and how does it work?

SAN FRANCISCO Wed Feb 26, 2014 6:34am IST

Some of Bitcoin enthusiast Mike Caldwell's coins are pictured at his office in this photo illustration in Sandy, Utah, January 31, 2014. REUTERS/Jim Urquhart/Files

Some of Bitcoin enthusiast Mike Caldwell's coins are pictured at his office in this photo illustration in Sandy, Utah, January 31, 2014.

Credit: Reuters/Jim Urquhart/Files

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SAN FRANCISCO (Reuters) - Mt. Gox, once the world's biggest bitcoin exchange, abruptly stopped trading on Tuesday, shaking investor confidence in the digital currency that is struggling for legitimacy.

WHAT IS BITCOIN?

A form of electronic money independent of traditional banking, bitcoins started circulating in 2009 and have become the most prominent of several fledgling digital currencies.

The virtual currency relies on a network of computers that solve complex mathematical problems as part of a process that verifies and permanently records the details of every bitcoin transaction that is made.

Unlike traditional currencies, where a central bank decides how much money to print based on goals like controlling inflation, no central authority governs the supply of bitcoins. Like other commodities and currencies, its value depends on people's confidence in it.

HOW VOLATILE IS IT?

The dollar price of bitcoins quoted on online exchange Bitstamp spiked from around $30 a year ago to more than $1,100 in December as more people became aware of the currency and speculators jumped into the highly volatile market. But growing attention from regulators and concerns that bitcoins could be more susceptible to fraud than previously thought have sparked a steady decline in prices, to around $530 on Tuesday.

Compounding the issue, its price can vary greatly depending on the exchange.

WHERE CAN I USE MY BITCOINS?

Proponents say bitcoins could one day become widely used by consumers for online shopping and other electronic transactions. Certain online retailers such as Overstock.com and physical stores, mostly smaller operations, already accept the digital currency, but its adoption is not widespread.

Critics say bitcoin is too volatile to be widely adopted and warn of its lack of regulation and its use to pay for illegal drugs and other nefarious transactions.

HOW DO YOU STORE, TRADE AND SPEND BITCOINS?

Bitcoins are held in virtual wallets with unique keys. Transactions are made by sending bitcoins from one wallet to a unique key associated with another wallet in a cryptographic process that is verified by computers across the bitcoin network.

Bitcoin wallets can be stored offline or online at exchanges like Bitstamp and BTC-E.

HOW ARE BITCOINS CREATED?

The system was designed to reward computers that do the crucial work of verifying transactions with the occasional payoff of new bitcoins in a process known as bitcoin mining.

The growth in the virtual currency's value has created a market for souped-up computers and chips especially designed for the cryptographic calculations used in bitcoin.

About 12.4 million bitcoins, worth $6.2 billion at recent prices, have been minted since the currency began circulating, according to Blockchain.info.

WHAT HAPPENED TO MT. GOX?

The Tokyo-based bourse halted withdrawals earlier this month after detecting "unusual activity", and on Tuesday it abruptly stopped trading. An unverified document circulating on the Internet purporting to be a crisis plan for Mt. Gox said more than 744,000 bitcoins were "missing due to malleability-related theft."

Mt. Gox began as a website for exchanging trading cards before turning to bitcoin.

WHAT'S THE FUTURE OF BITCOIN?

Bitcoin critics say Mt. Gox's apparent failure proves the unregulated currency is far from ready for widespread use. They also point to hacking attacks at other exchanges.

But proponents say it's early days for virtual currencies and note that newer bitcoin exchanges and other startups aiming to make bitcoin mainstream are supervised by seasoned venture capitalists and financial experts.

Many bitcoin advocates still hold out the hope of creating a digital currency system free of government intervention or control.

(Reporting by Noel Randewich, editing by Ross Colvin)

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