As the dust settles on Bitcoin’s fledgling flurry of rallies and crashes there is mounting speculation about its potential longevity. The Bitcoin economy is now worth more than $US1 billion and has now piqued the interest of financial regulators and industry players alike.
The Commodity Futures Trading Commission (CFTC) in the US is currently investigating whether Bitcoins are being used as the basis for derivatives contracts and thus fall within their regulatory mandate. Earlier this year, a department of the US Treasury concluded that Bitcoin miners, or those that generate digital currency and then sell them for real currency, would fall under the classification of Money Service Businesses (MSB’s) in the US.
The elegance of the Bitcoin system is that it attempts to circumvent such controls but if the motivation is there it wouldn’t be difficult for those at the reigns of US banking licenses to exert pressure on those banks providing real currency liquidity to traders.
Any attempts at regulation or oversight would have a big impact on Bitcoins core principles of being anonymous and untraceable. While it would be difficult to control the sharing or trade of Bitcoins between individuals it seems their focus would be on those that are operating as intermediaries between Bitcoins and real currency.
As far as industry players are concerned, Bitcoin is little more than a fad. The head of MasterCard’s emerging payments division, Jorn Lambert, recently told The Australian Financial Review that the virtual currency was for ‘geeks’ and that the greater public will not latch onto it.
While Lambert’s sentiment attempts to play-down the growth of Bitcoin as a potential competitor in online financial transactions, it also demonstrates that the likes of Mastercard are well aware of the growth of Bitcoin. More pointedly, it shows the conservatism with which MasterCard views the future of online transactions.
Taking Bitcoin mainstream
The beauty and strength of Bitcoin lays in the complexity of its algorithms and its inbuilt, but highly visible, checks and balances. The feverish media attention lavished on Bitcoin has gone a long way to help explain these systems and in the process it has helped garner Bitcoin an ever-growing level of trust, something that is vital in a medium of exchange.
Strong growth in both the valuations (the price spiked to $266 in mid-April) and transaction volumes (averaging around 60,000 per day) point to increasing confidence but also to an adoption of Bitcoin’s unique systems.
These systems can be tricky for the less tech-savvy amongst us; and they are one major obstacle to Bitcoins going mainstream. Similarly abstract are the concepts surrounding the creation of Bitcoins and the fact that individuals are able to “mine” the units.
A digital gold mine
Just like other rare commodities, such as gold, the process requires a large investment in time and effort; which is key to limiting supply. In Bitcoin’s case there is a distributed algorithm which offers valid blocks of coins to those willing to devote immense computing power to sorting through a raft of transaction data, Bitcoins are the reward. The system also dynamically adjusts and increases the effort it takes to find the units; this slows the rate of discovery and constricts supply to a predetermined timeline.
There are currently 10.8 million Bitcoins in the system, and this will cap out at 21 million coins by the year 2140, according to market research firm ConvergEx. Another thing to keep in mind is that despite the heightened interest in Bitcoins, and their rising value, their production rates are slowing.
The vast majority of us, however, won’t have the capacity to go mining and will instead have to rely on our antiquated real-world currencies to buy Bitcoins through a broker. This will most likely involve an international wire transfer as your credit card won’t help you. Bitcoins deride their potential for payments reversals and their pesky trail of fraud.
Once you have some Bitcoins you might want to use them to buy something, in which case you’ll need a wallet. Here the complexity grows further as the wallet is stored on your computer/phone/tablet - far from the cloud. This is a security measure and users must come to terms with their binary cash being stored in this single location. If you lose the device, ie the data, you lose the coins - there’s no central system of registration, if you lost it or its stolen… it’s gone.
While the number of vendors that accept Bitcoins is growing, there is an intrinsic difficulty in setting prices using Bitcoin units. The fluctuations in price mean that most major vendors choose to set prices in $US and then adjust with an exchange rate at the point of purchase.
New money, old money
While this may all sound far more onerous than typing in your credit card number there are some key factors that make Bitcoins different to the money in your bank account.
For one they are immune to inflation and bank defaults. There is no central bank and supply is constrained so as long as people are willing to accept or trade Bitcoins then their value should hold.
The currency was founded as an anti-establishment icon that aimed to circumvent the power of central banks. The process gave rise to a store of value that has low marginal transaction costs, a high level of security and is close to anonymous.
For those buying illicit substances on the Silk Road website this is great. It’s also useful for Cypriots who are at risk of having their deposit accounts skimmed. Bitcoins have the benefits of a store of value like gold, but they are far more liquid. They can be transferred anywhere in the world on P2P networks and there is no risk of a central government inflating away its value.
These factors show the extenuating circumstances that have fueled the popularity and growth of Bitcoins.
The sad truth is that crises like these are not likely to abate in the near future, ensuring a place for an alternative to the status quo of banking and currency. Technology has reached a point where the processes are possible.
However, in a country like Australia where the currency is stable and there are few restrictions to currency exchange, there may be little utility in the Bitcoin system.
The popularity of Bitcoins seems inverse to the faith people have in the traditional banking system.