The ‘virtual currency’ Bitcoin, has been receiving a raft of publicity in the last few weeks, being hailed variously as the future of money, or a glorified Ponzi scheme. The currency exists outside of any regulation, and outside of any government or, indeed, any owner at all, being based on a peer-to-peer model that is independent of everyone, and everything; something which has distinct advantages, and also disadvantages.
To address some fundamentals: Bitcoin is a virtual analogy of gold. Bitcoins are earned, or ‘mined’, by effectively solving highly complicated mathematical problems, which require huge computing power. Once earned, they can then be traded. Like gold, there are a finite number of coins which can be earned (21m to be precise) and, like gold, they become harder and harder to locate as time progresses. Thus, unlike traditional currency, they can never be subject to devaluation by governments printing more of them. Bitcoins have received attention due to their increasing popularity, especially in the wake of the attempt in Cyprus to skim a percentage of everyone’s bank savings; Bitcoins are, for the time being, seen as possibly safer and not subject to government interference. Thus, their value has rocketed, with the price of a Bitcoin rising to $138 in the last few days, up from $30 a month ago.
That price rise indicates one of the current problems of the system – it is clearly experiencing a bubble, which cannot last indefinitely. However, over the longer term, it is highly probable that it will settle down to form a stable pseudo-currency. It is frictionless, highly fungible and can be used across the world with any currency – these are attractive qualities for many businesses. Unfortunately, because of its lack of supervision, it is theoretically liable to cybertheft; but then, with the system four years old, it has proved remarkably resilient considering the vast majority of hackers have attempted to ‘crack’ it. In addition, the accusations of it being a Ponzi scheme are perhaps false: while it is true that early adopters will benefit as the price rises and if they get out early, it is not built into the system that later ones will lose everything – they may lose some value when a crash comes, but then so will everyone who doesn’t time their exit perfectly.
The great problem it has is a long-term one. As mining bitcoins becomes more difficult, it is likely to lead to increased problems with destructive computer hacking; as miners harness hacked computers to do their work. More fundamentally than that, though, because there is a limited supply of the coins (as opposed to normal currencies which governments can print) the system encourages deflation. This means that consumers are incentivised to hold on to their bitcoins, rather than spend them, in the expectation that their purchasing power will increase over time, rather than decrease, as with most normal currencies.
Given the potentially economically damaging aspects of the system, and the fact that government tend to dislike monetary forces that lie outside their control, bitcoins are unlikely to escape some kind of state control over the long-term. The idea has merit, but with long-term problems present, and the short-term dangers of bubbles bursting, potential investors would be wise to approach with caution.