Bitcoin is like nothing we have known. That makes it a fascinating subject,
but also impossibly difficult to comprehend, no matter what monetary theorists,
Internet entrepreneurs, Wall Street analysts or cryptographers tell us. It’s
called a virtual currency but that’s merely wishful at this stage. Some have
dubbed it “fool’s gold”. Nobel Prize-winning economist Paul Krugman thinks
that, conceptually, the Bitcoin is no different from the gold standard that
countries demolished in the 20th century. Then there are some who are convinced
it’s just another online scam.
If Bitcoin were a real currency in a real country, that country would be a lot bigger than the Vatican’s 500 population, but that’s not saying much. It would be like the currency in, say, Aruba or Tonga, with about 100,000 users. In reality, it’s not even there yet. It’s less like a currency and more like a commodity that could be used to, say, trade several things online but not that much real stuff in the real world. You could think of it as the Internet-era cattle or cowrie shells, the earliest form of “currency” in the earliest forms of barter trade, and maybe dream about its eventual rise one day to the status of a real currency.
“You can earn it, find it, counterfeit it, steal it. Or, if you’re Satoshi Nakamoto, you can invent it. That’s what he did on the evening of January 3, 2009, when he pressed a button on his keyboard and created a new currency called Bitcoin. It was all bit, and no coin. There was no paper, copper, or silver—just thirty-one thousand lines of code and an announcement on the Internet.” – The New Yorker
I use the word “real,” not as the opposite of the term virtual but as something tangible. Perhaps, not in the manner of being able to feel the Bitcoins in one’s pocket, but as in being able to walk out the door and buy some real stuff at real places, or even fling a tip to a hat-holder. Sure, the currency has come some ways since its invention by an anonymous probable hacker four years ago, using a combination of zeroes and ones, the staple of binary codes. Today, one could buy a drink at a Manhattan bar, among other things. But don’t kid yourself about going too far with it, even though talk abounds of Bitcoin ATMs in Cyprus, scene of the latest global financial crisis that stoked Bitcoin’s parabolic rise on trading exchanges.
Many investors—greedy speculators, perhaps—might be close to re-learning the adage that if something is too good to be true, it’s probably not true. Ever since the Cyprus banking crisis erupted mid-March—the small island nation barred withdrawals of its currency and shut down ATMs for days together—the Bitcoin has soared, inviting dreamers, speculators and venture capitalists alike. The Winklevoss twins, famously the founders of the earliest version of Facebook, Netscape founder Marc Andreessen’s venture fund and a hedge fund in Malta, among others, are feeding the Bitcoin frenzy in diverse ways.
“What we want from a monetary system isn’t to make people holding money rich; we want it to facilitate transactions and make the economy as a whole rich. And that’s not at all what is happening in Bitcoin.” – Nobel Prize-winning economist and The New York Times columnist Paul Krugman.
Tyler and Cameron Winklevoss have built up positions that may be among the biggest individual holdings of Bitcoins, having bought plenty when the currency was being traded in single digits against the dollar; the venture firm Andreessen and Horowitz is funding a startup called OpenCoin that wants to build a better Bitcoin; and the hedge fund is doing what hedge funds do best—vigorously speculate.
It’s no surprise the currency is going through one of its wildest swings, evoking instant comparisons with 17th century Holland’s tulip mania or the more recent dotcom bubble starting in the late 20th century. Nearly all of this wild oscillation has followed the crisis in Cyprus, but it is not the first time Bitcoin has suffered noticeable swings. It has experienced fair volatility, some caused by technical outages, in 2011 and earlier. Still, its recent spike is exceptional and the one that has made the world sit up and take note of the alternative currency. It soared to a stratospheric $266 peak before plunging a whopping $160 on a single day on April 10, amid obvious speculation and reports of anomalies on the electronic trading exchanges. It seems the Bitcoin is no longer for the faint-hearted, if ever it was in the past.
“It has been four
years and it has yet to be discredited as a viable alternative to fiat
currency. We could be totally wrong, but we are curious to see this play out a
– Tyler Winklevoss, a co-founder of the earliest version of Facebook and with twin brother Cameron, one of the largest holders of Bitcoins.
The origin of the
Bitcoin is in the best traditions of the Internet, and, perhaps, noble, too. It
was created as an alternative to fiat currencies controlled by governments in
the hope that it would sidestep crises that cripple the global financial system
with unerring regularity. With technology at its core, Bitcoin was designed to
be free, open, seamless, global and disruptive.
Such was the honest dream of its founders, or its followers, that some even fancy it as the “last safe haven” from financial turmoil.
Still, it’s hard not to see in its creator an anarchist. Satoshi Nakamoto is the pseudonymous person or persons who came up with the Bitcoin concept. He is believed to be a British male in his late 30s but that is only of minor consequence. What is significant is his ideology. Nakamoto was clearly inspired by rebellious Internet organisations such as Napster, a music-sharing network brought down for its patent illegality that sought to change the world. He loathed controls, hated the world’s monetary system and dreamed of an utopian currency. Many think he was not a simple programmer but an analytical thinker.
This is because of some pedestrian software code and fairly lofty ideals and systemic rigour found in the Bitcoin system.
“Bitcoin is a
fantasy. The Internet’s currency—a secure, private, decentralized type of money
that makes possible anonymous and virtually costless transactions across
borders—contains the seeds of its own destruction. More than anything else, it
resembles a Ponzi scheme—and the wild claims made on its behalf reveal a great
deal about a libertarian strain of thinking with deep roots in the American
– Eric Posner, professor, University of Chicago Law School,
in the online magazine Slate.
“Yes, [we will not find a solution to political problems in cryptography,] but we can win a major battle in the arms race and gain a new territory of freedom for several years,” Nakamoto purportedly wrote. “Governments are good at cutting off the heads of a centrally controlled network like Napster, but pure P2P networks like Gnutella and Tor seem to be holding their own.”
Over the years, libertarians have reinforced Nakamoto’s ideals, especially the dream of a currency beyond the control of governments, and, by implication, one free of endemic global crises. Many of its followers see the Cyprus crisis as vindication of their ideals, probably leading to the currency’s insane rise.
On more pragmatic terms, followers see Bitcoin as a way of liberation from institutions such as Visa and MasterCard, or even PayPal, the Internet-era money transfer company, that profit from high fees.
economy, on the other hand, can't do anything to stop a collapse once it's in
motion. And the current panic of Bitcoin enthusiasts proves that while people hate
currency manipulation and government intervention in boom times, they're
slightly fonder of it when the sky is falling.”
– The New York Times.
The first Bitcoin,
version 0.1, was “mined”—to use the term that describes creation of the
currency, the equivalent of the traditional minting of coins or printing of
currency notes—on January 11, 2009. The first transaction took place when the
unreal Nakamoto handed over 10 Bitcoins to Hal Finney, a real character with a
real degree from CalTech who belonged to a real Silicon Valley company called
PGP Corporation, the acronym standing for Pretty Good Privacy.
Finney is a self-confessed cypher-punk—a term used to describe people who, innocently perhaps, believe the way to social and political change is through cryptography—who was fascinated by the Bitcoin project.
Finney did not make a notable contribution to the Bitcoin system but unlike sceptical “cryptographers (that) have seen too many grand schemes by clueless noobs,” he was “positive” about it, spreading hope and acceptance, having “long been interested in cryptographic payment schemes”.
Even though an
exciting new alternative currency had been born, Bitcoin faced a peculiar
situation. There was no real way to value the crypto currency, created with
binary code and encrypted with advanced computer technologies.What could be its
worth, relative to everything or every currency we know?
Its creator was virtually unknown. It had no backing, either by government or a private company. It had no controls, meaning nobody except clever manipulators or wily hackers could disturb the currency.
Besides, its supply
was predetermined at birth. By a predetermined algorithm whose rhyme or reason
is unknown, even if it exists, Bitcoins can be “mined” at the rate of 2.5 coins
per minute. It’s not clear how that rate was set because the way computers
“mine” the coins is by solving complex maths problems.
Perhaps, the problems have a similar level of difficulty. But that may not accurately anticipate the future capabilities of computers, a reason why some believe quantum computing—if and when it becomes real—could scuttle the Bitcoin system. Regardless, Bitcoin’s system also caps its supply at 21 million units, a figure likely to be reachedin 2032, from the present 11 million.
The virtual currency was, predictably, first benchmarked against the American
dollar in October 2009 in order to endow some value to it. In its earliest
days, a Bitcoin was considered the equivalent of four American cents, or about
two Indian rupees. It went through several oscillations, reaching a peak of $31
in 2011, and has traded in its earliest days for less than a cent. On January
1, 2013, the virtual currency was valued at $13, which meant that the total
value of all Bitcoins in circulation was still less than $150 million, the cost
of a F-22 fighter aircraft.
In its recent spurt the Bitcoin crossed $1 billion in value, and at its peak of $266, was worth nearly $3 billion, still a mere drop in the global economy worth trillions of dollars.
economics dictates that a currency, to be so considered, must serve three
functions. It must serve as a medium of exchange, as a store of value, and as a
unit of account.
Of the three, Bitcoin best meets the latter standards. It barely meets the first because it is accepted by so few businesses. It meets the standard as far as being a store of value but its volatility will make it hard to accept. Historically, global currencies have witnessed huge swings, or rather, swift and severe declines as Germany after the Second World War. Still, no currency in the world can dive over 50 per cent in a day, as the Bitcoin did on April 10, and win acceptance.
Krugman is convinced that, like gold, any monetary system with a fixed supply has no future. Eric Posner, a law expert at the University of Chicago, calls the Bitcoin a Ponzi scheme—a scam, if you will—in which the later buyers will be left high and dry.
The Bitcoin’s legality remains largely unquestioned. The US doesn’t consider it as legal tender that competes with its currency. Consequently, it simply ignores it while applying conventional financial rules including taxation to any “convertible decentralized virtual currency.” Its rise will surely draw regulators’ attention across the world, especially if Bitcoins attract use by gamblers, drug syndicates, money launderers or other criminals including hackers.
Contrary to the Bitcoin’s ideal of being the world’s only uncontrolled currency, a Bitcoin Foundation with a governing board has already emerged, ostensibly to advance use of the currency but not to regulate it. The foundation pledges to keep the currency non-political, open and independent, but expresses the need for an organised mechanism to “fight noticed barriers to its widespread adoption—botnets that attempt to undermine the network, hackers that threaten wallets, and an undeserved reputation stirred by ignorance and inaccurate reporting.”
Today, the Bitcoin is looking dystopian, rather than the utopian currency it was intended to be. But with the entry of venture capitalists and Wall Street investors, I would expect the currency to live—not die. Or a new better alternative virtual currency, even more than one, could emerge from the rubble of the Bitcoin.