Bitcoin – bonkers or brilliant?
By Stephen Foley
Not since the dotcom bubble at the turn of the millennium, when business plans that would have been laughed out a bank manager’s office floated with multimillion pound valuations, has there been such temptation as there is around Bitcoin.
The virtual currency went up 5,580 per cent in price last year, which rather puts 30 per cent equity market returns in their place.
Fred Wilson, one of the most respected venture capitalists in New York, says he has not seen a technology with this much potential since the invention of the internet.
Little wonder, given the giddiness, that so many people are asking “what is Bitcoin?” and “should I buy some?” – and not necessarily in that order
What is Bitcoin:
Bitcoin was created five years ago by a mysterious computer scientist with the pseudonym Satoshi Nakamoto, who conceived it as an alternative to government-controlled currencies and a means to transfer money quickly, cheaply and anonymously outside the slow, expensive and highly regulated international banking system.
Bitcoins are no more unusual in theory than Air Miles, Nectar points, or credits in online games, except that they can be transferred easily between people and used to pay anyone who wants to accept them, giving them greater currency than loyalty schemes.
So far, only 20,000 or so merchants worldwide accept payments in Bitcoin, and only Overstock.com among mainstream retailers, but the number is growing all the time.
What is truly revolutionary is that the currency does not rely on any single entity – there is no British Airways, Sainsbury’s, or central bank for that matter – to create Bitcoins, process transactions or to keep tabs on who has how many. They are also stored by users in online wallets, rather than in a bank account.
New Bitcoins are handed out as rewards for helping run the network, a peer-to-peer network of computers that confirms transactions and maintains an online ledger showing where all the Bitcoins are.
Once the number of Bitcoins hits 21mn that will be it. No printing money, quantitative easing-style for this currency. That built-in scarcity – a bit like the gold standard – is one of the reasons the price is being driven up, as speculators anticipate greater use of a fixed pool of currency.
If it takes off in the way its adherents hope, Bitcoin might help everyone’s personal finances, cutting out a lot of the fees and the hassle associated with transferring money through the banking system, particularly for sending money overseas.
Regulators, though, may have something to say about that. Banks run lots of anti-money laundering checks and the absence of those meant that some of Bitcoin’s earliest adopters were low-level drug dealers operating on the secret e-commerce site for contraband, Silk Road.
The FBI shut Silk Road down last October and seized its assets, with the bizarre outcome that the US Department of Justice is now one of the biggest holders of Bitcoins.
Even regulators who are not immediately inclined to regulate Bitcoin are sounding warnings to consumers.
In December, the European Banking Authority listed numerous dangers in using virtual currencies. As well as the wild price swings, and the risks of a hacker breaking into your wallet and making off with your coins, it also pointed out that consumers do not have any of the normal protections, such as the right to refunds, when making purchases in virtual currency.
The EBA’s statement concluded bluntly: “You should not use ‘real’ money that you cannot afford to lose.” Germany’s Bundesbank has also been very sceptical.
Susan Athey, an economics professor at the Stanford Graduate School of Business, told a New York regulatory hearing last month: “I don’t think this is a great investment for small investors, just like investing in Silicon Valley start-ups is also not a good investment for small investors.”
“A Silicon Valley start-up has a profile that it might get very big, or it might go bust, it might go to zero, and that’s a good way to look at an investment in Bitcoin as well.”
How much is Bitcoin “worth”:
The only sure answer to that question is, a lot more or a lot less than it was yesterday and will be tomorrow. Volatility is the only constant in the Bitcoin price, which hit a high of $1,155 in December only to swing as low as $533 a fortnight later.
Bitcoin is more talked about than used at this point in its young life, so its future – even whether it has a future – is unknown. Compound that with illiquid markets, and you have all the conditions for speculators getting burnt.
There is not even agreement on what, conceptually, Bitcoin actually is. Does its societal value lie in making the payments system more efficient, in which case maybe it should be thought of as a payments system rather than a currency? Or is it a store of value, like gold, used by investors who want to keep some of their assets out of fiat currencies that can be debased by politicians or central bankers?
To begin discussing what Bitcoin might fundamentally be worth is to enter a veritable grocery store of apples-to-oranges comparisons.
The Bitcoin Investment Trust’s marketing materials include some tantalising ideas in a slide called “Bitcoin upside”.
If the total allowable stock of Bitcoin were to equal the $23bn value of PayPal, the market-leading online payments company, then a single Bitcoin would be worth $1,949, according to the slide. If it equals “the monetary base of Turkey” ($92bn), a single coin would be worth $7,851, 12 times as much as today. If it grows to be worth just 5 per cent of the total of the world’s gold, that other beloved store of value, then Bitcoin’s market capitalisation would be $352bn and a single Bitcoin would trade above $30,000.
Financial analysts are weighing in. Bank of America Merrill Lynch analyst David Woo suggested a maximum value for Bitcoin of $15bn, based on comparisons to money-transfer company Western Union, to gold and to consumer bank deposits relative to annual consumer spending.
Ms Athey says everything hinges on how big a share of e-commerce will be conducted in Bitcoin in the future, which implies a certain size of monetary base.
The death of Bitcoin:
The list of things that could kill Bitcoin is long.
First, the technology might not be up to the task. There was a scare this month when attackers exposed the complexity of the underlying software and exploited some of its quirks to halt withdrawals temporarily from the major Bitcoin exchanges.
Second, regulators might strangle innovation, fearing criminal activity, or governments might strangle Bitcoin altogether, fearing competition for their sovereign currencies.
Third, and perhaps most likely, it could be killed by competition. Nakamoto’s code had already been copied several times over the past five years, before the hype in 2013 prompted dozens more. And Bitcoin has to contend not only with copycats but with satires.
In December, Jackson Parker and Bill Markus created Dogecoin, the first virtual currency to be based on an internet meme. They created tens of billions of Dogecoins and what started as a joke is finding currency as a means of making small tips to bloggers and others whose internet content a user wants to reward.
And still the jokes keep coming. Dogecoin now has its own copycat, called Catcoin.
Banks are finally fighting back, too, with innovations like depositing cheques by photographing them and payments via mobile phones. Startups like Dwolla and Square are rolling out online payments systems to rival Visa and MasterCard.
“The whole space is being figured out right now,” says Chris Larsen, co-founder of OpenCoin, which has its own more serious rival to Bitcoin, called Ripple. “It’s a land grab, and the pioneers are racing through the prairies, but who will be first to reach the sea?”
The excitement that everyone felt around the turn of the millennium was justified. The internet age has revolutionised commerce, media and communications, just as evangelists predicted. But that didn’t stop the dotcom bubble from bursting.
Bitcoin may be the “internet for money”, or it may just be the most currently intriguing in a long line of experiments in payments and in virtual currency. Whatever happens, it will continue to be a wild ride.
Investing in cryptocurrency:
Happily for worried watchdogs, it is still quite hard to buy Bitcoins. Kitting yourself out with an online wallet and signing up to an exchange where you can swap your dollars, pounds or yen for virtual currency requires some technical savvy and a certain amount of ID.
Traditional investment vehicles that provide exposure to Bitcoin without having actually to own the currency are proving slow to get off the ground, and are mostly US-based. One such vehicle is the Bitcoin Investment Trust, created by Barry Silbert – the same entrepreneur who built Second Market for trading shares in hot start-ups such as Twitter and Facebook before they went public.
Mr Silbert says more than 150 investors have come aboard since launch in December, including finance industry professionals. “I think it is a precursor to Wall Street moving into Bitcoin in a big way,” he said. “These are the decision makers. If they get comfortable with Bitcoin as an asset class, I don’t think clients’ money will be far behind.”
Tyler and Cameron Winklevoss, the twins who petitioned Lawrence Summers to protest that Mark Zuckerberg stole their idea for Facebook, plan to launch an exchange traded fund that tracks a Bitcoin price index. The index, which they are calling the Winkdex, launched last week but the ETF itself is unlikely to make it through a sceptical Securities and Exchange Commission approvals process this year.
Even bullish Fred Wilson is not primarily expressing his enthusiasm by buying Bitcoin. He is doing it by investing in companies like Coinbase, which converts Bitcoin into hard currency for merchants and consumers. If Bitcoin evolves into something else, a professionally run company such as Coinbase ought to be able to shift gears and pursue those opportunities, he reasons.
Going shopping with Bitcoins:
Using Bitcoins to buy and sell real goods and services is certainly possible, but still a long way from being ubiquitous, writes Jonathan Eley.
You can get an idea of how many physical businesses accept Bitcoins or Litecoins at coinmap.org
, which lists them. As of Thursday this week, it listed 3,169 Bitcoin-accepting outlets globally – of which about 180 are in the UK. They range from a tobacco-seed supplier in Southend to a Scottish-themed gift supplier in Dundee. Many are companies that sell a lot of their products abroad and so incur costs converting foreign currencies, and they tend to offer Bitcoin payment as well as – not instead of – more conventional payment methods such as credit cards and PayPal.
Germany – a country that has had a major currency collapse in the past century – leads Europe in Bitcoin adoption, with Berlin home to many cafés, bars and record shops (such as BuyReggae.com, below) that accept digital currencies – though they still tend to list prices in euros.
Mobile phones are integral to Bitcoin purchases, so news that Apple has barred Bitcoin apps like Blockchain and BitPak from iTunes may slow its adoption.