The Economist examines India's Economic Performance

 From The Economist

In the second week of 2024 business leaders descended on Gujarat, the home state of Narendra Modi, India’s prime minister. The occasion was the Vibrant Gujarat Global Summit, one of many gabfests at which India has courted global investors. “At a time when the world is surrounded by many uncertainties, India has emerged as a new ray of hope,” boasted Mr Modi at the event.

He is right. Although global growth is expected to slow from 2.6% last year to 2.4% in 2024, India appears to be booming. Its economy grew by 7.6% in the 12 months to the third quarter of 2023, beating nearly every forecast. Most economists expect an annual growth rate of 6% or more for the rest of this decade. Investors are seized by optimism.

The timing is good for Mr Modi. In April some 900m Indians will be eligible to vote in the largest election in world history. A big reason Mr Modi, who has been in office since 2014, is likely to win a third term is that many Indians think him a more competent manager of the world’s fifth-largest economy than they do any other candidate. Are they right?

To assess Mr Modi’s record The Economist has analysed India’s economic performance and the success of his biggest reforms. In many respects the picture is muddy—and not helped by sparse and poorly kept official data. Growth has outpaced that of most emerging economies, but India’s labour market remains weak and private-sector investment has disappointed. But that may be changing. Aided by Mr Modi’s reforms, India may be on the cusp of an investment boom that would pay off for years.

The headline growth figures reveal surprisingly little. India’s gdp per person, after adjusting for purchasing power, has grown at an average pace of 4.3% per year during Mr Modi’s decade in power. That is lower than the 6.2% achieved under Manmohan Singh, his predecessor, who also served for ten years.

image: the economist

But this slowdown was not Mr Modi’s doing: much of it is down to the bad hand he inherited. In the 2010s an infrastructure boom started to go sour. India faced what Arvind Subramanian, later a government adviser, has called a twin balance-sheet crisis, one that struck both banks and infrastructure firms. They were left loaded with bad debt, crimping investment for years afterwards. Mr Modi also took office at a time when global growth had slowed, scarred by the financial crisis of 2007-09. Then came the covid-19 pandemic. The difficult conditions meant average growth among 20 other large lower- and middle-income economies fell from 3.2% during Mr Singh’s time in office to 1.6% during Mr Modi’s. Compared with this group, India has continued to outperform (see chart 1).

Against such a turbulent backdrop, it is better to assess Mr Modi’s record by considering his stated economic objectives: to formalise the economy, improve the ease of doing business and boost manufacturing. On the first two, he has made progress. On the third, his results have so far been poor.

India’s economy has certainly become more formal under Mr Modi, albeit at a high cost. The idea has been to draw activity out of the shadow economy, which is dominated by small and inefficient firms that do not pay tax, and into the formal sphere of large, productive companies.

Mr Modi’s most controversial policy on this front has been demonetisation. In 2016 he banned the use of two large-value banknotes, accounting for 86% of rupees in circulation—surprising many even within his government. The stated aim was to render worthless the ill-gotten gains of the corrupt. But almost all the cash made its way into the banking system, suggesting that crooks had already gone cashless or laundered their money. Instead, the informal economy was crushed. Household investment and credit plunged, and growth was probably hurt. In private, even Mr Modi’s supporters in business do not mince words. “It was a disaster,” says one boss.

Demonetisation may have accelerated India’s digitisation nonetheless. The country’s digital public infrastructure now includes a universal identity scheme, a national payments system and a personal-data management system for things like tax documents. It was conceived by Mr Singh’s government, but much of it has been built under Mr Modi, who has shown the capacity of the Indian state to get big projects done. Most retail payments in cities are now digital, and most welfare transfers seamless, because Mr Modi gave almost all households bank accounts.

Those reforms made it easier for Mr Modi to ameliorate the poverty resulting from India’s disappointing job-creation record. Fearing that stubbornly low employment would stop living standards for the poorest from improving, the government now doles out welfare payments worth some 3% of gdp per year. Hundreds of government programmes send money directly to the bank accounts of the poor.

It is a big improvement on the old system, in which most welfare was distributed physically and, owing to corruption, often failed to reach its intended recipients. The poverty rate (the proportion of people living on less than $2.15 a day), has fallen from 19% in 2015 to 12% in 2021, according to the World Bank.

Digitisation has probably also drawn more economic activity into the formal sector. So has Mr Modi’s other signature economic policy: a national goods and services tax (gst), passed in 2017, which knitted together a patchwork of state levies across the country. The combination of homogenous payments and tax systems has brought India closer to a national single market than ever.

That has made doing business easier—Mr Modi’s second objective. gst has been a “game-changer”, says B. Santhanam, the regional boss of Saint-Gobain, a large French manufacturer with big investments in the southern state of Tamil Nadu. “The prime minister gets it,” adds another seasoned manufacturing executive, referring to the need to cut red tape. The government has also put serious money into physical infrastructure, such as roads and bridges. Public investment surged from around 3.5% of gdp in 2019 to nearly 4.5% in 2022 and 2023.

The results are now materialising. Mr Subramanian recently wrote that, as a share of gdp, in 2023 net revenues from the new tax regime exceeded those of the old system. This happened even as tax rates on many items fell. That more money is coming in despite lower rates suggests that the economy really is formalising.

Yet Mr Modi is not satisfied with merely formalising the economy. His third objective has been to industrialise it. In 2020 the government launched a subsidy scheme worth $26bn (1% of gdp) for products made in India. In 2021 it pledged $10bn for semiconductor companies to build plants domestically. One boss notes that Mr Modi personally takes the trouble to convince executives to invest, often in industries where they face little competition and so otherwise might not.

image: the economist

Some incentives could help new industries find their feet and show foreign bosses that India is open for business. In September Foxconn, Apple’s main supplier, said it would double its investments in India over the coming year. It currently makes some 10% of its iPhones there. Also in 2023 Micron, a chipmaker, began work on a $2.75bn plant in Gujarat that is expected to create some 5,000 jobs directly and 15,000 indirectly.

So far, however, these projects are too small to be economically significant. The value of manufactured exports as a share of gdp has stagnated at 5% over the past decade, and manufacturing’s share of the economy has fallen from about 18% under the previous government to 16%. And industrial policy is expensive. The government will bear 70% of the cost of the Micron plant—meaning it will pay nearly $100,000 per job. Tariffs are ticking up, on average, raising the cost of foreign inputs.

image: the economist

So what matters more: Mr Modi’s failures or his successes? As well as economic growth, it is worth looking at private-sector investment. It has been sluggish during Mr Modi’s time in office (see chart 2). But a boom may be coming. A recent report by Axis Bank, one of India’s largest lenders, argues that the private-investment cycle is likely to turn, thanks to healthy bank and corporate balance-sheets. Announcements of new investment projects by private corporations soared past $200bn in 2023, according to the Centre for Monitoring Indian Economy, a think-tank. That is the highest in a decade, and up 150% in nominal terms since 2019.

Although higher interest rates have sapped foreign direct investment in the past year, firms’ reported intentions to invest in India remain strong, as they seek to “de-risk” their exposure to China. There is some chance, then, that Mr Modi’s reforms will kick growth up a gear. If so, he will have earned his reputation as a successful economic manager.

The consequences of Mr Modi’s policies will take years to be felt in full. Just as an investment boom could vindicate his approach, his strategy of using welfare payments as a substitute for job creation could prove unsustainable. A failure to build local governments’ capacity to provide basic public services, such as education, may hinder growth. Subhash Chandra Garg, a former finance secretary under Mr Modi, worries that the government is too keen on “subsidies” and “freebies”, and that its “commitment to real reforms is no longer that strong.” And yet for all that, many Indians will go to the polls feeling cautiously optimistic about the economic changes that their prime minister has wrought.

The runaway locomotive of Electronic Voting Machines

Tabish Khair in The Hindu

It happened in December 1841 near Reading, England. A Great Western Railway luggage train travelling from London Paddington to Bristol Temple Meads station had just entered Sonning Cutting. Rain had loosened the soil next to the track, which had caused mud to spill on to the track and cover it. This forced the broad gauge locomotive, containing three third-class passenger carriages and some heavy goods wagons, to derail. Eight passengers died on the spot and many were seriously injured. One passenger died later in hospital.

The tragedy set in process a largely unremarked legal change: it led to the abolishment of ‘deodands’. Deodands were penalties imposed on ‘moving objects that caused deaths’. After the Sonning Cutting accident, a deodand of £1,000 (about £100,000 today) was imposed on the train engine. This was, however, never paid (how could it be?), and five years later deodands were abolished.

From our perspective, this marks a significant change: from objects associated and controlled by humans to objects with much more leverage of their own. From a dropped box or a mismanaged horse carriage to a derailed engine. In 1841, deodands existed in a world that had changed. Trains marked not just the increase of pace while travelling, they also enabled a kind of tragedy which was difficult to imagine in an age of horses: now dozens, soon hundreds, of bodies could be mangled in a single accident. Blame for a derailed engine was a different matter than blame for a brick dropped from a window or an overturned carriage.

An opportunity and a danger

I start with this example to highlight the obvious fact that all technological developments come with some advantages and dangers. A society that ignores the former for the latter stays stuck in time, but a society that ignores the latter for the former might well plunge down a precipice.

Electronic voting machines represent such an opportunity — and danger. But because too much capital is invested in selling and replicating these systems, the opportunities and advantages are currently drummed up more than the dangers. Electronic voting machines have been accused of advertent or inadvertent ‘flaws’ in many countries, including India. But governments argue that some malfunctioning is inevitable when we use voting systems in vast lands with great educational disparity.

But let us talk about Denmark. Denmark is an egalitarian country of only six million people, all of whom receive basically the same kind of education until high school, and can choose to go to university free of charge. It has a high literacy rate and its politicians are at least theoretically more accountable than those of India or the U.S. It also has a high voting percentage.

And yet, recently, a small controversy erupted in Denmark. The fact that it is only a small controversy is frightening — because it has to do with the very nature of democracy, and Danes are a proudly democratic people. The largely neo-liberal government of Denmark decided to put the partly electronic voting system of Denmark up for a bid between rival companies. Three companies applied, including the public-owned company that has provided these services in the past. Then the government lowered the maximum bid amount. This forced two of the companies — including the public-owned one — to withdraw. The single company that stayed in the fray could submit a cheaper offer because it already runs similar voting systems in a number of countries — where the system has been accused of malfunction or vulnerability to tinkering.

As this was a private corporation, questions were asked in the Danish Parliament about its ownership. The Parliament was wrongly assured by a minister that it was a Danish company. When the major Danish daily, Politiken, traced the company’s head office to a tax-haven island off South America, the government promised more information.


Who are the owners?

But in the process, a vital factor seems to have been overlooked — not just by members of the Danish government, which is not surprising, but also by many of its critics. It is this: the island on which the company is registered permits companies not to disclose their ownership. In other words, the Danish voting system might be produced by a company whose real owners are invisible. Surely, there is something seriously wrong about the increasing vulnerability of democracies to the digitalised chicanery of invisible or half-visible corporate owners? Surely it is legitimate for citizens to demand to know the real owners of such companies? For instance, would a company controlled by the Russian mafia or the Koch brothers of the U.S., with their history of lobbied interference in democratic matters, be a neutral player and a reliable service provider?

As trains came into being, not only were ineffective laws, like that of deodands, remade or abandoned, new laws were put in place to ensure safety and accountability. Today, with the locomotive of digitalisation rushing at us, we largely lack a concerted effort to protect democracy against its dangers. Electronic voting systems need far greater scrutiny that those who are singing the siren songs of ‘progress and digitalisation’ want us to realise. It is time to plug our ears, and ask some hard questions — in every country of the world.

Has Big Data already captured the world?

George Monbiot in The Guardian


Has a digital coup begun? Is big data being used, in the US and the UK, to create personalised political advertising, to bypass our rational minds and alter the way we vote? The short answer is probably not. Or not yet.

A series of terrifying articles suggests that a company called Cambridge Analytica helped to swing both the US election and the EU referendum by mining data from Facebook and using it to predict people’s personalities, then tailoring advertising to their psychological profiles. These reports, originating with the Swiss publication Das Magazin (published in translation by Vice), were clearly written in good faith, but apparently with insufficient diligence. They relied heavily on claims made by Cambridge Analytica that now appear to have been exaggerated. I found the story convincing, until I read the deconstructions by Martin Robbins on Little Atoms, Kendall Taggart on Buzzfeed and Leonid Bershidsky on Bloomberg.

None of this is to suggest we should not be vigilant. The Cambridge Analytica story gives us a glimpse of a possible dystopian future, especially in the US, where data protection is weak. Online information already lends itself to manipulation and political abuse, and the age of big data has scarcely begun. In combination with advances in cognitive linguistics and neuroscience, this data could become a powerful tool for changing the electoral decisions we make.

Our capacity to resist manipulation is limited. Even the crudest forms of subliminal advertising swerve past our capacity for reason and make critical thinking impossible. The simplest language shifts can trip us up. For example, when Americans were asked whether the federal government was spending too little on “assistance to the poor”, 65% agreed. When they were asked whether it was spending too little on “welfare”, 25% agreed. What hope do we have of resisting carefully targeted digital messaging that uses trigger words to influence our judgment? Those who are charged with protecting the integrity of elections should be urgently developing a new generation of safeguards.

Already big money exercises illegitimate power over political systems, making a mockery of democracy: the battering ram of campaign finance, which gives billionaires and corporations a huge political advantage over ordinary citizens; the dark money network (a web of lobby groups, funded by billionaires, that disguise themselves as thinktanks); astroturf campaigning (employing people to masquerade as grassroots movements); and botswarming (creating fake online accounts to give the impression that large numbers of people support a political position). All these are current threats to political freedom. Election authorities such as the Electoral Commission in the UK have signally failed to control these abuses, or even, in most cases, to acknowledge them.

China shows how much worse this could become. There, according to a recent article in Scientific American, deep-learning algorithms enable the state to develop its “citizen score”. This uses people’s online activities to determine how loyal and compliant they are, and whether they should qualify for jobs, loans or entitlement to travel to other countries. Combine this level of monitoring with nudging technologies – tools designed subtly to change people’s opinions and responses – and you develop a system that tends towards complete control.


Already big money exercises illegitimate power over political systems, making a mockery of democracy

That’s the bad news. But digital technologies could also be a powerful force for positive change. Political systems, particularly in the Anglophone nations, have scarcely changed since the fastest means of delivering information was the horse. They remain remote, centralised and paternalist. The great potential for participation and deeper democratic engagement is almost untapped. Because the rest of us have not been invited to occupy them, it is easy for billionaires to seize and enclose the political cyber-commons.

A recent report by the innovation foundation Nesta argues that there are no quick or cheap digital fixes. But, when they receive sufficient support from governments or political parties, new technologies can improve the quality of democratic decisions. They can use the wisdom of crowds to make politics more transparent, to propose ideas that don’t occur to professional politicians, and to spot flaws and loopholes in government bills.

Among the best uses of online technologies it documents are the LabHacker and eDemocracia programmes in Brazil, which allow people to make proposals to their representatives and work with them to improve bills and policies; Parlement et Citoyens in France, which plays a similar role; vTaiwan, which crowdsources new parliamentary bills; the Better Reykjavík programme, which allows people to suggest and rank ideas for improving the city, and has now been used by more than half the population; and the Pirate party, also in Iceland, whose policies are chosen by its members, in both digital and offline forums. In all these cases, digital technologies are used to improve representative democracy rather than to replace it.  

Participation tends to be deep but narrow. Tech-savvy young men are often over-represented, while most of those who are alienated by offline politics remain, so far, alienated by online politics. But these results could be greatly improved, especially by using blockchain technology (a method of recording data), text-mining with the help of natural language processing (that enables very large numbers of comments and ideas to be synthesised and analysed), and other innovations that could make electronic democracy more meaningful, more feasible and more secure.

Of course, there are hazards here. No political system, offline or online, is immune to hacking; all systems require safeguards that evolve to protect them from being captured by money and undemocratic power. The regulation of politics lags decades behind the tricks, scams and new technologies deployed by people seeking illegitimate power. This is part of the reason for the mass disillusionment with politics: the belief that outcomes are rigged, and the emergence of a virulent anti-politics that finds expression in extremism and demagoguery.

Either we own political technologies, or they will own us. The great potential of big data, big analysis and online forums will be used by us or against us. We must move fast to beat the billionaires.

Unconnected and out of work: the vicious circle of having no internet

Stephen Armstrong and Maruxa Ruiz del Arbol in The Guardian

In a modern-day version of the old casual labour scrum outside the local docks, Nick East scrambles for a free computer screen when the doors of Newcastle’s city centre library open.

The fourth floor computer room of the glass-fronted library is stocked with 40 terminals, plus a handful of iMacs. Even so, it’s almost always packed, with people waiting for a computer to become free for a designated two-hour slot.

“You have to get there very early or all the screens will be gone and you have to hang around,” said the 24-year-old, who has been unemployed for 18 months. “And you can’t afford a city centre coffee [while waiting], so you just walk about the streets.”

East’s need for computer time has nothing to with catching up with friends on social media, online shopping or video downloads. He must apply for 24 jobs a week – with applications taking up to an hour each – on the government’s digital jobcentre looking for work, or lose his benefits. When you don’t own a computer, this is no mean feat – as East has found out.

In an increasingly digital society, large swaths of the population – lacking computers, broadband, email addresses or even phones that function without regular cash top-ups – are discovering harsh consequences to being unconnected. About one fifth of households, have no internet access, according to figures compiled by broadband analysts Point Topic, although government statistics put the figure at 16%. At any one time, there are an estimated 10m pay-as-you-go phones without the credit needed to make calls or pick up voicemail messages.

“The primary reason people don’t have broadband is cost,” said Oliver Johnson, Point Topic’s CEO. “It’s still expensive to buy all the kit you need, let alone the monthly subscription. Ironically, the cheapest rail fares and the cheapest goods are online – meaning poorer people suffer twice over.”

Meanwhile, the government is moving more and more services online. Significantly, universal credit, a benefit which will replace six means-tested allowances and tax credits, will be a digital-only service. Claimants are expected to apply online, manage any subsequent changes online, and contact between the government and the claimant will be made online. 

Jobcentres are installing extra computers to cope with this, according to the Department for Work and Pensions. “We expect jobseekers to do all they reasonably can to find work and many employers are now only advertising their jobs online,” a spokesperson said. “Jobcentres across the UK now provide free Wi-Fi and more than 6,000 job search terminals, with staff providing additional support if needed so benefit claimants can look for and apply for jobs.”

But with the number claiming jobseeker’s allowance currently standing at 791,200, it is clear 6,000 terminals cannot service all those who need to be online between 10 and 35 hours each week. “You can’t just walk in to the jobcentre and use the computers, you have to make an appointment,” said Andrew Young of Newcastle Citizens Advice. “We had one client who was homeless and couldn’t get an appointment to use the computer but the jobcentre insisted he apply online. They told him to use the library – but you need an address to apply for a library card.”

East lost his job as a kitchen porter in a country pub after being late for work one time too many. His ageing motorbike had finally collapsed and he didn’t have the money to replace it; the bus was irregular and dropped him off some way from the pub. When he signed on, the jobcentre told him to apply for a minimum 24 jobs per week on Universal Jobmatch, the government’s digital replacement for the old jobcentre noticeboard.

Universal Jobmatch seems like a smart response to the digital age. It can monitor online activity to make sure people are actively hunting for work. If they don’t meet their targets, they are sanctioned, losing benefits for anything from four weeks to three years. But applying for 24 jobs on the Universal Jobmatch system is, at best, a complex and time-consuming business – and for those without broadband, it’s far worse.

East travels to Newcastle’s city centre library from his flat in Newbiggin-by-the-Sea – a good 30 minutes away, with one bus every half hour, and a return fare costing £3.90. The journey three times a week takes almost £12 from his jobseeker’s allowance, leaving him about £6 per day to pay for food, bills and other essentials.

Each job takes a minimum of half an hour to apply for, up to an hour if there are added questionnaires on skills – requiring 12 to 24 hours per week online. If he reaches the end of his two-hour session with an unfinished application, Universal Jobmatch does not give him the option of saving for later completion, meaning he has to start afresh at the next session.

Four months ago, he failed to hit his target of 24 applications and received an official warning. “There just weren’t the jobs,” he said. “I was down for bar work, factory work and general labouring but there weren’t any jobs.”

A few weeks later, he missed his target again when he did not have enough cash for the bus fare to the library. “They sanctioned me. Four weeks with no money – they took my JSA [jobseeker’s allowance], my housing benefit and council tax benefit. I had nothing.”

In Wigan, Lisa Wright, 47, a former factory worker who has been unemployed for three years after the food processing plant she worked for closed, is doing a mandatory six-month community work programme. Alongside 30 hours of community service each week, she has to put in 10 hours on Universal Jobmatch.

“I can only get to a computer in Wigan library on Thursday evenings, Fridays and Saturday mornings,” she said. “There’s sometimes a queue so you can hang around for up to an hour. That’s the only time I can check my emails, which means if I get sent a reply to a job application on Monday I don’t see it for days. It feels like you’re constantly doing things wrong and struggling just to keep up. I met a kid last week doing 200 hours’ community service for robbing a shop. I’m doing 780 hours’ community service and my only crime is being unemployed.”

She feels under constant pressure from using shared computers. “I like to do an application and then go back to it and perfect it and make sure it’s good - but using a shared computer, someone else is waiting. You’re cutting and pasting things from another application. Before you get your application in, you’re already at a disadvantage.”

One of the most deprived areas in the country is Speke, Liverpool – designed as a postwar garden suburb built around a cluster of factories, but the factories closed in the late 70s and early 80s. “Around 85% of our clients don’t even have email addresses,” said Bob Wilson at Speke Citizens Advice.

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 The volunteer adviser room at the Newcastle Citizens Advice office. Photograph: Mark Pinder/the Guardian

Citizens Advice clients use its phones to appeal against benefits sanctions if they have no phone credit or cannot afford long calls on an 0800 number, which until June this year are free from landlines but not from mobiles.

Rebecca Thompson, 36, was sanctioned for turning up late to a jobcentre interview and then could not afford to top up her phone for two weeks. She had to borrow a neighbour’s phone to make a doctor’s appointment when she was sick, and faced difficulty applying for an emergency loan to tide her over.

“It takes about two hours to apply for a crisis loan from the welfare fund over the phone. It’s a free number, but it’s not free from a mobile and most people on benefits don’t actually have a landline,” she said.

Data on how many pay-as-you-go mobile phone customers regularly run out of credit is elusive. The UK has 36.1 million pre-pay users, according to Ofcom figures, but no company will release exact figures on how many have zero credit at any one time. A source at one mobile phone company suggested this ran at about 30% – “but it’s hard to be sure exactly why they’ve got a zero balance”, he said. So there could be about 10 million people unable to make calls or access their voicemail at any one time. 

And for those who can afford broadband, there’s a final divide: broadband quality. Last June, Ofcom surveyed broadband speeds in 11 UK cities, finding wide variations in speed by region. Residents of Cardiff and Inverness were twice as likely to be on a slower connection as those in London or Birmingham. Superfast broadband was more restricted in city neighbourhoods with lower household incomes. For example, 57.8% of homes and business in the poorest parts of Glasgow had access to superfast broadband, while for most of the cities the figure was 90%.

In December 2014 the government set out its digital inclusion strategy, aiming to reduce the number of people offline. “By 2020, we will have reduced the number of people who lack basic digital skills to around 4.7 million – less than 10% of the adult population,” said the Cabinet Office minister Francis Maude.

Meanwhile, the country is racing towards increasingly digitised election campaigns in which online petitions and Twitter storms can influence government policy. “If 20% of the country can’t take part in this, they can’t be part of the conversation,” warned Mike Harris, CEO of policy and public affairs consultancy 89Up.

For Nick East, the strain of bouncing from home to library to jobcentre is starting to show. He has always been friendly and sociable, with a mop of tousled hair and a cheerful grin, but he’s started to feel miserable every time he climbs the library stairs or walks in to the jobcentre.

“You can see all these gloomy faces – no one wants to be there, I don’t want to be there,” he says quietly. “If I get sanctioned again it’ll be for longer – how do they expect you to pay for stuff? It’s like they’re pushing you to go and commit crime.”

Bitcoin Survival Guide: Everything You Need to Know About the Future of Money

• BY ROBERT MCMILLAN AND CADE METZ
• 11.25.13
• 6:30 AM

Illustration: T.A. Gruneisen/WIRED

The price of a bitcoin topped $900 last week, an enormous surge in value that arrived amidst Congressional hearings where top U.S. financial regulators took a surprisingly rosy view of digital currency. Just 10 months ago, a bitcoin sold for a measly $13.

The spike was big news across the globe, from Washington to Tokyo to China, and it left many asking themselves: “What the hell is a bitcoin?” It’s a good question — not only for those with little understanding of the modern financial system and how it intersects with modern technology, but also for those steeped in the new internet-driven economy that has so quickly remade our world over the last 20 years.

The spike was big news across the globe, from Washington to Tokyo to China, and it left many asking themselves: ‘What the hell is a bitcoin?’

Bitcoin is a digital currency, meaning it’s money controlled and stored entirely by computers spread across the internet, and this money is finding its way to more and more people and businesses around the world. But it’s much more than that, and many people — including the sharpest of internet pioneers as well as seasoned economists — are still struggling to come to terms with its many identities.

With that in mind, we give you this: an idiot’s guide to bitcoin. And there’s no shame in reading. Nowadays, as bitcoin is just beginning to show what it’s capable of, we’re all neophytes.

Bitcoin isn’t just a currency, like dollars or euros or yen. It’s a way of making payments, like PayPal or the Visa credit card network. It lets you hold money, but it also lets you spend it and trade it and move it from place to place, almost as cheaply and easily as you’d send an email.

As the press so often points out, Bitcoin lets you do all this without revealing your identity, a phenomenon that drove its use on The Silk Road, an online marketplace for illegal drugs. But at the same time, it’s a system that operates completely in the public view. All Bitcoin transactions are recorded online for anyone to see, lending a certain transparency to the system, a transparency that can drive a new trust in the economy and subvert the anonymity sought by those on The Silk Road, which the feds shut down last month.

Bitcoin is much more than a money service for illegal operations. It’s a re-imagining of international finance, something that breaks down barriers between countries and frees currency from the control of federal governments. Bitcoin is controlled by open source software that operates according to the laws of mathematics — and by the people who collectively oversee this software. The software runs on thousands of machines across the globe, but it can be changed. It’s just that a majority of those overseeing the software must agree to the change.

In short, Bitcoin is kind of like the internet, but for money.

Birth of the Bitcoin

Click to enlarge. Illustration: T.A. Gruneisen/WIRED

What does that mean, specifically?

About five years ago, using the pseudonym Satoshi Nakamoto, an anonymous computer programmer or group of programmers built the Bitcoin software system and released it onto the internet. This was something that was designed to run across a large network of machines — called bitcoin miners — and anyone on earth could operate one of these machines.

This distributed software seeded the new currency, creating a small number of bitcoins. Basically, bitcoins are just long digital addresses and balances, stored in an online ledger called the “blockchain.” But the system was also designed so that the currency would slowly expand, and so that people would be encouraged to operate bitcoin miners and keep the system itself growing.

When the system creates new bitcoins, you see, it gives them to the miners. Miners keep track of all the bitcoin transactions and add them to the blockchain ledger, and in exchange, they get the privilege of, every so often, awarding themselves a few extra bitcoins. Right now, 25 bitcoins are paid out to the world’s miners about six times per hour, but that rate changes over time.

Why do these bitcoins have value? It’s pretty simple. They’ve evolved into something that a lot of people want — like a dollar or a yen or the cowry shells swapped for goods on the coast of Africa over 3,000 years ago — and they’re in limited supply. Though the system continues to crank out bitcoins, this will stop when it reaches 21 million, which was designed to happen in about the year 2140.

The idea was to create a currency whose value couldn’t be watered down by some central authority, like the Federal Reserve.

When the system quits making new money, the value of each bitcoin will necessarily rise as demand rises — it’s what’s called a deflationary currency — but although the supply of coins will stop expanding, it will be still be relatively easy to spend. Bitcoins can be broken into tiny pieces. Each bitcoin can be divided into one hundred million units, called Satoshis, after the currency’s founder.

The Key to the System

How do you spend bitcoins? Trade them? Keep people from stealing them? Bitcoin is a math-based currency. That means that the rules that govern bitcoin’s accounting are controlled by cryptography. Basically, if you own some bitcoins, you own a private cryptography key that’s associated with an address on the internet that contains a balance in the public ledger. The address and the private key let you make transactions.

The internet address is something everyone can see. Think of it like a really complicated email address for online payments. Something like this: 1DTAXPKS1Sz7a5hL2Skp8bykwGaEL5JyrZ. If someone wants to send you bitcoins, they need your address.

If you own some bitcoins, what you really own is a private cryptography key that’s associated with an address on the internet

If you want to send your bitcoins to someone else, you need your address and their address — but you also need your private cryptography key. This is an even more complicated string that you use to authorize a payment.

Using the math associated with these keys and addresses, the system’s public network of peer-to-peer computers — the bitcoin miners — check every transaction that happens on the network. If the math doesn’t add up, the transaction is rejected.

Crypto systems like this do get cracked, and the software behind Bitcoin could have flaws in it. But at this point, Bitcoin has been tested pretty thoroughly, and it seems to be pretty darned secure.

For the ordinary people who use this network — the people who do the buying and the selling and the transferring — managing addresses and keys can be a bit of a hassle. But there are many different types of programs — called wallets — that keep track of these numbers for you. You can install a wallet on your computer or your mobile phone, or use one that sits on a website.

With these wallets, you can easily send and receive bitcoins via the net. You can, say, buy a pizza on a site that’s set up to take bitcoin payments. You can donate money to a church. You can even pay for plastic surgery. The number of online merchants accepting bitcoins grows with each passing day.

But you can also make transactions here in the real world. That’s what a mobile wallet is good for. The Pink Cow, a restaurant in Tokyo, plugs into the Bitcoin system via a tablet PC sitting beside its cash register. If you want to pay for your dinner in bitcoins, you hold up your phone and scan a QR code — a kind of bar code — that pops up on the tablet.

How to Get a Bitcoin

If all that makes sense and you wanna give it try, the first thing you do is get a wallet. We like blockchain.info, which offers an app that you can download to your phone. Then, once you have a wallet, you need some bitcoins.

In the U.S., the easiest way to buy and sell bitcoins is via a website called Coinbase. For a one percent fee, Coinbase links to your bank account and then acts as a proxy for you, buying and selling bitcoins on an exchange. Coinbase also offers an easy-to-use wallet. You can also make much larger bitcoin purchases on big exchanges like Mt. Gox or Bitstamp, but to trade on these exchanges, you need to first send them cash using costly and time-consuming international wire transfers.

Ironically, the best way to keep bitcoin purchases anonymous is to meet up with someone here in the real world and make a trade.

Yes, you can keep your purchases anonymous — or at least mostly anonymous. If you use a service like Coinbase or Mt. Gox, you’ll have to provide a bank account and identification. But other services, such as LocalBitcoins, let you buy bitcoins without providing personal information. Ironically, the best way to do this is to meet up with someone here in the real world and make the trade in-person.

LocalBitcoins will facilitate such meetups, where one person provides cash and the other then sends bitcoins over the net. Or you can attend a regular Bitcoin meetup in your part the world. Because credit card and bank transactions are reversible and bitcoin transactions are not, you need to be very careful if you’re ever selling bitcoins to an individual. That’s one reason why many sellers like to trade bitcoins for cash.

The old-school way of getting new bitcoins is mining. That means turning your computer into a bitcoin miner, one of those nodes on Bitcoin’s peer-to-peer network. Your machine would run the open source Bitcoin software.

Back in the day, you could do bitcoin mining on your home PC. But as the price of bitcoins has shot up, the mining game has morphed into a bit of a space-race — with professional players, custom-designed hardware, and rapidly expanding processing power.

Today, all of the computers vying for those 25 bitcoins perform 5 quintillion mathematical calculations per second. To put it in perspective, that’s about 150 times as many mathematical operations as the world’s most powerful supercomputer.

And mining can be pretty risky. Companies that build these custom machines typically charge you for the hardware upfront, and every day you wait for delivery is a day when it becomes harder to mine bitcoins. That reduces the amount of money you can earn.

This spring, WIRED tested out a custom-designed system built by a Kansas City, Missouri company called Butterfly Labs. We were lucky enough to receive one of the first 50 units of a $275 machine built by the company.

We hooked it up to a network of mining computers that pool together computing resources and share bitcoin profits. And in six months, it has earned more than 13 bitcoins. That’s more than $10,000 at today’s bitcoin prices. But people who got the machine later than we did (and there were plenty of them) didn’t make quite so much money.

Online Thievery

Once you get your hands on some bitcoins, be careful. If somebody gets access to your Bitcoin wallet or that private key, they can take your money. And in the Bitcoin world, when money is gone, it’s gone for good.

This can be a problem whether you’re running a wallet on your own machine or on a website run by a third party. Recently, hackers busted into a site called inputs.io — which stores bitcoins in digital wallets for people across the globe — and they made off with about $1.2 million in bitcoins.

In the bitcoin world, when money is gone, it’s pretty much gone for good.

So, as their bitcoins start to add up, many pros move their wallets off of their computers. For instance, they’ll save them on a thumb drive that’s not connected to the internet.

Some people will even move their bitcoins into a real physical wallet or onto something else that’s completely separate from the computer world. How is that possible? Basically, they’ll write their private key on a piece of paper. Others will engrave their crypto key on a ring or even on a metal coin.

Sure, you could lose this. But the same goes for a $100 bill.

The good news is that the public nature of the bitcoin ledger may make it theoretically possible to figure out who has stolen your bitcoins. You can always see the address that they were shipped off to, and if you ever link that address to a specific person, then you’ve found your thief.

But don’t count on it. This is an extremely complex process, and researchers are only just beginning to explore the possibilities.

Bitcoin vs. the U.S.A.

Bitcoin is starting to work as a currency, but because of the way it’s built, it also operates as an extremely low-cost money-moving platform. In theory, it could be a threat to PayPal, to Western Union, even to Visa and Mastercard. With Bitcoin, you can move money anywhere in the world without paying the fees.

The process isn’t instant. The miners bundle up those transactions every 10 minutes or so. But today, payment processors like BitPay have stepped in to smooth things out and speed them up.

The feds have stopped short of trying to kill Bitcoin, but they’ve created an atmosphere where anybody who wants to link the U.S. financial system to Bitcoin is going to have to proceed with extreme caution

The trouble is that federal regulators still haven’t quite figured out how to deal with Bitcoin.

The currency is doing OK in China, Japan, parts of Europe, and Canada, but it’s getting its bumpiest ride in the U.S., where authorities are worried about the very features that make Bitcoin so exciting to merchants and entrepreneurs. Here, the feds have stopped short of trying to kill Bitcoin, but they’ve created an atmosphere where anybody who wants to link the U.S. financial system to Bitcoin is going to have to proceed with extreme caution.

Earlier this year, the U.S. Department of Homeland Security closed the U.S. bank accounts belonging to Mt. Gox, which has generally been the world’s largest Bitcoin exchange. Mt. Gox, based in Japan, let U.S. residents trade bitcoins for cash, but it hadn’t registered with the federal government as a money transmitter, and it hadn’t registered in the nearly 50 U.S. states that also require this.

The Homeland Security action against Mt. Gox had an immediate chilling effect in the U.S. Soon, American Bitcoin companies started reporting that their banks were dropping them, but not because they had done anything illegal. The banks simply don’t want the risk.

Now, other Bitcoin companies that have moved fast to operate within the U.S. are facing the possibility of being shut down if they’re not following state and federal guidelines.

Even if the feds were interested in shutting down Bitcoin, they probably couldn’t if they tried, and now, they seem to understand its promise. In testimony on Capitol hill earlier this week, Jennifer Shasky Calvery, the director of the Treasury Department’s Financial Crimes Enforcement Network, said that Bitcoin poses problems, but she also said that it’s a bit like the internet in its earliest days.

“So often, when there is a new type of financial service or a new player in the financial industry, the first reaction by those of us who are concerned about money laundering or terrorist finance is to think about the gaps and the vulnerabilities that it creates in the financial system,” she said. “But it’s also important that we step back and recognize that innovation is a very important part of our economy.”

It is. And Bitcoin richly provides that innovation. It just may take a while for the world to completely catch on.

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Once You Use Bitcoin You Can’t Go ‘Back’ — And That’s Its Fatal Flaw

• BY NICHOLAS WEAVER
• 11.26.13
• 9:27 AM 

Photo: Ariel Zambelich / WIRED

Bitcoin is the world’s most popular digital currency — not just a form of money, but a way of moving money around — and the darling topic du jour of the tech industry right now. [WIRED has its primer on what bitcoin is and how it works here.]

As a security researcher, I admire bitcoin-the-protocol. But I believe bitcoin-the-currency contains a fatal flaw.

As a security researcher, I admire bitcoin-the-protocol. It’s an incredibly clever piece of cryptographic engineering, especially the proof-of-work as a way of maintaining an indelible history and a signature scheme which, when properly used, can limit the damage that might be done by an adversary with a quantum computer. But I believe bitcoin-the-currency contains a fatal flaw, one that ensures that bitcoin won’t ever achieve widespread adoption as a currency.

The flaw? That bitcoin transactions are irreversible. That is, they can never be undone: Once committed, there is no “oops”, no “takeback”, no “control-Z”. Combined with bitcoin’s independence — it is a separate currency with a floating exchange rate — this flaw is arguably lethal to money systems.

Once committed, there is no ‘oops’, ‘takeback’, or ‘control-Z’.

Bitcoin advocates will argue that both its irreversibility and independence are benefits. That they were explicit design decisions to defy control by governments or banks. But to me these features are flaws, because a tenet of modern finance asserts that anything electronic must be reversible. If bitcoin really is the internet applied to money … then it, too, should have a “back” button.

Without an undo/ back button, it’s only possible to prevent fraud. With an undo, it would also be possible to detect and mitigatefraud; to see that something bad happened and then actually do something about it. Credit cards, bank account transfers, and all other electronic transactions involving a bank all have an “undo” button.

Banks rely on the reversibility feature every day to stop fraudulent activities. Bitcoin robbery casesaren’t just rising because of interest in the currency — the most recent is a European bitcoin payment processor losing $1M after a DDoS attack — they’re rising because robbing a bank online involves much less friction than doing so in person.

Nicholas Weaver

Nicholas Weaver is a researcher at the International Computer Science Institute in Berkeley and U.C. San Diego (though this opinion is his own). He focuses on network security as well as network intrusion detection, defenses for DNS resolvers, and tools for detecting ISP-introduced manipulations of a user’s network connection. Weaver received his Ph.D. in Computer Science from U.C. Berkeley.

In the current financial system, the only major irreversible transactions involve withdrawing cash. This is a process that must happen in person and therefore naturally imposes substantial limits; in-person requirements provide attribution, keep an attacker from automating the process, and limit the “attack surface”. For example:

• To steal a million dollars hidden under mattresses, a thief needs to break into thousands of homes.
• To steal a million dollars from a typical business’s bank account, thieves need to transfer it to a network of roughly 100 money mules.
• Each mule must then withdraw less than $10,000 from their account within a short period of time, take the cash to Western Union, and wire the money to the thieves. (This is why those running the mules can claim up to 40-50 percent of the take!)

To steal a million dollars worth of bitcoins stored by a business, however, a thief only needs the private key. Likewise, to steal $1000 worth of bitcoins each from 1000 people, the thief only needs to have his or her bot software running on enough victims with enough bitcoins to automate the process.

This means bitcoins should never be “stored” on an internet-connected device. That includes our computers and our smartphones. (And have you heard the one about the guy who keeps his key on his finger?) Let’s pause for a moment to reflect on that: What sort of online currency requires using offline computers and objects for all storage?

Now, it is theoretically true that stolen coins could be blocked. If a portion of the network blocks stolen bitcoins today, then the same mechanism could block bitcoins that passed through black markets or offshore exchanges (such as BTC-e) that don’t implement anti-money-laundering protections. Yet the bitcoin community strongly resists the idea of blacklists, because it eliminates fungibility — the notion that all bitcoins are identical — which is essential for a currency. If every dollar used in a drug deal couldn’t be used again, would dollars work as currency? Especially if, sometime after acceptance, a dollar becomes void and blacklisted after the fact because of its previous involvement in a crime?

Bitcoins should never be stored on an internet-connected device. But what sort of online currency requires using offline computers for all storage?

Bitcoin advocates insist that the theft problem is solvable. For the sake of argument, let’s assume that some bitcoin-centric hardware company deploys completely secure and free hardware bitcoin wallets for anyone to use. And let’s also assume consumers are happy with such an unregulatable model and don’t care that merchants can now rip them off with near impunity. Immunity from theft is not enough. Irreversibility, combined with volatility, ensures that bitcoin still will never see wide adoption.

Bitcoin’s irreversibility means that a bitcoin exchange can never accept credit cards or wire transfers to quickly provide bitcoins in significant quantities. These agencies must carefully audit customers, wait on any large purchases, and assign blame when attackers breach accounts. Any exchange that does not follow such precautions would be a magnet for fraud, and cease to exist once they start receiving chargebacks.

As a consequence, the only ways to quickly buy bitcoins require cash — again, I’m talking about convenience here which surely should be a feature of internet applied to money. This convenience can happen via a cash drop at a drugstore; a cash deposit into the exchange’s bank account; a face-to-face meetup; or at an actual ATM, complete with cameras and withdrawal limits. (The world’s first bitcoin ATM just went live a month ago in Canada. Incidentally, it takes cash, not ATM cards.)

Blacklists eliminate fungibility, which is essential for a currency.

And almost every bitcoin purchase needs to start with such a consuming, hastle-prone step if the buyer is unwilling to risk the wild swings in value that bitcoin experiences on a day-to-day basis. Since bitcoin has no stable value, the recipient should immediately go the other way. After all, if bitcoin’s volatility is desired by the merchant, they can just buy bitcoins independently. Instead, any sensible merchant receiving them will immediately turn them back into Dollars, Euros, or whatever local currency they need at a cost of roughly 1 percent. Which means the buyer first had to go the other way, turning dollars into bitcoins. Otherwise, the system would be out of balance.

Thus to actually buy something with the “digital currency of the future” — without having to wait, have funds predeposited at an exchange, or risk that one’s bitcoins drop in value — the buyer has to go to the bank, withdraw cash, turn it into bitcoins, and then spend it quickly.

The only way to quickly buy bitcoins requires cash: a consuming, hastle-prone step.

The need to go in person and withdraw cash conservatively costs the buyer 2 percent, as gas stations can charge over 2 percent to accept credit cards (and yet, people regularly use credit over cash). For reference, compare this to Square, which charges 2.75 percent to process credit cards. So even if you canconveniently get bitcoins from your local ATM — though we’re nowhere near there yet — a bitcoin transaction will cost the buyer and seller a combined 3 percent or more.

Even the much-vaunted international transfer use case doesn’t make sense here: A bitcoin transaction may be cheaper than a SWIFT wire transfer, but the cash requirement means it is not necessarily cheaper than Western Union. (To Mexico, it’s $8 plus a currency exchange fee. Europe is far more expensive, but that’s due to a lack of competition rather than something intrinsic.) If Western Union charges nearly double the currency conversion fee of a bitcoin exchange, it still comes out approximately the same since a foreign bitcoin transaction involves two currency exchanges rather than one.

Even at a 10 billion dollar market cap — the peak achieved by Beanie Babies in 1999 — bitcoin is almost irrelevant in financial terms.

Bitcoin therefore only works for merchants who face substantial chargebacks but who can’t say “pay cash”, are selling to bitcoin believers willing to pay the premium price to use bitcoins, or want to conduct business that the credit card system blocks. Yet many of the transactions blocked by the credit card system — namely gambling, drugs, and crypto-extortion — are themselves illegal. In those cases, does it really make sense to use such an innately traceable currency with a permanent record? I think not. (You can bet that redandwhite, the “hitman” Dread Pirate Roberts allegedly hired, is going to be asking himself that question over the coming months.)

This is not to say that bitcoin won’t retain its price. After all, the greater-sucker theory of speculation can ensure a large price for a long period. As long as bitcoin believers can recruit enough new money to balance the newly mined-for-sale coins, the price may sustain itself indefinitely. And, in the greater scheme of things, bitcoin is small: even at a roughly 10 billion dollar market capitalization it is almost irrelevant in financial terms. This is probably roughly the peak market capitalization achieved by Beanie Babies in 1999.

There are indeed important and valuable ideas that exist in bitcoin’s design. But bitcoin itself? Its volatility and built-in irreversibility will doom it to the ash-heap of history.