Bitcoin and the Value of Money

12/04/2013

Bitcoin is a digital currency, favoured of late by a number of tech-savvy futurists looking for an alternative to regular monetary systems. While this all might sound a little ridiculous at first glance, Bitcoin has experienced massive growth since its introduction in 2009. Bitcoin works through an open-source encryption protocol based on peer-to-peer technology, similar in ways to some file sharing services and torrent networks. The Bitcoin system is not managed by a central authority, and works without the need for any kind of intermediary bank or financial institution.

Bitcoins are created by users of Bitcoin software, in a process known as mining that involves solving a complex mathematical problem with a computer. The answer is a 64-digit number that takes some time to solve, and the reward is 25 Bitcoins. In order to regulate the Bitcoin economy, the value of a single Bitcoin changes in relation to the complexity of the equation, which is automatically adjusted to match the market. If you think this all sounds more like a computer game than an alternate economy, you are certainly not alone.

However, Bitcoins can be used to buy goods online, in much the same way as PayPal or regular online banking. While the market is still very small, there are a growing number of online retailers who accept Bitcoins along with regular money. Along with clothing websites, computer stores, and pizza joints, there are also a number of exchanges where regular currencies from around the world can be transferred into the online currency.

There are a finite number of Bitcoins in circulation, with 21 million the cap and 11 million currently shared among users. Instead of regulating the economy by adding more units like conventional economies do with printed currencies, the number of coins extracted per equation is halved every four years. In this way, the Bitcoin system shares more similarities with the finite gold and silver markets than it does with conventional currency.

Bitcoin has been in the news lately due to the rapid rise and fall of the currency, with the value of a single Bitcoin rising from $20 to more than $250 in April before falling back to $60. While regular currencies are also liquid, these extreme and rapid ups and downs are enough to make anyone question the long-term stability of Bitcoin. While the Bitcoin community are still trying to work out why these swings were so large, they certainly created enough of a splash to make everyone aware of this new currency.

Many critics of the Bitcoin ecosystem also refer to trust and security issues, with recent fluctuations in the Bitcoin market coming at least in part from a distributed denial of service (DDoS) attack on Mt. Gox, one of the biggest exchanges. Along with ongoing security issues, users of the system also have to trust unregulated institutions with their financial data, trust the longevity of the network, and trust that governments won't intervene to take down the currency in case of illegal activity.

Despite the obvious problems associated with this currency system, the rise of Bitcoin manages to raise a number of interesting questions about the nature of money. The Bitcoin system all seems a little silly until you realise that all money works in much the same way, being in essence a symbolic system that only works so well because everyone takes part in the charade. The physical form of money is divorced from its value in much the same way as a Bitcoin is, the only difference is that traditional currency systems have enough history and scale to make them more relevant and secure.

While Bitcoin is an interesting theoretical experiment and a useful exchange for a small segment of the population, it is unlikely to threaten or even impact upon traditional currency markets. No matter what the future is for Bitcoin, it has certainly brought up a number of questions about the intrinsic value of currency and the importance that faith and consensus play in any economic system.