Bitcoin Puzzle: Heads, It’s Excitement. Tails, It’s Anxiety.
ECONOMICS, 2 Dec 2013
George Frey | Bloomberg | Getty Images
Bitcoin isn’t ready for popular consumption, and it may never be.
It doesn’t fit into a neat product category. Often called a virtual currency, it’s not legal tender anywhere on the planet. It’s not an income-generating asset class suitable for most investors. Its value, in dollars, fluctuates wildly from one minute to the next. And while it can be a cheap way of transferring money, there are too many glitches in its emerging network for bitcoin to be entirely reliable.
Even its advocates have been raising red flags. As Patrick Murck, general counsel for the Bitcoin Foundation, a nonprofit devoted to “fostering the bitcoin ecosystem,” acknowledged in a Senate hearing last week, “It’s very much still an experimental currency and it should be considered a high-risk environment for consumers and investors at the moment.”
Yet bitcoin has been receiving plenty of attention, and not just because well-publicized speculators have been making money on it.
High-risk experiment though it may be, bitcoin embodies an elegant and disruptive technology. It uses file-sharing, the peer-to-peer computer innovation that spawned early music services like Napster, Kazaa and LimeWire. In their early days, they sometimes walked on the wild side, but their experiences led to a wholesale digital transformation of the music business.
(Read more: As bitcoin skyrockets, is a bubble at hand?)
Bitcoin gives file-sharing a brilliant twist. In essence, it has created “a decentralized virtual currency that uses a peer-to-peer consensus system to confirm and verify transactions,” two researchers at the Federal Reserve Bank of St. Louis concluded in a recent study. And François R. Velde, a senior economist at the Federal Reserve Bank of Chicago, made this assessment in a new report on bitcoin: “It represents a remarkable conceptual and technical achievement, which may well be used by existing financial institutions (which could issue their own bitcoins) or even by governments themselves.”
Bitcoin’s advantages as a low-cost means of transferring money have intrigued a number of corporate clients of the law firm Proskauer, though none of them are using it, said Jeffrey D. Neuberger, co-chairman of the firm’s technology, media and communications group. “It’s an early-stage technology,” he said. “But it could be revolutionary.” In short, in a world that some people consider almost as important as music — the precincts of money and finance — bitcoin, or a successor technology that shares its DNA, is given a good chance of influencing the future.
That’s what made last week’s hearing of the Senate Homeland Security and Governmental Affairs Committee so intriguing. It assessed the “potential risks, threats and promises of virtual currencies,” with bitcoin foremost among them. So what is bitcoin today? Senator Thomas R. Carper, Democrat of Delaware and chairman of the committee, acknowledged that he wasn’t sure how to make sense of it: “Virtual currencies, perhaps most notably bitcoin, have captured the imagination of some, struck fear among others and confused the heck out of the rest of us, including me.”
The Senate committee’s attempt to get a grip on the digital currency was, in a way, the first step in what will surely be a continuing tension. On one side are those seeking ease and anonymity in transactions; on the other is the government.
Speculators and money launderers have already found much to like about the relatively anonymous digital currency, and that has forced the government to play catch-up. Bitcoin allowed the website Silk Road, which the government shut down in October, to become “the largest illegal drug and contraband marketplace on the Internet,” according to Jennifer Shasky Calvery, the director of the Treasury’s Financial Crimes Enforcement Network. While it was in business, customers “were required to pay in bitcoins to enable both the operator of Silk Road and its sellers to evade detection and launder hundreds of millions of dollars,” she said.
The virtual currency isn’t impervious to determined government snooping, however. “We are innovating as criminals are innovating,” said Mythili Ramam, an acting assistant attorney general, at the hearing. Individual bitcoin transactions are encoded, but large numbers of them may be compared statistically with other databases available to the government, and patterns will emerge, several experts said.
(Read more: Bitcoin world domination ‘a bumpy ride’: CEO)
While bitcoin users need a secret, numerical key to unlock their accounts, the anonymity of the system is vulnerable when the virtual currency is exchanged into dollars. Federal and state authorities are requiring firms that exchange bitcoin into currency, or use it to transfer funds, to comply with existing regulations. But when the movement from bitcoin to hard currency takes place in a country where American authorities don’t have access, “there may be opportunities for money-laundering,” said Mr. Neuberger at Proskauer.
The S.E.C., for its part, has been warning investors of the danger of “potential investment scams” involving bitcoin and other virtual currencies. In one case, it has charged Trendon T. Shavers, a Texas man, with running a bitcoin-based Ponzi scheme with the promise of vast riches.
“Con men read the headlines like everyone else,” said Lori Schock, director of the S.E.C.’s Office of Investor Education and Advocacy. “Bitcoins sound sexy and new, but at the end of the day, if they’re making claims about limitless wealth from unregistered investments it comes down to an old-fashioned Ponzi scheme.”
The agency is also studying a legitimate bitcoin proposal by Cameron and Tyler Winklevoss, the technology investors best known for their involvement with Facebook, to open an exchange-traded fund, or E.T.F., that tracks the bitcoin market. If the E.T.F. is ever approved, a fund based on a volatile virtual currency is hardly likely to be a safe, core holding for buy-and-hold investors.
More from the NYT
An Abridged History of Bitcoin
Bitcoin Gets a Cautious Nod From China’s Central Bank
Regulators See Value in Bitcoin, and Investors Hasten to Agree
In the meantime, the virtual currency’s soaring value has inspired tales like this one: Kristoffer Koch, 29, of Oslo, told the BBC last month that he bought $22 worth of the currency while doing technical research on it four years ago. He promptly forgot about it. When he unlocked his long dormant account recently, it was worth $850,000.
Even with all of its problems, the eventual creation of a reliable, decentralized, peer-shared, computer-based currency remains the holy grail in some circles. Back in 1999, Milton Friedman, the Nobel laureate who remains the guiding light of many libertarians, predicted its eventual arrival. He saw the Internet as a congenial environment for innovators. Markets would flourish in cyberspace, freeing people from what he considered the stifling grasp of a paternalistic and inefficient government. But one ingredient was missing, he said. He called it “a reliable e-cash.”
(Read more: Bitcoin hits the road from limos to hotels)
What was required, he said, was e-cash that enabled you to “transfer funds from A to B, without A knowing B or B knowing A — the way in which I can take a $20 bill and hand it over to you and there’s no record of where it came from. And you may get that without knowing who I am.”
Unfortunately, that would create new problems, he said, because such a currency would have “a negative side.”
“The gangsters,” he said, “the people who are engaging in illegal transactions, will also have an easier way to carry on their business.”
That tension is part of progress, he said. It may be where we find ourselves now.
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