Bitcoin – legal tender of the future or fad?

Bitcoin (BTC) is the world’s newest currency, pushing the Euro out of that coveted spot.  It is not your traditional currency however; it is a digital, decentralised currency based on open source.  Put simply, it is international and not controlled by any central bank.  Virtual currencies have existed for some time, e.g. Linden Dollars, but are traditionally controlled by the organisation behind them such as Second Life, and have been limited to a particular virtual environment.  Enter Bitcoin, a truly revolutionary and potentially universally acceptable virtual form of payment.

There are three main ways to get your hands on Bitcoins – you buy them in exchange for ‘real’ money, you accept them as payment for goods and/or services or you mine them.  The first two methods are self-explanatory. Mining involves solving extremely complex algorithms to unlock a “new” block of Bitcoin.  The easiest way to get your head around this is by thinking of it as an oxymoronic, skill based lottery in which there are regular draws, in which the ticket holders are whizz kids behind high spec computers and in which the prize is a certain amount of virtual cash.

“Bitconians” cite its benefits as the absence of bank charges, middlemen, Forex conversions and territorial frontiers.  Fans feel it will help ease online commerce across borders and eventually replace credit cards.

Other notable advantages exist.  As Bitcoin will be limited in supply, there is no risk of quantitative easing devaluing your digital cash.  Nor is there the risk of your bank committing daylight robbery by taking a percentage of your savings, as we saw threatened in Cyprus earlier this year.  Bitcoin could indeed strengthen international trade, as there are no currency barriers and transactions can be arranged and processed very quickly.

I am not convinced.  I am, however, a bit like the current UK Government, prepared to do a U-turn so please feel free to comment at the bottom of this blog and change my mind.  For now though, there are a variety of reasons I am not a fan.

The lack of central bank or Government control has advantages but is also one of Bitcoin’s greatest weaknesses.  After decades of trying, we finally have a relatively robust system in place to prevent fraud and money laundering in the western world. In the UK, the Money Laundering Regulations 2007, the Proceeds of Crime Act 2002 and Terrorism Act 2000 place an obligation on businesses to maintain appropriate policies and procedures to prevent them from being used for money laundering by criminals or terrorists.  Bitcoin circumvents these safeguards in one fell swoop as you can generate a different ‘address’ for each Bitcoin transaction you make and thereby remain anonymous.  It is no wonder that the currency has some negative connotations when it is the currency of choice of the online black market Tor-operated website Silk Road, described as the Amazon of illegal drugs.

The fact that political barriers (often in place for very good reasons) can be circumnavigated by Bitcoin does not necessarily inspire public confidence either.  It is well known that Bitcoin donations flooded in to Wikileaks even after financial blockades were put in place following the publication of confidential US diplomatic cables by the website.  I am all for freedom of speech but what happens when Bitcoin is used to fund terrorist organisations or countries subject to trade sanctions?

As the currency is not backed by a central bank, there is no guarantor if your Bitcoin wallet is hacked.  If your online bank account is hacked, your bank will generally compensate you for your loss.  If your online Bitcoin wallet is hacked, or indeed you accidentally delete your wallet, you are up the creek.

The value of Bitcoin is also very volatile.  At the time of writing, one BTC1 is worth US$129.49 or £85.27 on Mt. Gox, which describes itself as the world’s most established Bitcoin exchange.  The value rocketed during the Cyprus saga earlier this year but dropped to circa BTC1 = US$76 when Mt. Gox suffered a cyber-attack in April.  I am not suggesting that established currencies do not fluctuate, but not to this degree.

Arguably, Bitcoin enthusiasts themselves are eroding trust in the currency by building and using high spec computers designed to mine Bitcoin making it almost impossible for anyone else to do so.  This seems intrinsically unfair.

The practical reality is that although you can buy many things using Bitcoin via the internet, you cannot use it in your local supermarket or pub.  Unless and until Bitcoin is widely accepted both online and offline, it will not mount a serious challenge to traditional currencies or threaten safe havens such as gold.

For now, I am going to be a cynic and suggest that Bitcoin is more fad than future.  This is after all, something that started out as an ‘I owe you’ between hackers, and was not envisaged as a global currency. Having said that, I may be completely wrong.  This week it was reported that people in the UK are relying more and more on electronic payment methods such as contactless cards, leaving cash in the past.  Arpanet was intended to be an internal military network and turned into the internet. Bitcoin may be the next global revolution.

Simon Halberstam