Bitcoin may herald a change to the economic world


By Alex Hern  /  The Guardian

Wed, Dec 04, 2013 - Page 9

The past weeks have seen a surprising meeting of minds between US Federal Reserve Chairman Ben Bernanke, the Bank of England, the Olympic-rowing and Zuckerberg-bothering Winklevoss twins, and the US Department of Homeland Security. The connection? All have decided it is time to take bitcoin seriously.

Until now, what pundits called in a rolling-eye fashion “the new peer-to-peer cryptocurrency” had been seen just as a digital form of gold, with all the associated speculation, stake-claiming and even “mining”; perfect for the digital wild west of the Internet, but no use for real transactions.

Bitcoins are mined by computers solving fiendishly hard mathematical problems. The “coin” does not exist physically: It is a virtual currency that exists only as a computer file. No one computer controls the currency. A network keeps track of all transactions made using bitcoins, but it does not know what they were used for — just the ID of the computer “wallet” they move from and to.

Right now the currency is tricky to use, both in terms of the technological nous required to actually acquire bitcoins, and finding somewhere to spend them. To get them, you have to first set up a wallet, probably online at a site such as, and then pay someone hard currency to get them to transfer the coins into that wallet.

A bitcoin payment address is a short string of random characters and, if used carefully, it is possible to make transactions anonymously. That is what made it the currency of choice for sites such as the Silk Road and Black Market Reloaded, which let users buy drugs anonymously over the Internet. It also makes it very hard to tax transactions, despite the best efforts of countries such as Germany, which in August declared that bitcoin was “private money” in which transactions should be taxed as normal.

It does not have all the advantages of cash, though the fact you can not forge it is a definite plus. bitcoin is “peer-to-peer” and every coin “spent” is authenticated with the network. Thus you can not spend the same coin in two different places and nor can you spend it without an Internet connection. You do not have to spend whole bitcoins. Each one can be split into 100 pieces — with a piece known as a satoshi — and spent separately.

Although most people have now vaguely heard of bitcoin, you are unlikely to find someone outside the tech community who really understands it in detail, let alone accepts it as payment. Nobody knows who invented it; its pseudonymous creator, Satoshi Nakamoto, has not come forward. He or she may not even be Japanese, but whoever it is certainly knows a lot about cryptography, economics and computing.

It was first presented in November, 2008 in an academic paper shared with a cryptography mailing list. It caught the attention of that community, but took years to take off as a niche transaction tool. The first bitcoin boom and bust came in 2011, and signaled that it had caught the attention of enough people for real money to get involved — but also posed the question of whether it could ever be more than a novelty.

The algorithm for mining bitcoins means the number in circulation will never exceed 21 million and this limit will be reached in about the year 2140. Already 57 percent of all bitcoins have been created; by 2017, 75 percent will have been. If you tried to create a bitcoin in 2141, every other computer on the network would reject it as fake because it would not have been made according to the rules of currency.

The number of companies taking bitcoin payments is increasing from a small base, and a few payment processors such as Atlanta-based Bitpay are making real money from the currency. However, it is difficult to get accurate numbers on conventional transactions, and it still seems that the most popular uses of bitcoins are buying drugs in the shadier parts of the Internet, as people did on the Silk Road Web site, and buying the currency in the hope that in a few weeks you will be able to sell it at a profit.

This is remarkable because there is no fundamental reason why bitcoin should have any value at all. The only reason people are willing to pay money for the currency is because other people are willing to as well. Try not to think about it too hard. However, sensible economists are saying that bitcoin might become part of our future economy. That is quite a shift from October last year, when the European Central Bank said that bitcoin was “characteristic of a Ponzi [pyramid] scheme.” This month, the Chicago Federal Reserve commented that the currency was “a remarkable conceptual and technical achievement, which may well be used by existing financial institutions (which could issue their own bitcoins) or even by governments themselves.”

It might not sound thrilling, but for a central banker, that is like yelling “BITCOIIINNNN!” from the rooftops. And Bernanke, in a carefully dull letter to the US Senate committee on Homeland Security, said that when it came to virtual currencies, the US Federal Reserve had “ongoing initiatives” to “identify additional areas of ... concern that require heightened attention by the banking organizations we supervise.”

In other words, Bernanke is ready to make bitcoin part of US currency regulation — the key step towards legitimacy.

Most reporting about bitcoin until now has been of its extraordinary price ramp — from a low of US$1 in 2011 to more than US$900 earlier this month. That massive increase has sparked a classic speculative rush, with more and more people hoping to get a piece of the pie by buying and then selling bitcoins. Others are investing thousands of pounds in custom “mining rigs,” computers specially built to solve the mathematical problems necessary to confirm a bitcoin transaction.

However, bubbles can burst. In 2011 it went from US$33 to US$1. The day after hitting that US$900 high, bitcoin’s value halved on MtGox, the biggest exchange. Then it rose again.

Speculative bubbles happen everywhere, though, from stock markets to Beanie Babies. All that is needed is enough people who think that they are the smart money, and that everyone else is sufficiently stupid to buy from them. The bitcoin bubbles tell us as much about the usefulness of the currency itself as the tulip mania of 17th-century Holland did about flower-arranging.

History does provide some lessons. While the Dutch were selling single tulip bulbs for 10 times a craftsman’s annual income, the British were panicking about their own economic crisis. The silver coinage that had been the basis of the national economy for centuries was rapidly becoming unfit for the purpose: It was constrained in supply and too easy to forge. The economy was taking on the features of a modern capitalist state, and the currency simply could not catch up.












For some, that means bitcoin can never achieve ubiquity.



For bitcoin developer Hearn, that is not a concern.



