Are Bitcoins here to stay? The crypto-currency‘s early adopters and fans believe that it will disrupt banking and the use of fiat currency and could be a safe haven in an economy bent on hyper-inflation. Does the banking community feel the same way?
Bitcoin is an electronic currency based upon algorithms and cryptography. Its value is set by use, which is increasing, and not by government policy, regulation or a central bank. Bitcoins are exchanged in online peer to peer transactions. The currency is being used to buy everything from homes and cars to coffee and cocaine — its use in the shadow economy was prominent at first but its use in the legitimate economy is increasing. In April, someone bought a Porsche in the Cayman Islands for 300 Bitcoins, which worked out to around US$39,000. The Bitcoin community reported the buyer was an early adopter of Bitcoins and bought them for approximately US$4 each which means he actually spent US$1,200 on the car. This week, XE.com added Bitcoin to its currency exchange rate portal.
Bitcoin exchanges track the currency’s use in real time and other indicators used to track fiat currencies. Bitcoin trades happen outside of the mainstream financial channels. Banks and other related entities cannot stand in the middle of trades and collect fees for managing transactions. The crypto-currency’s users are convinced this will disrupt regular banking channels. Others are sitting back and waiting for their Bitcoins to hold value when other fiat currencies lose theirs. Unlike other digital currencies – see Liberty Reserve – Bitcoin is promoting itself as ‘freeing people to transact on their own terms.’ In June, Mt. Gox, a large Bitcoin exchange, took out a full page advertisement in the G8 Summit’s official magazine inviting readers to ‘come join us.’ A more shadowy organisation would probably market itself less directly.
No central bank
Imagine a bank ledger which is kept by all of the account holders, and then remove the bank. That’s how Bitcoin works.
The currency’s use is managed by the universal record of transactions contained in the block chain, the unique code which identifies each Bitcoin. The block chain authenticates the coins and records information on each transaction made with it ensuring the same Bitcoin cannot be used twice. Added security for transactions comes from peer verification as each Bitcoin transaction is verified by at least six peers in the user’s network. Once the user initiates a transaction, the coin disappears from the virtual wallet, is verified by the network and appears in the receiver’s wallet after verification. Finally, another defining factor of Bitcoin is its currency control policy. The maximum number of Bitcoins that will ever be in circulation is 21m. Once the last coin is mined – which the Bitcoin Foundation estimates will be in 2140 – the number of coins in circulation remains static. Only their value will increase or decrease.
Part 2 of this article looks at how to acquire Bitcoins, how to use and safeguard them and the risks associated with use.