Bitcoin – currency of the future?

Update (14/10/11) – As of today, the currency is around 4 USD for one Bitcoin. I now believe that the viability of Bitcoin as a currency is highly dubious given its extreme fluctuations and unequal distribution.

There’s recently been a lot of attention on Bitcoin, this new virtual currency that can be traded in exchanges and can be sold for US$. Personally, I think Bitcoin is a great idea. It represents the decentralisation of the monetary system, away from the political system to a computerized one where not one individual can dictate how the value of the currency should be. Due to the many inherent problems of the banking system, such as being constantly plaqued by quantitative easing and other manipulation (which I suppose may come into play for Bitcoin, but not just yet), Bitcoin offers a fresh alternative to the politicised economy and I think we are witnessing the beginning of a financial revolution. Bitcoin may never replace “real-life” currency such as the USD, GBP, CHF etc. but it may well prove to be a very viable alternative.

Just for historical perspective, here’s a graph of the rise of Bitcoin’s significance (as of 7/6/2011).

More surprisingly, only 3 months ago, 1 Bitcoin was worth less than USD2. See chart:

All graphs taken from Mt Gox.

So, as I write this article, Bitcoin is trading at USD19.231 which is quite extraordinary for a virtual currency, isn’t it? I think the reason for the rapid rise in value of the Bitcoin is due to the idea of Bitcoin being spread by the mass media and people gradually accepting Bitcoin as a form of currency (or an irrational “RUSH” for Bitcoins).

So here’s a breakdown of Bitcoin’s Advantages:

1. No transaction costs – Really. Although you can opt to pay an optional transaction fee, there is no need to. With a 0% transaction fee, who can beat that?
2. Readily available market to trade Bitcoins for USD via Mt Gox.
3. Anonymity – no one needs to know how much money you have, not even your bank, your government or anyone else for that matter. The key is to keep your computer secured, because all the information is stored securely in the “wallet” file that Bitcoin generates on your system
4. No storage costs – That’s what makes it better than gold or physical currency. You can probably carry your “wallet” file in a thumbdrive, encrypted of course, or alternatively, encrypted and “in the cloud” (using one of the various flavours of backup solutions. for example, SpiderOak is highly recommended for its emphasis on encryption and security, whereas using some other more popular solution that I won’t mention by name will require you to encrypt it before uploading to the cloud)

Now, there are also cons of using Bitcoin:

1. It’s not legal tender, nor is it universally accepted. There’s no authority to enforce any legality of the currency whatsoever. For example, if I wanted to pay in Bitcoin for a coffee at my local Starbucks, they wouldn’t accept it (currently, anyway). However, if Bitcoin really takes off in a big way, then it probably would be accepted at Starbucks everywhere. The key to this happening is when everyone starts accepting Bitcoins. This is the network externality in action.
2. People can evade taxes, due to the anonymous nature of Bitcoin. Currently, it is impossible to track how many Bitcoins someone has due to the high encryption level of the software. If the government doesn’t know how many Bitcoins you have, then it can’t tax you right? Alright, assuming Bitcoins become the global currency, then what would happen to government revenues if nobody paid taxes? In other words, the old model of the government collecting taxes might just disintegrate with the loss of control over the most commonly used currency. It will likely lead to a sea change in government taxation policies, though I’m not certain how the government would implement taxation if they couldn’t be traced.
3. Requires the internet to work. What would happen if the internet was disconnected to some freak event? Then the economy would slow to a standstill. Then again, this restriction also applies to the electronic money in the system with billions of dollars/pounds/etc. traded over the internet so it might be a moot point. However, consider the mum-and-pop small shops in small towns. Installing internet terminals so that their customers could pay with Bitcoin would incur some costs, so this idea might take a while to be implemented. Also consider developing countries. The people of developing countries have little access to the internet, so this “starting over” of a new monetary system is not exactly equitable. The consideration of fairness would be the best, although perhaps the perfect monetary system is unattainable anyway.

In conclusion, I think Bitcoin is a very promising virtual currency and its significance in our economy cannot be underestimated with the growing number of people and merchants using Bitcoins. In my opinion, the main feature that makes Bitcoin attractive to use is the zero transaction fees and zero storage fees. I can see how this is attractive to a large number of small businesses. With an ever increasing number of people embracing Bitcoin, Bitcoin may one day surpass the Swiss Franc in terms of importance as a “safe haven” currency.

Perhaps. We’ll see.