Bitcoins: Exciting, anarchic and risky

MOHAN R. LAVI | Updated on March 10, 2018

So virtually real

This attraction of the bitcoin is also its weakness: the absence of centralised control.

One image on the Internet that appears to have attracted a lot of attention is that of a pizza outlet owner saying on the phone: “Sorry, we can’t deliver your pizza as an attachment.” The cyber world appears to have intruded into almost every aspect of human life — though we still have to make/buy and eat our food and drive our cars.

Hence, we have cryptocurrency, called bitcoin, invented by Satoshi Nakomoto, who by virtue of having a patent on bitcoins effectively controls the quantity of bitcoins in circulation. The idea of digital wallets with bitcoins got people talking about this as the next best thing. They even named the smallest unit of bitcoins after the inventor — patoshi. The new-fangled currency has already got into trouble with the Federal Bureau of Investigation busting an online drug cartel called Silk Road and stumbling upon a stash of bitcoins.

Anonymous currency

Bitcoins are an anonymous, decentralised digital currency. In contrast to electronic money, no company controls the bitcoin, nor ever could: all the rules about how it works are embedded in the very operation of trade, including the rate of inflation and how to verify transactions.

For most users, the easiest way to get bitcoins is to buy them. But due to strict anti-money laundering controls, even that is tricky. Most bitcoin exchanges such as Mt Gox, which issue bitcoins at the prevailing exchange rate, require users to wire money from their banks to the exchange. A small group of hardcore users get extra bitcoins through ‘mining’ for them: running computers which perform the calculations needed to make the currency work, in exchange for a share of the built-in inflation.

Bitcoins have no physical existence, although some people have devised ways to spend the digital currency by printing the necessary information on paper notes. Instead, they are long lists of the digital signatures of previous owners. When a Bitcoin is spent, the old owner adds her/his digital signature to the end of the list, combined with the digital signature of the new owner.

Few mainstream places accept bitcoins, though the number is growing and now includes fashion websites, pubs and online dating services. You can buy web hosting, geeky t-shirts, and even membership of the Reddit social network with bitcoin.

The currency has been through two boom-and-bust cycles, with the cost of one bitcoin rising from $2 to $30 in 2011, and then from $13 to $266 earlier this year. But having a fortune in bitcoin is a bit like having a fortune in gold: you have to sell your holdings to really make the most of it.

The big driver in bitcoin’s early growth was the online drug marketplace, Silk Road, which took advantage of the currency’s qualities to provide anonymity to patrons. While Silk Road is now gone, a number of smaller outfits offer the same services. But beyond access to illicit substances, for many fans use of bitcoin is a political statement: its existence proves that a currency with no centralised control is possible. Although there have been some bugs with the currency’s programming, all of the reported thefts have come from the outside. If users don’t keep their ‘private key’, the password which lets them spend their bitcoins, well hidden, they can easily lose everything. And, of course, anonymity cuts both ways: if you get tricked by a scammer into parting with your bitcoins, there’s no higher authority to turn to.

The future

Economists and developers point to several flaws in the implementation of the bitcoin which renders it unsuitable for widespread use. One problem is that the currency has deflation built in to its core — only 21 million bitcoins will ever be produced, says Nakomoto, and more than 50 per cent have already been issued.

Most economists believe deflation is disastrous for an economy.

A more immediate problem is that it’s not clear that the backbone of the currency can withstand the increased use that going mainstream would mean.

Transactions can already experience relatively lengthy delays in processing and that’s just with the bitcoin remaining mostly popular amongst enthusiasts.

Only time will tell if bitcoins can ever replace hard currency or a credit card.

The biggest advantage of the bitcoin may well be its main disadvantage — the fact that it is unregulated. History has enough evidence to prove that when the flow of money in any form is unregulated, it would be used for purposes other than buying pizzas.

If anyone wants to either trade or invest in bitcoins, it would be worthwhile remembering the concept of caveat emptor before doing so — let the buyer beware.

(The author is Director, Finance, Ellucian)

Published on October 09, 2013

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