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In no one we trust: the digital dollar’s rise

Friday 3 May 2013

By Chris Cook

The Bitcoin bubble is a modern tulip mania but without the pretty flowers, writes Chris Cook

A buying frenzy has sent the value of the total Bitcoin stock past $1.5bn and the price of a single Bitcoin has doubled in less than two weeks.’

Financial Times, April 3

So, er, what is a Bitcoin?
It’s a “digital currency”. Normal currencies have banknotes, each with a registration number. Imagine that, instead of printing the notes, you just kept a list of the registration numbers of each of the notes and who owned them. People could pay one another by transferring the registration numbers online. That’s how Bitcoins work. A network of computers is keeping track of who owns a pot of 11m of these numbers. It’s the price of putting a number in your Bitcoin account that’s soaring – this week it hit $147, a more than tenfold increase in price since January.

That doesn’t sound revolutionary.
Well, Bitcoin has a few peculiar features. The oddest is that we don’t yet know who actually devised the whole system.

What do you mean?
All that we have is the founder’s pseudonym: “Satoshi Nakamoto”. It’s a Japanese name, but they could be a person or people anywhere in the world. Whoever they were, they mistrusted government enough to set up a private currency and an online bank account system outside its reach.

What’s the monetary policy for this currency?
Rather simple. The network of computers generates a fixed number of new Bitcoins a day. The system also has a cap built into it – so there can never be more than 21m of the registration numbers.

It gets odder. The whole network is anonymised. So while there is a register saying who owns which of the numbers, it is designed to make it extremely difficult to track which real-life person owns what.

Why did someone do this?
They wanted a currency they could use online that was outside government control.

And they don’t trust the conventional banks?
I think that goes without saying these days.

How easy is it to get an account?
It’s a hassle.

And do any major businesses accept them for payment?
Er, no.

That sounds like quite a significant bug in something calling itself a “currency”.
They are, in that regard, less useful than Air Miles.

So is a Bitcoin account as secure as a bank account?
No. It’s safe from governments – for now – but there have already been several high-profile hacking incidents and thefts from accounts on the network. Savers who lose out aren’t covered by any insurance – and the police can’t trace thefts.

So why exactly did people start to use this service?
Lots of people agree that the government can’t or shouldn’t be trusted with the money supply. Some Bitcoin investors are libertarians who want to support a private central bank. And others worry that expansionary monetary policy – like Japan’s super-loosening this week – will set off hyperinflation.

And they think Bitcoins are valuable precisely because not that many of them can be generated.

Like those “limited edition” plates commemorating royal weddings?
I suspect Bitcoin investors would prefer to think of it as a digital alternative to gold. But the rationale is the same. Less idealistically, there are other people for whom untraceable bank accounts are rather helpful.

Go on...
Bitcoin’s anonymity attracted illegal operations. Its most famous use, until recently, was as the currency in an online narcotics emporium.

So why has its price risen so fast? A rise in the demand for drugs?
Not quite. It looks like the tax on bank deposits in Cyprus spooked some people, who jumped to buy untaxable, unfindable Bitcoins. Then, as the price rose, more people bought in.

People bought because the price was rising?
They expect more rises. It’s a modern tulip mania.

Except without a pretty flower at the end of it.
Or a Kate Middleton plate.

So what does the rise in the price of Bitcoins mean?
In the real world, even when inflated to $1.5bn, the Bitcoin market is tiny. That said, the inflation hawks who bought early can make a killing from the rise in the price. If, that is, they can be persuaded to turn them in for government-backed money. You know, the kind you can buy actual stuff with.
And the drug dealers?
They’re probably pretty happy right now, too.
Copyright The Financial Times Limited 2013.

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