Exit the dollar, the euro, etc. Not so fast! Non-governmental currencies have existed before; however, an unregulated virtual currency is something new and different. Bitcoin is a cryptocurrency that was created in 2009 by a computer scientist known only under the pseudonym Sutoshi Nakamoto. Bitcoins are not held in bank accounts but in digital wallets on laptops or smartphones and can be transferred cheaply and anonymously by sending a code from the wallet of the buyer to that of the seller.
The supply is determined by an algorithm that will limit the total number of coins created to 21 million (close to 12 million have been created so far). Scarcity means value, although value is also determined by the demand side of the market, which consists mainly of speculators, some anti-government folks and a few crooks.
The value of bitcoin has been fairly low and stable at first, probably because of the lack of market participants, and then became very volatile. Until January 2013 its value increased slowly toward $14 (with a spike in 2011). It reached an all time high in March/April of $266 coinciding with the bailout of Cypriot banks. Suddenly it crashed to about $80, went back up to $150, was about $110 in June and is now around $200. This volatility makes it the instrument of choice of speculators and gamblers whose objective is to make money by trading in and out of the market. It is certainly not appropriate for a buy and hold investment strategy!
It has also attracted anti-government libertarians, tax dodgers, and criminals. In October 2013, the FBI closed Silk Road, the digital black market website used to trade illegal drugs and illicit goods and services with bitcoins. Following the raid, the price of bitcoin fell but recovered fairly quickly. This seems to indicate that the FBI raid caused no short-term damage and may even help to legitimize the digital money by distancing it from Silk Road illegal activities.
The U.S. Federal government has also seized some of the bank accounts of Mt. Gox, the largest Bitcoin exchange. Bitcoin is also accepted by a handful of real-world shops, mostly run by anti-government evangelists. Money transfer businesses, Western Union and Moneygram, are also said to be looking at the possibility to accept bitcoins in order to reduce the cost of sending money abroad.
Several hedge funds have gotten involved and an application for the creation of an Exchange Traded Fund (ETF) replicating the performance of bitcoins has been sent to the U.S. Securities and Exchange Commission (SEC) for its approval. It seems as this time that the Treasury has no interest in outlawing bitcoin but only in regulating it, perhaps through the Commodities and Futures Commission (CFTC). However such regulations would undermine the laissez-faire philosophy based on the Austrian economic theory of Ludwig Von Mises and Friedrich Hayek that sustains bitcoin.
It is doubtful whether Bitcoin will be able to survive; not only it is not commodity based and is not a fiat currency (i.e. a contract between citizens and their government), but it is socially unproductive in the sense that it provides few benefits to ecommerce, consumers, and society in general. It mainly facilitates the personal gains of speculators, tax evaders, anarchists and criminals. It looks like we are moving toward a more regulated bitcoin market; but then will bitcoin lose its raison d’être?
Pierre Canac, Ph.D.
Associate Professor of Economics