Bitcoin has had a wild ride these past few months. The stateless digital currency’s price has soared to new heights only to plunge back down to earth at less than half its previous value. As the price of gold takes a nose dive of its own, some serious economists have risen to Bitcoin’s defense as true believers urge traders to hang on. Others argue the electronic money scheme is either a dangerous fad, a form of Dadaist art, or more simply, not money at all. But even as the debate rages on, one thing that's fostering hope for Bitcoin as a stable store of value is the fact that, unlike a gold bar or a dollar bill, new code and alternative currencies being built alongside Bitcoin might help change it for the better.
Since Bitcoin is open source, many of these solutions potentially lie within its own thriving developer community. Take for example Bitcoin’s most advertised feature, its supposed anonymity. Everyone from the mainstream media to Wikileaks to the now-disbanded hacker collective LulzSec has trumpeted Bitcoin as "anonymous." But the truth is that researchers have long since proven it's anything but — since every bitcoin transaction appears on a public ledger distributed to everyone in the network (called the "block chain"), tracking bitcoins back to individuals is often trivial.
Zerocoin promises true anonymity by giving Bitcoin its own built-in money laundering system
One team of researchers is saying they might be able to fix that. Developed by cryptographers at Johns Hopkins University, Zerocoin is being proposed as a kind of "plugin" for Bitcoin clients that promises true anonymity by essentially giving the Bitcoin network its own built-in money laundering system. Bitcoin laundries normally work by taking your coins and mixing them up with other peoples’ in a big pool. But being as how they're controlled by third parties, using a laundry means trusting your bitcoins with often-shady intermediaries like Silk Road, the notorious darknet bazaar where you can find everything from black tar heroin to contract killers.
That's not true with Zerocoin, since the laundry would be built into the Bitcoin network itself by standardizing code across client software. If adopted, the new functionality would allow you to add a transaction to Bitcoin's block chain that turns a bitcoin into a zerocoin — a “flipped” bitcoin, if you will. Then, when you redeem (“spend”) your zerocoins, your client scans the block chain and returns a totally different set of coins, making it impossible to determine who they really came from.
Transactions on a normal Bitcoin block chain (top) and one using Zerocoin (below).
The special sauce is a zero-knowledge proof, a statement used to verify a piece of secret information without giving away the secret in the process. This makes it so that if someone looks at the block chain, they’ll be able to see that you minted a zerocoin at some point, but there will be no way to tell which one you're redeeming.
It's a promising solution that tackles a crucial missing piece in the narrative of bitcoins as "crypto-anarchist cash." But still unaddressed is the even bigger problem of liquidity — the fact that buying and trading bitcoins in the first place is still such a huge pain. It’s for this reason that some economists believe the future of Bitcoin is not an upgrade to the currency itself, but a new generation of digital currencies that take the best of Bitcoin while avoiding its weaknesses.
To that end, consider Ripple, another digital money scheme with its own transaction network and a shared public ledger very similar to Bitcoin's. Although Ripple uses its own currency (known as Ripples or XRP), the people behind it — including Jed McCaleb, creator of the P2P software eDonkey2000 and Bitcoin exchange Mt. Gox — are nonetheless directly appealing to Bitcoin users.
It's easy to see why. If you want to buy bitcoins right now you have a few options, and none of them are great. The easiest and (usually) safest method is using an exchange like Mt. Gox. But those trades can take time (the transaction must first be verified by number-crunching bitcoin miners) and of course forces you to trust in the reliability of a centralized third party. That trust has been repeatedly shaken within the Bitcoin community following massive heists, DDoS attacks, and recurring downtime due to network overload — not to mention the recent closure of the fourth-largest bitcoin exchange, Bitfloor.
Ripple promises to be quickly and easily swapped for any other currency
Where Ripple starts to sound interesting for Bitcoiners is its promise to be quickly and easily swapped for any currency — bitcoins, euros, rupees, whatever — with virtually no fees and without the need for these big centralized exchanges. There’s no mining, so ripples exist in a fixed amount, and a tiny fraction is destroyed in each transaction to prevent people from spamming the system (which should be no problem assuming the ripple's value appreciates). Ripple’s built-in exchange system uses “gateways,” conversion portals which can be run by any individual or company connected to the Ripple network. The big difference here, Ripple’s creators say, is that the liquidity is “pooled” — if one gateway gets taken out by a DDoS attack, you can simply use another.
“Trading can continue without interruption because it does not rely on a particular Gateway,” explains McCaleb. He also points out that unlike bitcoin exchanges like Mt. Gox, the system is designed so that gateways can’t freeze accounts or seize funds, “meaning it takes less trust to use a Gateway versus an Exchange.”
But what’s more interesting is that the Ripple system also supports the opposite of Bitcoin’s “trustless” anonymous exchange: a form of trust-based P2P lending (pioneered by its original designer, Ryan Fugger) that lets you rely on the trustworthiness of people in your social network rather than a gateway or exchange.
It works a lot like Facebook’s “friends-of-friends” mechanic: if I wanted to exchange USD for BTC, I’d find someone I trust in my social network who knows someone else that’s selling bitcoins. A line of credit would be created, using the credit limit and terms that my acquaintance assigned to the person I’m buying from. In other words, everyone becomes their own bank, issuing IOUs based on personal reputation.
IEEE Spectrum's Morgan Peck explains:
When you join the Ripple network, you designate primary contacts and establish levels of trust by choosing the amount of credit you are willing to offer each individual. I might feel okay lending up to $1000 to a few close friends whom I know will have a deep obligation to pay me back, while making only $50 available to the man I talk to every morning at the deli. But with Ripple, the credit isn’t only available to my acquaintances. It becomes available to anyone else who knows the people in my network.
Let’s say, for example, that I want to sell a Web application to Bob, who knows my close friend Alice (credit limit $1000). Ripple allows Bob to trade with me using his credit limit with Alice. If she trusts him for $100, that becomes his credit limit with me. I would send Bob the merchandise in exchange for his promise to pay. But instead of owing me, Bob would actually owe Alice, who would in turn owe me. Once Bob satisfied his debt, the Ripple network would destroy the entire chain of IOUs.
It’s hard to tell how most of this will actually play out in practice. Ripple is just getting started, and the company behind it, OpenCoin, claims it will be “distributing” 100 billion ripples among everyone who starts an account. That’s led to some ambivalence and suspicion within the Bitcoin community — not to mention the fact that OpenCoin is a for-profit company, having just finished a major round of angel funding that brought in VCs like Lightspeed Ventures and Andreeson Horowitz. Still, Ripple and Zerocoin both stand to potentially improve things for Bitcoin in their own way. Of course that all depends on their widespread adoption — something that, in a community of traders founded on mutual distrust, is always a hard sell.