By Daniel Roberts, reporter
FORTUNE -- If you want a chicken pita from Meze Grill in midtown Manhattan today, you can fork over $8.75 or give them about half a Bitcoin. The restaurant began accepting Bitcoin Tuesday and its owner is excited, although a manager on Wednesday said that so far no customer had paid this way.
Bitcoin is an unregulated, peer-to-peer currency that only exists online; it sounds like a concept out of Mario games or The Matrix. It was started in 2009 by a programmer known by the pseudonym Satoshi Nakamoto. And a few weeks ago most people had never even heard of Bitcoins.
But a story from Gawker about the drug website Silk Road, which uses Bitcoin as its payment method, brought the currency into the mainstream. Now Senators Chuck Schumer (D-New York) and Joe Manchin (D-West Virginia) are demanding a crackdown. Last week, they wrote Attorney General Eric Holder a letter that expressed fears about both Silk Road and Bitcoin, pointing out that Silk Road's method of payment is "an untraceable peer-to-peer currency," adding that it's "an online form of money laundering."
Bitcoin isn't really "untraceable," and many of its uses have nothing to do with Silk Road. In simple terms, here's how it works: Using a platform such as Dwolla, users can convert money from a credit card into Bitcoins. From there, they can enter online Bitcoin exchanges like Mt. Gox Bank and trade with others. Mt. Gox functions essentially like a stock exchange floor that allows bartering and setting your own rate, though most people adhere to an average rate (as of writing, the rate was around $19 per BTC). There are no names used, but every transaction is visible at a public page.
Bitcoins, which can be purchased with any currency, have grown steadily in value since they launched in late 2009, when they were worth about 5 cents. Since then, Bitcoins have had volatile ups and downs but never a full crash. Proponents say that the currency is built to resist inflation because the entire supply is capped at 21 million Bitcoins -- there will never be more created, though they can be sub-divided up to eight decimal places.
Who's really making money from this? "The people who have made the most are the early adopters who got in at the beginning and stayed with it," says Bruce Wagner, an IT expert who spotted Bitcoin in 2010 and says he "became obsessed." He created Bitcoinme.com, a "Bitcoin for dummies" site that explains step-by-step how merchants can accept Bitcoin. The site was translated into twelve other languages within a week. "But because of the anonymous nature, no one really knows who they are. There are addresses that have enormous numbers of Bitcoins, you just don't know who owns them. I know a guy in Brazil who bought $20 worth of Bitcoin when it was at half a cent, so you do the math." (That buyer's investment is worth nearly $80,000 now.)
The exchanges are making money too, though just how much is another unknown. Mt. Gox charges 0.65% per trade, while TradeHill, another exchange that just popped up, charges less if users have a referral code for 10% off, which most do, and is good on all trades for life.
Now there are even other Bitcoin-like currencies, such as Namecoins, which are bought with Bitcoins and used to pay for domain name hosting. Some traders believe the biggest potential is in the limitless creation of these e-currencies.
Limited shopping options
At the moment, Bitcoins can't really be used at any mainstream retailers. According to a wiki list of businesses that accept Bitcoin, you can use the currency to buy real goods and services, but we're not exactly talking about Amazon.com (AMZN). The vast majority of these little known sites have names that begin with the word "bit," and many are programming businesses that sell web site design services or domain hosting.
Of course, Meze Grill is an exception -- one of the few brick-and-mortar stores jumping onto the Bitcoin bandwagon early. The owner, Marwan Salem, heard about Bitcoin months ago from Wagner, who was a regular customer. Salem used Wagner's web site to set up Meze Grill's QR code, which they keep on a laminated sheet behind the register. A customer can then pay with BTC via any Bitcoin exchange app (they exist only for Android, the operating system of choice for true techies).
But the value of the Bitcoin could sink the day after a customer pays with it, so the store would have effectively charged too little. If they really wanted to ensure they aren't losing money from sales paid with Bitcoins, they'd have to watch the exchange rate closely and adjust their price every single day. "Yeah, that is the only catch," says Jose Vega, a manager at Meze. "But it is a big catch."
The controversy over Bitcoins intensified this week, when a trader posted on a forum that he had been robbed of around $500,000 worth of the currency. It happened because a prime way to store Bitcoins is in a "wallet" file that sits on a computer's desktop and, like a real wallet, can be stolen if left unprotected.
Who are these Bitcoin owners? "I don't think there is a prototypical Bitcoin user," says John Robb, a Boston-based entrepreneur who was a Forrester tech analyst in the early days of the Internet, and has watched Bitcoins closely since their inception. "There are a bunch of Libertarians in there, or people who like gold. A lot of people are just doing it for the fun."
The regulatory question
While many praise the lack of regulation of Bitcoins, there are possibly as many traders who want it regulated, and see potential for it as a legitimate global currency. "It could get much more mainstream with the creation of more exchanges, like Mt. Gox or TradeHill," says Mark Oates, a computer programmer in Oklahoma. "If you were a merchant and you wanted to begin accepting it, you'd be taking a risk. It's like when credit cards first came out."
Oates, 30, read about Bitcoins on a tech forum and asked his parents to invest with him two weeks ago. He converted about $2,000 and is letting it sit. He likes that the currency can't be forged, that each Bitcoin has a public transaction chain, and that "it encourages saving instead of spending."
Robb points out that it shouldn't matter whether BTC goes mainstream or not; it's already a success and, he claims, maybe even a safeguard against a collapse of the dollar. "The thought that it has to be globally accepted is an old way of thinking," he says. "If you don't get it, your loss. The same thing happened when the Internet took off. Some businesses moved quickly into it and made money, and some didn't, and they got hammered."
If the government finds this entire system alarming enough -- and Schumer's letter is likely just the beginning -- it will simply shut Bitcoin down, although any legislation doing so would certainly take a couple of years. Bitcoin traders insist that the government wouldn't be able to shut it down for a number of reasons, including that it has no centralized location the way Napster did (which was shuttered in 2001, two years after its creation) and that even if the U.S. cracked down, it would still exist in other countries.
"If the USA wants to shut it down," Wagner reasons, "the Internet has a way of detecting censorship and rallying around it. They could block Bitcoin transactions, but it would be censorship."
But in fact, because users all have identifying web IDs, the government could rather easily identify users today, make it illegal to operate a Bitcoin node, and drive users away with the same scare tactics that the content industry uses on illegal downloaders. And censorship protests or not, there isn't much American traders could do.
The reality is that a currency that has no regulator, trades on an open exchange, and can be easily stolen is one that won't sit well with lawmakers. So whether Bitcoins are a risky investment or not, expect Uncle Sam to keep the average American consumer from ever getting to make that choice.
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