Bitcoin soars: What you need to know about the virtual currency

The value of the cyber currency bitcoin is skyrocketing – even causing its own system to crash on Wednesday – and prompting many investors to ask: What the heck is bitcoin?

It was a question that came up a few times as this writer reached out to some financial experts to find out more about the virtual money being used to pay for everything from pizza to real estate.

Thanks to the European debt crisis, and more recently the banking collapse in Cyprus, bitcoin has gained popularity, rising by more than 150 per cent over the past month and surpassing a market capitalization of US$1 billion.

On Wednesday morning, the largest bitcoin market, Tokyo-based Mt. Gox , went offline for about an hour after the currency spiked by more than 20 per cent to just under US$150 per bitcoin. In a statement, Mt. Gox said that “due to high volume trading,” there was a lag in trading and some orders were cancelled.

While many believe bitcoin is a bubble, driven up by technology geeks and nervous investors, diehard bitcoin users argue the time has come for the alternative currency.

Consider the Canadian man who says he’ll exchange his Alberta home for bitcoins, as well as its growing acceptance at some eateries and retailers around the world.

While there are still many skeptics, the bitcoin boom is empowering computer geeks and, mercifully, giving gold bugs something new to talk about, at least temporarily.

Bitcoin describes itself as a “digital currency, a protocol and a software” that provides transactions between mutual users worldwide. The so-called “crypto-currency” was first described in 1998 and conceptualized in 2009 by a person(s) under the pseudonym Satoshi Nakamoto. The bitcoin story then reads like a mystery movie trailer, highlighting a creator who moved on to other projects but “never revealed his identity and simply left his intention to the world.”

Bitcoins are transferred on a network through a process known as “mining,” which takes care of the transaction records through an online ledger in a matter of seconds.

Unlike traditional currencies, bitcoin is highly decentralized and can’t be seized by local authorities, which helps to explain its reported rise in use right now in places such as Cyprus.

There is also a market limit of about 21 million bitcoins, which helps create the basic economics of supply and demand - also contributing further to the recent surge in value.

Finally, the transactions are free, with the exception of those that use large amounts of data.

The Bitcoin Foundation (yes, it even has its own lobby group) describes bitcoin as “non-political online money” backed by computer code which means, “ultimately – it is only as good as its software design.”

That description proved to be true as bitcoin exchange Mt. Gox recently experienced a “distributed denial of service” or “DDoS” cyber attack. Of course bitcoin isn’t the only financial system that has been the victim of hackers, but it has been a multiple target as a result of its increasing credibility – and of course, the rising price.

Benjamin Reitzes, senior economist with BMO Capital Markets, doesn't see bitcoin going mainstream any time soon since uses for the currency remain selective, and the method hasn't been time tested.

“It’s tough to say that its time has come. It doesn’t have a long enough history and you still have to trust that your money won’t disappear,” says Reitzes. “It’s not that prevalent yet, but I guess, you never know.”