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Bitcoin Economics: A Primer On A Volatile Currency


NEW YORK (AP) â¿¿ Bitcoin, the virtual currency composed of digital bits, is based on cutting-edge mathematical schemes that guard against counterfeiting. But it's also based on an old idea, now dismissed by mainstream economists, about how a currency should operate â¿¿ an idea that could be setting bitcoins up for an abrupt plunge.

Bitcoin was started in 2009 as a currency free from government controls, an entirely digital means of exchange for a digital age. It's a rapidly growing phenomenon that has taken root as a payment method on some websites for both legal and illegal goods.

Each "coin" has been worth less than $10 for most of the currency's history, but this week the value surged past $200 â¿¿ with the recent bailout crisis in Cyprus seen by many as one of the triggers of the surge. Wednesday saw a "flash crash," as the value dipped close to $100 before recovering.

The meteoric rise in value is also linked to what some economists say is the biggest problem with the currency: that the supply of bitcoins increases only slowly, at a rate that's coded into the system.

That's a contrast to a regular paper currency like the dollar, whose supply is managed by a central bank like the Federal Reserve. The Fed engineers the dollar supply to increase slightly faster than the growth of the economy, which means that the value of the dollar falls slightly every year, in the phenomenon known as inflation.

New bitcoins are "mined" or generated by computers. They get harder to generate all the time, which means the inflow of fresh bitcoins keeps falling. There are about 8 million bitcoins in circulation today, and the maximum that can be generated is 21 million. By 2032, 99 percent of those will have been created.

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