Editor’s Note: my InformationWeek India article was first published on January 20, 2014. Given the recent volatility in crypto prices and the continuing questions around its relevance, I wanted to show that this mania has been going on for years.
Critics are quick to judge Bitcoin and the concept of virtual currencies. These technologies do indeed possess many risks. But once “cryptocurrencies” are fully baked, virtual currencies could do to transactions what the Internet did to information.
In the age of crowd companies, digitally-driven social empowerment and advancing technologies, new technologies and memes jump to the forefront of public awareness and publicity more quickly each year. Hype bubbles rise, peak and burst ever more fleetingly as new concepts capture the public’s attention.
The hype bubble du jour: Bitcoin and related virtual currencies. The media has caught wind of the story and headline opportunities around Bitcoin, and as awareness builds, people the world over are scrutinizing and weighing in on Bitcoin even as it struggles through its nascent infancy. Opportunistic headlines instill fear, uncertainty and doubt by asking questions like, “Bitcoin: a solution, or a menace?”
Let’s take a less sensational look at Bitcoin from a risk/reward factor.
What has driven the rapid adoption and interest in Bitcoin?
With any exchange between two parties, agreement is reached on the value of what is being exchanged. This applies to Bitcoin as it does to stock pricing, cash purchase or gold. And as with any trade, there is some risk inherent in the transaction.
As solvency in the financial system and the intentions of big banks and governments have come into question—fuelled by hair-raising scenarios like the 2013 Cypriot deal to give some depositors a significant one-time deposit levy—investors and consumers have looked for ways to avoid such risks and to remove “questionable” middlemen from the equation. Enter virtual currencies: peer-to-peer transactions that might escape the fees and taxes sought by treasury and tax departments and bank shareholders. Bitcoin’s adoption is such a reaction to governmental policies and financial manipulation, offering the opportunity to work around unwanted interference.
Bitcoin’s main value comes from its utility, particularly around international remittances and the empowerment of unbanked consumers. Money, goods or services can be transferred via Bitcoin between two consensual parties without risk of transfer fees, high taxes, or the prying eyes of the NSA or other governmental entities.
As awareness and usage of Bitcoin has grown, its adoption has increased its value. One site estimates that more than 20,000 businesses now accept Bitcoin as a form of currency. Law firms, e-commerce sites, hosting companies, dating sites and even US NBA basketball teams like the Sacramento Kings now accept this digital currency. And in a huge sign of acceptance, Internet retail giant Overstock.com began accepting Bitcoin early this month. It’s reasonable to assume that the more businesses (and consumers) that accept Bitcoin, and the more the initial hype bubble wears off, the more stable and valid it will become as an alternate currency.
ATMs that allow fiat-cash/Bitcoin exchange are beginning to appear (particularly in Canada). As cash and bitcoin conversion becomes more accessible, more people will inject money into the ecosystem. By adopting Bitcoin as a common currency, liquidity within the ecosystem will grow as will the ease of moving larger amounts of virtual cash.
But early stage technology means there is plenty of risk
There is no question that such a new approach to currency is fraught with risk.
Part of the problem of Bitcoin is the differing mentalities of currency speculators versus consumers who want Bitcoin’s utility. As the trade price skyrockets, speculators buy up more of the outstanding bitcoins in an effort to see a healthy return. Yet this creates a volatility that reduces the benefit of Bitcoin and raises concerns from those who would benefit from its utility.
As governments and central banks begin to intrude into this peer-to-peer phenomenon, as seen in December 2013 when governments in China and India began shutting down exchanges, investors worry and sell, creating a Bitcoin valuation plunge (albeit the valuation has returned to previous levels within weeks). This extreme volatility represents significant risk to potential Bitcoin users. If the future consists of heavy government intervention into peer-to-peer transactions, Bitcoin could die a very quick death.
Adding to the danger are the multiple impacts of hackers. Security software provider Kaspersky Labs predicts Bitcoin wallets will be targeted more heavily in 2014. Hackers create bot-nets on the computers of unsuspecting consumers to mine for bitcoins, some set up phony exchanges, and others attempt to hack wallets in order to gain access to funds.
Large banks can invest millions in state-of-the-art security software and hardware. Your household PC? Not so much.
Also, investors with greater Bitcoin stashes can influence the system. And since the US FBI recently became the holder of the largest Bitcoin wallet, they can have impact on its value. Recent reports show the FBI has confiscated nearly $120MM in today’s value from former Silk Road sites and affiliates.
Finally, newer, superior “cryptocurrencies” could arrive on the scene, easily diminishing the value of early efforts like Bitcoin. Remember Friendster? Tribe.net? Orkut before Facebook?
Too early to be judged?
Virtual currencies are a very new concept. While many risks exist, I would suggest that as with any empowering technology, the future potential upside is huge—as long as we have the patience to see this through.