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Two sides of the bitcoin - wonder currency or tulip mania?

The virtual money is being hailed by fans as the wonder currency of the future and by detractors as the short-lived tulip mania of the 21st century

PUBLISHED : Tuesday, 26 November, 2013, 11:49am
UPDATED : Wednesday, 27 November, 2013, 5:43pm

It was one of the runners-up for the word of the year as chosen by Oxford Dictionaries; it has received a partial blessing from Ben Bernanke, the chairman of the US Federal Reserve, but a warning from US law enforcement agencies; it has soared in value by 5,000 per cent since the start of the year.

But financial authorities, not to speak of economists, are sharply divided on whether the bitcoin is the currency of the future or an empty promise with nothing to back it so that it will and should fade away.

The hearings before the US Senate last week illustrated the concern about virtual currencies, and particularly bitcoin.

Committee chairman Senator Tom Carper set the scene. "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," he said.

He is worried virtual currencies could ease the sale of "weapons, child pornography, and even murder-for-hire services".

Worry about use of bitcoins for illegal activities burst into the open with allegations about the underground US website Silk Road, sometimes described as the Amazon.com of illegal drugs, which used bitcoins as the currency of choice.

In October, the FBI raided and shut down Silk Road and arrested Ross William Ulbricht on suspicion of drug trafficking, soliciting murder, facilitating computer hacking and money laundering.

At the Senate hearings, Mythili Raman, acting assistant attorney general in the Department of Justice's criminal division, said since every transaction of every bitcoin is recorded, that constitutes a trail of evidence. She said: "Cash is still probably the best medium for laundering money."

But Raman then said: "Many virtual currency systems offer legitimate financial services and have potential to promote more efficient global commerce."

Bernanke's letter to the Senate committee cited 1995 testimony by Alan Blinder, then the vice-chairman of the Fed. Bernanke summed up Blinder, saying: "While these types of innovations may pose risks related to law enforcement and supervisory matters, there are also areas in which they may hold long-term promise, particularly if the innovations promote a faster, more secure and more efficient payment system."

After Bernanke's testimony and the comments of Raman about the "legitimate" potential of virtual currencies were published, the price for a bitcoin soared by more than US$200 and briefly touched US$900, a testament to the dream and the nightmare of the currency.

Volatile is too calm a word to describe the vicissitudes of the bitcoin from a lowly US$20 at the start of February. Even last week, after touching US$900, the bitcoin fell to US$500 overnight, then jumped to US$745, before continuing on a roller-coaster ride. On Monday, it was close to US$800 again.

Cash is still probably the best medium for laundering money

The bitcoin appeals to market purists. Its transfer is instantaneous, without the delay or the costs of going through banks. It does not have the storage or carrying costs of gold or silver.

Bitcoins are mathematically generated in a process called "mining" as computers go through number-crunching tasks. But the system was set up so that it became increasingly difficult to mine bitcoins, The maximum total number has been set at 21 million, so there is no way a national or multinational central bank can issue new bitcoins and devalue the currency. The mathematically pure logic of having the market set the rate even leads some supporters to hope the rise of the bitcoin could lead to the death of governments.

But the recent volatility could also lead to the death of bitcoins. Wolf Richter amusingly speculates on the Naked Capitalism blog that the US authorities may be encouraging the volatility as a way of killing the virtual currency without getting their hands dirty by banning bitcoins.

The volatility of bitcoins is reminiscent of other mania down the centuries for gold or land or even tulips.

But at the end of the day when the mania crashed, the losers had some physical possession to console themselves with.

Even if your bitcoins soar in value, you cannot see them; if your bitcoins crash, you have no physical asset. Is the pain of loss only virtual or real?


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