Bitcoin started out 2013 as a little-known novelty, a form of money that doesn’t fold or jingle. By December almost half of Americans polled had heard of it — even if quite a few thought it was an Xbox game. Enthusiasts foresaw 2014 as the year when a mixture of Silicon Valley and Wall Street money would turn some Bitcoin entrepreneurs into newly minted titans of finance, but so far it’s been a mixture of disaster and farce. One thing that’s improved is its volatility: Bitcoin’s value on trading exchanges soared from $13 in January 2013 to more than $1,200 by December, then fell to around $600 before settling down. To supporters, its value signifies growing trust in the digital currency, while others see Bitcoin as a bridge to a more efficient virtual economy. Detractors just see a bubble. They all may be correct.
In 2013, Bitcoin grew up the way an errant child sometimes does: getting punished, followed by a chance to start fresh. In October, prices plunged after U.S. prosecutors indicted the operator of Silk Road, an anything-goes online market where drugs were peddled for Bitcoin. China cracked down on Bitcoin exchanges in December, and the European Union warned that users are vulnerable to fraud and theft. As advocates fanned out in Washington, U.S. regulators including New York’s superintendent of financial services started hashing out detailed rules of the road. Ben S. Bernanke, the former chairman of the Federal Reserve, said virtual currencies “may hold long-term promise.” The short term has been less forgiving. Mt. Gox, a Tokyo-based exchange, filed for bankruptcy in February after realizing hackers had spirited away 850,000 Bitcoins. And the U.S. Internal Revenue Service ruled that Bitcoins would be treated as property, not currency — meaning that buying a $2 cup of coffee with Bitcoin you bought for $1 could trigger a capital gains tax.
Virtual currencies are not new — online fantasy ventures such as Second Life have been using them for some time — but the prospect of a secure currency without a central issuer has rightly turned heads. Bitcoin’s pseudonymous creator, Satoshi Nakamoto, solved a problem central to any currency: how to control its issuance, i.e., prevent counterfeiting. At the same time, he also solved one specific hurdle for digital money — how to stop users from spending the same unit of currency over and over. His breakthrough idea involves an online ledger that records, anonymously, every single Bitcoin transaction. The ledger is created through code-breaking work done by a network of Bitcoin “miners” that validates each transaction, preventing double-spending. The miners earn a reward of newly issued Bitcoin. The pace of creation is limited, and no more than 21 million Bitcoins will ever be issued; by the end of 2013, more than 11 million were in circulation. Bitcoins can be used to buy an ever-expanding list of things, including a Tesla sports car, while new exchanges are making it easier to acquire the currency by using old-fashioned money.
Bitcoin’s early adopters were mainly crypto-anarchists and arch-libertarians looking for an alternative to fiat currency, money that is valuable because a government says it is. As Bitcoin moved toward the mainstream, other perspectives emerged. A new breed of speculators treated Bitcoin as an asset to be traded for profit, leading some, including former Fed chairman Alan Greenspan to call it a bubble with no intrinsic value. Entrepreneurs with venture capital backing, like San Francisco’s Coinbase or Boston’s Circle Internet Financial, see Bitcoin as something more mundane and potentially more important: a new kind of payment system. Just as software protocols let people easily swap e-mails and web pages, virtual currencies will let people exchange value online without the cost, hassle and risk of bank transfers or debit cards. But not yet. Patrick Murck, general counsel for the Bitcoin Foundation, cautioned that it’s “an experimental currency, and should be considered a high-risk environment.”
The Reference Shelf
- Bloomberg Television has a video primer as part of its “The 12 Days of Bitcoin” series
- Bloomberg Markets traced the interest of Silicon Valley investors in Bitcoin.
- CoinDesk has a Bitcoin price index; Bitcoincharts.com has a range of data.
- Two explainers, one aimed at kindergarteners and the other a you-too-can-mine-Bitcoin project, plus an exploration of the double-spending problem.
- The New Yorker looks at Dark Wallet, a project meant to speed the spread of Bitcoin, from the law student who invented the printable gun.