Bitcoin: beyond the bubble

Whether it’s a fad or a threat, the much hyped e-currency Bitcoin is making differences in people’s pockets and headlines across the globe. It started in 2009 when a hacker, using the pseudonym Satoshi Nakamoto, launched a form of currency that escaped the reaches of the global financial crises. It’s currently experiencing a boom that some are calling a bubble and others a perfect storm. What is the hype about, and why is it important?

This currency is created through a process called ‘mining’. This is where your computer, after downloading a specific client, is used to work out complicated algorithms and eventually reward you with a certain number of Bitcoins.

Bitcoin is said to be above all decentralised. Meaning that it doesn’t abide by any authoritative regulation or monitoring. It can be exchanged with whoever for whatever. Bitcoin can be used to trade anything from illegal firearms, drugs or other unsavory items.Things you wouldn’t want your credit card statement to record. It has no payment-handling system in place such as bank-monitored account transfers, third-party organizations such as PayPal or associated nationality. It is theoretically anonymous and neutral. Also, maybe more importantly, it doesn’t fall under the market tides of recessions and crunches.

Why it’s important

This is important because the currency has increased in value from US$20 for one Bitcoin in March to over US$200 a couple of days ago. The value is dictated by supply and demand. So the more people getting their hands on Bitcoins, the greater the value. This would have made out to be a great investment a few years ago.

People have connected the Cyprus bailout to the most recent spike in this digital currency as it was believed to be a safer bet. Understanding this strange economy might give rise to better solutions or even a more attractive alternative to the post hoc form of trade.

Why it might not be so important

It all sounds good in theory but as with all investments, it comes at a price and a risk. The price being the actual hardware and power required to generate these Bitcoins. The risk being that this phenomenon is still very new, strange and, above all, complicated.

As discussed by sceptics such as Mathew Ingram in his article “How Bitcoin Wants to Make Your Money Even More Virtual“, the currency is run by the raw shadowy underground figures of the web. The “dark side” of the web if you will, where only those with exceptional technical know-how can operate. This mysterious anonymity creates doubt.

It’s noted in this Forbes article that the hardware used for mining has become so expensive “Bitcoin miners have organized themselves into “pools” that cooperate and share the spoils among their members in proportion to the computing power they contribute” These “pools” then hold the majority of Bitcoin’s shares. So much so that it becomes very centralised.

It sounds quite dodgy. Just the fact that it’s associated with hackers puts people off. Also, there are stories about how hackers simply wiped people’s digital wallets where Bitcoins were stored. The lack of accountability makes people feel uncomfortable. Wired ran this article talking about a new Trojan virus “that takes control of infected machines and forces them to do what is known as Bitcoin mining.” On the other extreme there is this story of how a family sold their Porsche for 300 Bitcoins.

Now what?

That’s where the Coinsetter comes in. This New-York based startup has raised $500 000 in seed capital by gaining the trust from prominent investors associated with the likes of Facebook and Microsoft. As discussed in this TechCrunch article , the idea is to apply “familiar market practices to the wild, wacky and virtual world of Bitcoin.” This is done by making it more “accessible to both mainstream and institutional users by focusing on security, transparency and by offering a simple user experience.”

Although e-currency has been around for years now, it has recently drawn the attention of many prominent investors, theorists and economists including Paul Krugman who won the Nobel Memorial Prize in Economic Sciences in 2008. Do the pros outweigh the cons? And what are the limits of digital currency? I think a more important question is what possibilities digital currency creates for us.

Image: zcopley (via Flickr)