So, what is Bitcoin, anyway? As I see it, it’s a cross between a stock and a form of payment. It’s a form of payment because you can use Bitcoins to pay for things. You can also send small amounts of currency to people in other countries, without worrying about exchange rates or currency conversion fees. And this last is pretty important. No currency conversion or exchange rates.
It’s a stock because there’s a fixed number of “Bitcoins” in the universe. The value of each Bitcoin fluctuates based on the law of supply and demand. The more people that want to use them, the higher their value. One friend anecdotally reported Bitcoins bought in 2009-2010 for $1 (USD) each were recently sold for $1,200. That’s a lot of appreciation. But it’s not what Bitcoin’s evangelists focus on.
Marc Andreessen, founder of Netscape, recently wrote the best piece on Bitcoin I’ve read yet. You can read it here. Some of what I heard at the Bitcoin conference helped cut through the noise.
Bitcoin was envisioned as a peer-to-peer trustless exchange. In plain English, that means I want to do a transaction with you, but I don’t trust you with my credit card number or other personal information. I don’t care what country you live in, who you are, or what you do. You have something I want that has a value to me. It could be a computer, software package, document, box of cookies, bedspread…it doesn’t matter. You have it, I want it, but I don’t want you to know anything about me or my finances. I understand that any transaction we enter into will be irrevocable. That means I can’t call someone to say “Stop that payment.” Payment is made immediately. If you have a dispute, it has to be with the party you made the arrangement with. It’s about as arm’s length as you can get.
Information on every Bitcoin is recorded in what’s called a “ledger.” I think of it as the equivalent of the book and page number of the title to my old house in Boston. The book and page number didn’t change, only the owner of the title. When I sold my house, the ownership was transferred to someone else. The book and page number remained the same. Similarly, when someone pays for something with a Bitcoin, that spot in the ledger is transferred to the buyer. But thanks to technology, no one knows who the current owner of that spot is, or who the seller was. That information is encrypted and as far as I can tell, it cannot be unencrypted without a digital key. In fact, it’s very hard to separate Bitcoin, the currency, from Bitcoin, the technology. They’re inextricably linked. One could not exist without the other.
The very anonymity of transactions is a driver of concern for many. They cite Bitcoins as a ‘great’ form of payment for drug traffickers, murders-for-hire, and illicit weapons sales (the now-shuttered underground website Silk Road used Bitcoin as its exclusive method of payment). There’s no argument on that front beyond the obvious – cash works just as well, but is harder to manage. You’ve got to find a way to transfer it, find places to store it, retrieve it, and ultimately launder it. The digital nature of Bitcoin eliminates those problems. Still, there’s no denying that illegal activities have been going on for a long time. And while Bitcoin may make those activities easier, it also makes some very legal and healthy activities easier and less pricey as well.
As Mr. Andreessen points out, if you want to send relatives in other countries money, the banks (or Western Union WU +0.72%) might take a big bite out of that money transfer. With Bitcoin, there’s little to no transfer fee. And once you understand that core principle: minimal transaction cost, it starts to make sense why low-margin retailers like Overstock.com and electronics re-seller Tigerdirect.com decided to adopt it. As Mr. Andreessen points out, if you’re only making 6% selling some equipment, but are paying 3% for the credit card process, you’ve given away half your profit for little discernable value. And you have fraud risk. And chargeback risk. That makes Bitcoin sound really good.
But all is not sunshine and birds. There are a lot of things we take for granted with traditional currency that just aren’t there with Bitcoin.
First: At the moment, the currency is completely unregulated. That’s a source of joy for Libertarians, but a source of concern for potential investors. A panel of traditional and non-traditional investors at the conference all agreed that some level of regulation has to be in place before Bitcoin goes completely into the mainstream. It’s worth noting that Mr. Andreessen himself is now a Venture Capitalist who has investments in Bitcoin-based technologies. So he’s got a vested interest in its success. However, he’s not just a Venture Capitalist. He’s also a visionary who gave us the world’s first browser, Netscape. The man knows his stuff.
Second: Bitcoin’s value is not backed by anything real or tangible. The “gold standard,” as Mr. Krugman points out (using the words of fellow economist Brad deLong), holds an implication that when push comes to shove, gold can be traded for its own intrinsic value. It’s shiny, pretty, and people like to own it. Bitcoin has no such basis in reality. Of course, most countries, including the United States no longer tie their currency to the gold standard anyway. That standard began eroding in 1933 under President Franklin Roosevelt and was effectively ended in 1971 under President Richard Nixon. But Krugman argues (as does Mr. deLong), that it’s still in there somewhere. It creates the “floor” of what a dollar is worth. I know there are lots of people that would disagree with that statement, or who would say that floor is very far below-ground. I’ll let them duke it out. What’s clear is that the value of a Bitcoin is volatile. Treat it like a stock, and try to amass a lot of it, and you could take a serious financial bath.
Third: Bitcoins are not so easy to buy. The unregulated nature of the currency makes it hard to be sure you are dealing with a credible party. The self-descriptive site “howtobuybitcoins.info” starts with a warning to be very careful with your money. This is an area where regulation could really help.
Fourth: No one has found a way to really monetize the exchange of Bitcoins yet. While Bitpay (an intermediary between merchants and consumers) does charge a small fee, it’s still making most of its money on the spread between the Bitcoin and other currencies. It has a virtual stockpile of Bitcoins, and will pay participating merchants in the currency of their choice. So Bitpay’s corporate value is mostly based on the presumption that Bitcoins themselves will continue to go up in value. That’s not sustainable.
Having said that, it’s often hard to visualize how a new technology will generate wealth. I, for one, never imagined a way Twitter could be successfully monetized. I knew Facebook could make money. Twitter, not so much. I thought its highest and best use would be as the property of a news service. I was wrong.
The net for me is that the jury is still out. I’m not dismissing Bitcoin out of hand, nor am I going out looking to buy a swath to keep under my virtual pillow. I understand why retailers like Tigerdirect.com and Overstock.com are accepting the currency. In low margin businesses, there’s a lot of appeal to a low cost method of payment. In the wake of the Target TGT +0.25% data breach (with others to follow), guaranteed transaction anonymity and security will appeal to a lot more consumers.
Paula Rosenblum (Forbes)