Bitcoin: Currency Revolution or Bubblicious Fad?

Bitcoin has the media in a swoon. Libertarians are in love with it, and techies can’t get enough of the virtual phenom. Hailed as the world’s first decentralized digital currency, the beacon of a new alternative tender movement, and potentially the bane of big banks, the Bitcoin was born in 2009 to a mysterious developer (or perhaps multiple developers) known by the pseudonym Satoshi Nakamoto.  

Bitcoin quickly got a high-profile customer in the form of Wikileaks and gained a cult following. Lately, Bitcoin has burst into mainstream consciousness with a wild boom-and-bust rollercoaster ride and the endorsement of the twins Cameron and Tyler Winklevoss, the brothers famed for suing former Harvard classmate Mark Zuckerberg for stealing their social media idea. The value of a Bitcoin, which was worth $10 at the start of the year, recently leapt to $250, then nosedived to below $150 on April 11.

How does it work? (Warning: your head may explode)

Part of Bitcoin’s mystique is the glorious wonkery surrounding how it gets made and passed around. There’s a public peer-to-peer transaction log, called a block chain, which is stored on computers running Bitcoin and records transactions. You start your Bitcoin adventure by installing a “wallet” from on your computer or smartphone. Now you’re in the network, and you can conduct transactions between other people in the network, much as you can call another Skype user once you’ve downloaded the program and joined the circle of Skype users.

Bitcoins are like gold in that there are a finite amount of them – this was done to try to keep the Bitcoin economy stable and prevent inflation. A fixed amount of Bitcoins will be released (“mined”) each year set within the open source code of the Bitcoin project.  Bitcoins, in blocks of 25, are awarded to miners when their computer generates a 64-digit number from a complex algorithm. The maximum number of Bitcoins is 21 million. Right now, there are about 11 million in circulation, and the number of coins that can be generated by the mining process gets cut in half every four years.

Bitcoins can be used to buy things online. The WordPress blog platform accepts Bitcoin, and so does WikiLeaks. Some sites offer gift vouchers for stores like Amazon, and you can also find sites selling electronic goods for Bitcoin. Bitcoin is also accepted on sites such as anonymous marketplace Silk Road, where users can buy illegal drugs.

The Bitcoin system is maintained by a volunteer open-source community coordinated by four core developers. Bitcoins are supposed to be encrypted in such a way that they can’t be “forged.” The transactions are made peer-to-peer and are supposed to be secure. Are they? No one really knows. It has been pointed out that handing over your bank information to strangers on the Internet (Bitcoin doesn’t take credit cards) may not be the wisest move. You also have to take it on faith that the limited number will stay limited and that it won’t be replaced by another digital currency.

Why are people excited?

The excitement over Bitcoin is a manifestation of the growing distrust of government, the global financial system and central banks, in particular. Tech-savvy libertarians get delirious over it because it’s touted as a form of cash that doesn’t need government backing, ostensibly beyond the reach of regulators and central bankers. Grassroots types who yearn for smaller scale, locally focused systems of exchange are also infatuated with Bitcoin. Many hope that Bitcoin is the future of the world economy.

Is Bitcoin something new? 

Not really. Alternative means of trade often surface during difficult economic times. They can be as simple as a seashell or as high-tech as Second Life “Linden dollars” (remember that craze?)

When times are tough, you might start to feel a deep anxiety about those slips of paper covered with Masonic symbols in your pocket. During the Great Depression, businesses in the U.S. issued all kinds of paper and metal tokens as currency, even things as weird as rabbit tails. Many people rush to gold, as they have done lately, only to find that the prices can come down just as easily as they can go up.

Bitcoin shot up in value after the financial crisis in Cyprus, when trust in bank deposits suddenly plummeted as savers faced a one-off levy as part of a eurozone bailout. People were highly pissed off that governments could raid their savings accounts, and the desire to have some kind of currency that seemed protected from uncertainty suddenly gained new allure. Of course, you don’t get rid of the government that easily: the US Treasury is looking into applying laundering rules to virtual currencies like Bitcoin. You also don’t get rid of uncertainly by using a currency whose value is susceptible to wild swings.

What’s the problem with Bitcoin?

Nothing, as long as you can afford to lose.

The idea that you can have stable currency in the absence of a government is a libertarian fantasy. Ordinary money is legal tender, and it gets to be that because a government decrees it. By law, it must be accepted for the discharge of debts. Who has to take Bitcoin? Nobody.

Many economists are looking at Bitcoin as a kind of fashionable speculation, much like the famed Tulip Mania of the 17th century. Only with Tulip Mania, at least you got a bulb and would have a pretty flower to look at. Bitcoins are not even objects that you can use or wear. They’re more like art, the price of which goes up or down, depending on the fashion.

Money, remember, is purely a conventional item. If conventions change, it’s worth nothing. Can you buy anything with a rabbit tail today? Not likely.

Remember Beanie Babies, those dopey looking plush toys of the 1990s? They took off along with the tech bubble and sparked a trading frenzy that was heightened by the new Internet technology. They were supposed to transcend the normal rules of the market and subvert tried-and-true notions of investment value. Except they didn’t. And a lot of people ended up with a closetful of silly stuffed animals.

Really, Bitcoins are just a fad. They have also become a tool for financial speculation that has some disturbingly Ponzi-like elements. The complexity of the algorithm for creating them increases in stages, and so it takes more and more “investment” in terms of computer power and time to create Bitcoins. You may not want to be the person holding the Bitcoin bag when the fashion moves on.

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