The alternate digital currency bitcoin has received a lot of media attention in the past two days after the value of one bitcoin rose to over $200. By Wednesday, the value of each coin dropped to $105, and only six hours later, the value was back up to $160.
The media attention has a lot of people talking about bitcoin, and, understandably, there is a lot of confusion over what exactly it is.
So, what is it?
Bitcoin is an experimental digital currency. It was created by a person or group of people who go by the pseudonym Satoshi Nakamoto. The creators wrote an algorithm that releases new bitcoins at a fixed rate. Currently, that rate is 25 new bitcoins every 10 minutes. The rate will be halved to 12.5 bitcoins per 10 minutes by the year 2017, and will be continued to be halved every four years until a final amount of 21 million bitcoins are in circulation by the year 2140. Unlocking bitcoins requires “mining”. Users mine coins by solving digital algorithms created by Nakamoto’s software. If you solve an algorithm, you get a bitcoin. The monetary value of all bitcoins in circulation is currently over $1 billion USD.
Over 1,000 online vendors reportedly accept bitcoins as a form of payment. Unlike credit cards, there are no transaction fees when using them. Proponents of the currency point to benefits like this in an effort to encourage more vendors to accept the coins. Several exchange sites such as Mt. Gox and BitInstant exist for holders of bitcoins to exchange them for government issued money at any time. The coins have a fluid exchange rate similar to any other currency.
Bitcoins are far from the first digital currency. Cybercash and e-gold are two examples of prior attempts to establish an alternate online currency. While many think bitcoin will fail to establish itself as a viable form of money, others are investing large sums of money into the system.
The Winklevoss twins, made famous by their feud with Mark Zuckerberg over Facebook, are investing millions into bitcoin. The twins reportedly hold over $11 million USD worth of bitcoins at this time. They are far from the only investors betting on this currency, though. The start-up firm Draper Fisher Jurvetson has invested millions into Coinlab, a collection of bitcoin-related projects. Tribeca Venture Partners recently announced that it is investing in Coinsetter, a new trade platform for bitcoins.
Some big banking names are interested in the currency, too. Morgan Stanley and Goldman Sachs reportedly visit bitcoin exchanges up to 30 times per-day. The British-based financial company IG Group announced they will soon offer bitcoin pricing options.
The Winklevoss brothers offered some thoughts on the currency recently. They see bitcoins as a potential next big thing in the financial world. Understandably, they don’t want to miss out on Bitcoins as they did with Facebook.
“People say it’s a Ponzi Scheme, it’s a bubble,” said Cameron Winklevoss. “People really don’t want to take it seriously. At some point that narrative will shift to ‘virtual currencies are here to stay.’ We’re in the early days.”
“We have elected to put our money and faith in a mathematical framework that is free of politics and human error,” Tyler Winklevoss added. The brothers believe the recent trading fluctuations are “growing pains” similar to those that other young technologies experience.
“It has been four years and it has yet to be discredited as a viable alternative to fiat currency,” Tyler Winklevoss said. “We could be totally wrong, but we are curious to see this play out a lot more.”
Well-known financial investor Chris Dixon is on board as well. Dixon believes bitcoin represents the next phase of currency. “Three eras of currency,” he said. “Commodity based, e.g., gold; politically based, e.g., dollar; and math based, e.g., bitcoin.”
Not everyone is sold, however. Steve Hanke is an alternative currencies professor at Johns Hopkins University.
“It’s not something I’d want to be involved in or have any investors’ money involved with,” Hanke said. “To say highly speculative would be the understatement of the century.”
Others point to the problem of a fixed currency in a growing global economy. In order to maintain stable prices, currency circulation must grow at the same rate as markets. Bitcoins' fixed rate of growth could prove problematic if the currency is ever implemented at a large-scale level. The lack of human oversight of the currency could cause problems if viruses or hackers got a hold of peoples virtual wallets, too. Government entities like the IRS would not be likely to help victims of bitcoin-related financial fraud or theft given that the currency is used in opposition to government money.
Much like today’s trading values, the future of bitcoin is uncertain. Investors hope they are ahead of the curve and staking their claim on the next global phenomenon, while critics believe the currency is too flawed to ever catch on in any significant way.
Technology has a way of surprising us sometimes, though. Facebook, YouTube, and smart phones were almost unthinkable 20 years ago as well, and now they’re a daily part of our lives. Only time will tell if one day we'll look back at bitcoin in the same way.