This past week, the media and investors alike have become enraptured with decentralized virtual currencies, and the star of the show is Bitcoin, the world’s first virtual currency. In 2009, Bitcoin presented data mining as an alternative mechanism for introducing currency into circulation, awarding miners with bitcoins for solving complex math puzzles. Bitcoin operates by a peer-to-peer structure, with computers working together to process transactions, and the currency is capped at a fixed supply of 21 million Bitcoins.
Proponents of Bitcoin advocate its potential to spark a legendary wave of financial innovation and improve international payments. With its low exchange fees, Bitcoin provides an opportunity for developing countries, with little access to financial services, to easily send and receive digital payments. Last Thursday, the LA Times reported that the University of Nicosia in Cyprus will accept Bitcoins as tuition payment and offer a master’s degree in digital currency, with hopes that the government will make Cyprus a Bitcoin hub. A plethora of other virtual currencies have emerged, such as litecoin, alphacoin, fastcoin, peercoin, bbqcoin, and fireflycoin, sharing the same underlying principles as Bitcoin with different algorithms. Bitcoin is the most widely accepted currency, with an implied value of $6 billion.
Virtual currencies have also ignited distrust and fear due to associations with money laundering, drug trafficking, and other illicit activities, sparking Senate hearings about potential regulation. Bitcoin was the digital currency utilized in Silk Road, an online market that funneled illegal drugs and services. Concerning virtual currencies, Ben Bernanke wrote that the Federal Reserve “does not necessarily have the authority to directly supervise or regulate these innovations or the entities that provide them to the market.” However, the Federal Election Commission denied Bitcoins as legitimate funding for political action committees last Thursday. Although each Bitcoin contains a digital record of where it has been since creation, PACs have to publicly identify their donors, and Bitcoins do not provide private names.
A graph of Bitcoin’s price since November 2012.
With irrational exuberance, investors optimistically bid up Bitcoin’s price to a high of $900. The recent speculative activity has amplified uncertainty around the currency’s actual value. This made me think of a discussion I had this Wednesday in my ‘Mapping Victorian England’ literature class, in which we examined Haggard’s King Solomon’s Mines, an adventure novel about Englishmen journeying through Africa in search of diamonds. A witch named Gagool mocks the Englishmen, “there are the bright stones that ye love, take as many as ye will; take them, run them through your fingers, eat them, drink them!” In class, we discussed that diamonds have no intrinsic value; instead, a diamond’s value is derived from society’s determination of worth. Just as diamond miners cannot eat or drink a diamond, the data miners cannot directly consume a virtual coin – but this does not make them worthless. The value of a Bitcoin is determined by the products and services that it can purchase. Bitcoin has been ridiculed as a worthless currency, but there is clear demand, with agents willing to accept Bitcoins as payment, and so they have real economic and societal value. Although the recent price rally was driven by speculation, the markets are attempting to price Bitcoins, and only time will reveal what this price will be.
Do you think Bitcoin and other virtual currencies will revolutionize the financial system? Should the government pass regulation, or should virtual currencies remain decentralized and open?