If you have faith purely in market forces and have been looking for a currency free from political whimsy, regulatory bodies or human error, Bitcoin may be what you’re looking for. The digital crypto-currency now four years old has become increasingly popular since its rapid rise and fall in value this past April. Suddenly cast into the limelight of financial news, becoming the subject of much social media buzz, Bitcoin is now being introduced to more casual investors who find themselves scratching their heads at the mention of the mysterious new commodity unlike any other.
Today, a new adopter will find himself part of a unique community of computer wonks, hackers, illicit materials users, and investors. Though the original intention for the currency was to pay for products and services online, along the same lines of PayPal, it has been highly popular in the trade of illegal materials, such as drugs and guns (in some areas), due to its anonymous nature and lack of regulatory entity. Today you can use Bitcoins to pay for everything from guitars to alpaca-wool socks via specific websites that cater to this growing community.
So what is it about the currency that is making waves across news outlets, and does it deserve your attention or investment? Founded in 2009 by Satoshi Nakamoto – either an individual or a group of hackers – it has become the most well-known virtual currency; however it was far from the first such currency that existed solely on the internet, though it is unique in its method of creation. To understand what makes it stand apart, it might be best to understand what this ‘crypto-currency’ is. The ‘coins’ themselves are really hashes, or long strings of alphanumeric text, generated to validate blocks of transactions. The process of producing these hashes is called mining, commonly explained with a mining analogy where the individual and their computer are the ‘miner’ with more and more effort required for each additional coin. Mining is the only way new Bitcoins can be added to the market, the creation of which yields mining or transaction fees for the miner. The process itself, however, requires a vast amount of dedicated computer power and energy, with a falling yield of hashes over time due to the self-limiting nature of the commodity. It is designed such that every four years the yield will halve, leading to a maximum volume of coins at just fewer than 21 million by 2140.
Online trade has been popular in different forms for years, especially via “gold farming” in massive multiplayer online (MMO) games, such as the hugely popular World of Warcraft and Lineage, amongst others. Players dedicate hours of their lives to the game to sell virtual currency or items for real money online. Another route has been e-gold and Ripple, however these have been legislated against in many countries for reasons of tax or terms of services. The difference with Bitcoin is that it is based upon the value of nothing but itself, and is transacted peer-to-peer completely independent of the regulations of a game, the gold market, or a designated market regulator. Its basis is in mathematical algorithms controlling the production and volume – so that there is no possibility of rapidly generated new Bitcoins flooding the market, and counterfeiting is impossible. These qualities, along with the fact that its existence currently skirts ambiguous legislation about virtual currency in most countries, has drummed up interest and appeal of late.
The regulation of the currency is coming into discussion as the popularity of Bitcoin and other virtual currencies draws the gaze of regulators and politicians. In the United States, there is a new effort to regulate the nation-less crypto-currency by way of a Senate investigative committee and a series of subpoenas filed in New York. Though they made waves in the news, they bore little precedent for actual regulation, and served only to threaten regulation against current users. However, to provide a stamp of endorsement and faith that it is not a fleeting idea, the German Finance Ministry officially recognized the currency as legal tender and a unit of account. This greatly raises the profile of Bitcoins from currency of the black market to official legal tender. In addition, this may be the first step in its path to regulation by a government. Though it is legal tender, you cannot pay taxes in the currency, and there is increased discussion that earnings made in Bitcoins will be taxed in the future – an effort to stamp out untaxed earnings via a parallel economy.
This brings us to the point of contention, is Bitcoin viable, and can the casual investor buy some? Twins Cameron and Tyler Winklevoss, who famously sued Mark Zuckerberg over the creation of Facebook, have come out as big advocates for Bitcoin having bought up about 1% of all existing coins – about 11 million USD worth, in addition to creating a $20 million exchange traded fund for it. There is some speculation that other investment groups are looking into the commodity while also funding numerous Bitcoin related startups. Larger investment funds and ventures have not done so for a variety of reasons. For one, the currency has yet to be considered an investment stable or viable enough for large investment, due to its recent volatility and a lack of complete comprehension of the market by some. Furthermore, Bitcoins are not as liquid as normal currency, deterring investment organizations despite the current market capitalization of over 1.3 billion USD. For these reasons there is not a strong case for a large organization the likes of Goldman Sachs, JP Morgan or Credit Suisse to invest in the market, let alone for smaller investors. However, there has been a slow increase in the number of hedge funds and financial services dedicated to the Bitcoin market, which is anticipated to reduce volatility and uncertainty in the market. Regardless, with more and more people becoming aware about the currency the number of investors and miners has increased with the number of users of Blockchain, a popular virtual wallet for Bitcoin users, jumping by over 175,000 since April of this year.
Despite the growing support, this is not to say that the currency is without critics. People big and small in the world of economics and business have come out against the viability of Bitcoins. Common criticisms are the lack of liquidity, the highly volatile value against fiat currencies, the lack of infrastructure and the lack of regulation – the very reason many proponents are flocking to currency. Noble laureate for Economics Paul Krugman described the currency as superfluous, promoting illegal and anonymous actions and simply pointless. However, his New York Times op-ed reflected some misconceptions about Bitcoins. It is like any other currency – its value fluctuates with demand and supply and, being a currency, its acceptance as a form of payment. With a greater number of websites and individuals accepting Bitcoins, its demand is clearly increasing as is its acceptance, with its supply reflecting a deflationary trend that was overlooked by Krugman. He cites users’ flocking to the currency to escape from the ties of central banks and the mis-management of monetary policy, though there are many entering willing to invest the same way one decides to invest in market commodities. He concludes that we don’t need a new form of money; however we apparently can’t get enough things to invest in if one has examined Wall Street in the past decade.
In the world of Reddit, Twitter, and YouTube, where the internet thrives on more and more free action, where movements such as Occupy and the Arab Spring have arisen, and when government failure and regulatory mismanagement created the largest economic recession since 1929, it is no wonder that there is a growing interest in a currency managed by none and open to all. When frustrated about its value, people need not complain about overregulation or monetary policy but simply the effects of the free market. It has been heralded by online proponents as the future of online consumption and the nail in printed-money’s coffin. Though it is likely not going to replace fiat currency any time soon, and the internet has a plethora of other ways to pay for stuff, Bitcoin itself definitely has a bright future in which investors and casual internet surfers alike should look into.