The Rise and Fall (and rise again) of Bitcoin

Bitcoins have been causing quite a stir and amassing much interest recently. Part of this is thanks to the price skyrocketing in recent weeks. This digital currency of choice for hacktivists, described as “gold for computer nerds” is a peer-to-peer decentralised currency, meaning it isn’t controlled by any bank or government.

Bitcoin value in USD (08/04/2013)

Bitcoin value in USD (08/04/2013)

In the past, things worked differently. First there was commodity money, which was money that derived its value from the commodity from which is was made of, like gold, silver or seashell.

Then representative money was introduced. This money represented a value in gold. Banks stored gold and could only issue currency if they had the equivalent in gold in the bank vault.

The modern system of money, in which a national bank does not have to provide the equivalent in gold, means that the state can print an arbitrary amount of money. This fluidness was what enabled monetary policy, which is the idea that you can control a country’s economy, including unemployment and inflation, by changing the amount of money going into it.

An Okpoho manilla served as the traditional form of commodity money in West Africa until the 1940s

So how are Bitcoins different? Bitcoins do not rely on a central issuer like a bank or government. The way the Bitcoin protocol works is that everyone can see that a transaction has taken place on the public log, but only the two parties that took part in the transaction know where the money came from and went. To verify transactions, a complex algorithm has to be solved (very inefficiently) with a brute force method. This requires large numerical power, supplied by ‘miners’ who use their computer’s resources to help with the transaction of Bitcoins. Once one of these miners have completed enough of these puzzles they are rewarded with Bitcoins. The ease with which these Bitcoins are mined becomes exponentially harder until a finite amount (฿21 million) has been reached. The system itself is encrypted to prevent anyone from meddling and the code is self-sustaining to prevent inflation (no quantitative easing here, sorry Mr. Osborne). This fixed amount differentiates it from Dollars, Sterling, or Warcraft Gold and makes it comparable to other traditional commodities such as gold and therefore subject to speculation.

When first introduced they were very cheap, ($1 could get you ฿1300, which means that if you had invested $1000 in Bitcoins at the time, you would now have 182 MILLION DOLLARS!), the price then rose steadily until the first bubble back in 2011, largely due to media coverage, where it peaked at $33 but returned to normal (roughly $2) few months later. The recent surge in value, over 300% in a month, coincides with the financial crisis in Cyprus and no doubt the lure of a deregulated alternative investment channel – a safe haven from the prying hands of the European Central Bank, a role which Bitcoin fulfills. The current value of the Bitcoin economy stand at over $1Billion, the rise in value generates more interest (creating a positive feedback loop) and perhaps another bubble. So, as it stands, are your Bitcoins any safer than a Cypriot bank account?

All transactions occur over a p2p (peer-to-peer) network, making them all public. You are only identified by your Bitcoin wallet address, a random string, beyond that there are no identifying characteristics. Buying and trading Bitcoins utilises public key cryptography, to encrypt the transactions.  You can see these transactions occurring at blockchain.info. The anonymity of using Bitcoins is helpful to people who are not able to use normal payment services as they live in a country which block them, people who live in oppressive regimes etc. It also facilitates the exchange of illegal goods and gambling. Famously, the darknet website called the Silk Road, where drugs (among many other things) are sold, only accepts Bitcoins. There are also many legal ways to spend your Bitcoins, you can buy coffee, pizza, even a house directly without exchanging them for Dollars, Sterling etc… WordPress now accept them as a form of payment too. A full list of legal online and material services and products can be found here. With such a volatile currency, you must be thinking how is it possible to conduct business in a currency that fluctuates in such a short time. The reality is that the cost of products and services being sold for Bitcoins are expressed in dollars and converted at the market rate for Bitcoin at the time of transaction.

The future of Bitcoin relies on people’s confidence and their willingness to use them. This relies on a trust the it can hold its value. Unlike normal currencies it doesn’t have governments or central banks backing them. Its current volatility arises from a relatively low amount being in circulation. The main trading exchange MT.Gox has already come under attack from hackers hoping to cash in and one wonders how long it will be until the rush to be first out of the market leads to the next crash. In the long term, the currency has already gained large acceptance and usage around the interwebs to secure its future. Hopefully by then it will settle to a more stable amount and be a more viable alternative form of payment, making transferring money as easy as sending an email.

-Salman

Feature image by Isokivi

  • http://theconscience.com Iyobosa

    I really enjoyed this, well written. One concern I have, you say Bitcoins are exempt from governmental/ bank control. But they are expressed in $ terms? So they are reliant on the price of $. Please clarify. Thanks.

    • salman128

      The price is merely expressed in dollars as a comparison, similar to how oil prices or gold prices are given in dollars because of their international prevalence. In the same way that cost of gold isn’t reliant on the value of the dollar, merely traded in it, as are most commodities. You can see what the current price of Bitcoin is in different currencies here: http://bitcoinprices.com/

      • http://theconscience.com Iyobosa

        Thanks a lot, Very helpful.

  • http://www.mundybuddy.org Mundy Buddy

    Pretty good article. I am wondering because of the up and down price of a BTC how easy can it be to exchange services/products. We need everyone would need a smartphone and look-up the value before they made a sell with someone in Dollars.

    • salman128

      Tbh im not entirely sure but at the moment, most websites do this automatically, and yes, the volatility is a problem. Until it stabilises, it will remain difficult to trade on a day to day personal basis.

  • http://www.segmation.com segmation

    I don’t know if I believe that Bitcoins are worth something. Is it worth something because the current price is too high?.

    • salman128

      Bitcoins are inherently not worth anything, just bits and bytes of memory, they only have any value because people give it a value, why is a $50 note, a piece of paper got any value, because we all agreed to the fact it does, however if the US govt was to not exist tomorrow, it would probably have no value as a piece of paper. It terms of buying them now, that is the question every investor faces. Incidentally, there was an attack on the Mt.Gox exchange today that caused a massive drop in price.

  • http://georgetgeorge.wordpress.com georgetgeorge

    Reblogged this on WEB REVEALED and commented:
    Bitcoin, the digital currency, lost more than $160 (£104) in value on Wednesday, just hours after hitting a record high.

    Until recently Bitcoin had been a largely obscure currency used by the tech-savvy, libertarians wishing to thumb their noses at central bankers and people involved in more nefarious activities such as online gambling (often illegal in the US) or drug deals.

    There are around 11m Bitcoins in circulation, 25 new bitcoins are produced every 10 minutes, and they are traded through online exchanges like Mt.Gox.

  • http://scintillatingsilver.wordpress.com S.C.

    I think Bitcoin is really interesting. I love old coins and currency (in fact, that’s what my own blog is about) but really, anything that people perceive to have value has value. If vendors are willing to accept Bitcoins, then Bitcoins have value.

    That said, I don’t own a single Bitcoin, and I’d personally be wary of getting into that market right now just because it seems the price is so high compared to what it was. But maybe this kind of currency is just a taste of our future?

  • http://nodisappointment.wordpress.com Benny

    I had no idea what a bitcoin was until I read this blog. Thanks for teaching me something today! Cheers.

    • http://piecubed.wordpress.com piecubed

      You’re welcome! Thanks for reading!

  • http://www.klifton.org/ Klifton

    Reblogged this on Klifton and commented:
    Here is a brief Bitcoin story.

  • http://shiggyenterprises.wordpress.com Dirk Porsche

    Well said. Congrats to being freshly pressed. I owned some Bitcoins a few weeks ago. Unfortunately, I left them on the exchange (bitmarket.eu) where I bought them. Thinking it to be a more secure place then my hard drive. Unfortunately one of the administrators gambled with the customers coins and lost all of them. Including mine.

    I’m waiting for the next big price drop to get me some new. I see it more as a long term investment, anyway.

  • http://beautyalongtheroad.wordpress.com Beauty Along the Road

    Just this week I heard about bitcoins for the first time and here is this great article that explains it all. Great synergy. Thank you.

  • http://magicsthoughts.wordpress.com Magic (magicsthoughts.wordpress.com)

    Me and my wife discussed the Bitcoin which rises a concern for me. Ideally this is currency without regulation. There is a supply and demand technic that is at the hand of its creators. Technically they can control the supply and demand just like the Fed does. This makes the currency fluctuate rapidly making it unstable.

  • http://designforyouandme.wordpress.com vandammetienne

    personally, I like the idea but I wouldn’t buy any, it’s just too risky. I prefer good old $or€ :p
    http://design4youandme.wordpress.com/

  • http://www.washingtonstarjournal.com washingtonstarjournal

    Reblogged this on Washington Star Journal.

  • http://jaketar.wordpress.com mlnarik

    So, maybe I didn’t read closely enough but if there’s no issuer of bitcoin, then how did this currency come to be? I mean, who or what is it that introduces a numerical value of bitcoin into existence? My first thought is; how is it that some programming wizard couldn’t just wind up turning out fake money and wheeling in real dollars? Sorry for all the questions, but this could be stuff it would pay off to know in the near future.

    • salman128

      The “issuer” is an algorithm, by people helping the algorithm to compute by allowing it to use its processing power , the algorithm rewards you with Bitcoins, but as more are issued, it gets harder and harder to get rewarded, meaning more computing power is needed. Also the total number that will be allowed to exist are capped, like there is a finite amount of gold on Earth, but we are unlikely to reach this limit for a quite a few years yet.

  • http://aashuli99.wordpress.com Aashuli

    I have been trying to understand this issue and this article has been great help! thankyou!