Bitcoin – Revolution or Evolution?

It’s been around a while, but it seems that Bitcoin is continuing to make its presence felt, and hasn’t, as some predicted, simply passed away in the night, but instead seems to be growing in popularity. Or perhaps that should be notoriety? Because it does, however, seem to be followed around by a fairly dogged cloud of controversy – arguments abound between its supporters and opponents, and accusations of money laundering, cheating and stealing fly around the financial marketplace like nobody’s business (even Nouriel Roubini, the respected US economist, recently called it a “Ponzi game”). So it’s a bit like “real” money, if you stop to think about it.

And that’s the thing – whatever you think about it, whatever your opinion of cryptocurrency – there’s no getting away from the simple truth. It’s certainly a disruptive technology, but it’s also money. It’s starting to do the same job as money – people and businesses accumulating it in order to exchange it for goods and services, thieves wanting to steal it, and what’s perhaps more important, it’s being traded just like money, or any other currency or commodity. Yes, okay, for now it’s probably more of a commodity, but in exactly the same way that gold or diamonds are (think Krugerrands). So, if it sounds and looks like a duck…

Bitcoin operates on the principles of a distributed network, which is used to store details of every single transaction ever made in a huge version of a general ledger, called the block chain, or block. It’s the miners’ job to confirm those transactions, and write them into this block. A constantly updated copy of the block is then distributed across the network. The miners’ processing (or hashing) generates 25 bitcoins for each successful hash. However, the Bitcoin protocol says that bitcoins are created at a decreasing and predictable rate. The number of new bitcoins created each year is automatically halved over time until creation comes to a halt, with a total of 21 million bitcoins in existence. The ability to mine (generate these hashes) is governed by the processing power of hardware (needless to say, it’s ever-expanding).

So, bitcoins are low in volume, because of the way in which they’re mined, and it’s this rarity that makes it so appealing to commodity traders. And therefore it’s this commodity style of trading that makes the price index of currency equivalence fluctuate so wildly. In just this week the price index has fluctuated between $605 and $665 (US dollars per single bitcoin), although prior to October 2013, it primarily held steady below $150, but maxed out the year at over $1,100. You’d be hard pushed to find anything else on the markets quite that capricious. Of course, lack of regulatory control is no doubt contributing to such volatility – or at least that’s what the regulators seeking to apply it will certainly say, and they’re probably not wrong – but there’s also the fact that it’s an emergent market. There’s always going to be flux at the stage it’s currently at – it’s decentralized, so it’s likely to be a tad unruly.

That’s all well and good, but its detractors have a point – the volatility isn’t to be found just in the price index. Mt.Gox, once the world’s largest bitcoin exchange, recently declared itself bankrupt, citing the loss of around 750,000 of its clients’ bitcoins to hackers as the sole cause. And they haven’t been alone – there have been other such collapses. These losses aren’t indemnified, either (it’s decentralised and unregulated, remember?), so those pockets are likely to stay well and truly picked, at least for the foreseeable future. But then this behaviour isn’t exactly unprecedented when it comes to currencies. Fiat currencies (i.e. currencies unsupported by gold or silver, which in reality is pretty much all currency these days) have collapsed throughout history – even the Euro had a difficult 2013. It strikes me, however, that these bitcoin “collapses” are anything but. They’ve been security breaches, pure and simple.

So should we adopt it more wholeheartedly? I’m not convinced we shouldn’t, but I’m also reserving judgement for now. Not what you were looking for, I know, but I’m not by nature an early adopter (I update my model of iPhone a year later than everyone else, for goodness sake). I know I want it to succeed, though. I guess it needs people who aren’t like me to help with that.

My advice is this: if you’re the sort of person who can’t wait for the iPhone 6 to come out, then you should probably get into Bitcoin. Just don’t invest too heavily for now. And, at the risk of suggesting that you just can’t trust the banks these days, you should keep your bitcoins on thumb-drives (with backups).