Consumers and devotees of tech news are coming across an increasing number of articles devoted to the topic of Bitcoin (BTC); a decentralized encrypted peer-to-peer digital currency or cryptocurrency. Merely google the search term “bitcoin” and one will find a multitude of articles written about the topic since April of this year, the approximate point the topic went viral on the web.
Lauded by members of the hacker and libertarian communities, the Bitcoin recently has come under increased scrutiny from various members of Congress due to the Bitcoin’s use as the single currency of exchange for the infamous underground website Silk Road (commonly referred to as the ‘Amazon’ or ‘E-bay’ of illegal drugs) located on the Tor network.
The long term viability of the currency is still hotly debated amongst proponents and cynics, but it seems that many economists are relatively cynical about the currency and its viability as a medium of exchange in the digital economy of the 21st century. Adam Cohen’s article on Quora is a good representation of this viewpoint.
Currently, the BTC to USD exchange rate is hovering in the mid to upper $20s (USD). Due to the recently increasing interest and media exposure, the currency is the midst of what I believe to be a price bubble since speculators appear to be bidding up the price of the Bitcoin relative to the Dollar. Because there is still a limited market for goods and services for the Bitcoin, the real purchasing power of the Bitcoin is difficult to determine. As such, the value of the Bitcoin is still primarily based on its value of exchange relative to a “hard” currency such as the US Dollar (USD). If I had purchased bitcoins roughly 4 weeks ago, and someone were willing to buy them from me today, I would stand to gain a 300% - 400% profit because the BTC to USD exchange rate was averaging around $7 - $8 (USD) at the time.
Bitcoin Market Charts
From an academic perspective, I find the rise of the Bitcoin fascinating because it is a live socio-political and economic experiment in the real world. Nevertheless, I have serious concerns regarding the long-term viability of the currency.
1) The currency is not backed by any government.
Some libertarians find this to be a good thing, I do not. Not having a central governing authority means that one must rely on the goodwill of merchants to provide goods and services in exchange for currency in the absence of a regulated marketplace. More importantly, I find that enthusiasts of Bitcoin will typically assert that the adoption of the currency is so radical that is has the capacity to overhaul the existing global economic and financial system.
If this assertion has even a remote possibility of becoming true (e.g. our world will be radically changed), make no mistake, governments around the globe will unite together to ban the currency, thereby making it illegal to hold and use as a medium of exchange which will drastically increase the difficulty of converting BTC to “hard” currencies such as the USD or Euro. The protection of one’s national currency is linked to the security of the state. Unless full scale exchanges exist for goods and services, the value of the Bitcoin will plummet since one will not be able to convert the Bitcoin into other currencies due to the ease at which governments can shut down the bank accounts held by the various BTC currency exchange markets.
2) The system appears to be ripe for use in money laundering and other illicit activities.
In politics, perception is everything. I previously mentioned how the Bitcoin is undergoing increased scrutiny from the US government. It is now starting to come to the attention of other world governments as well. Regardless of one’s position on the “war on drugs” and other libertarian issues, if a significant portion of market for goods and services taking payment in Bitcoin is illicit in nature, or at least perceived to be, the currency is at risk of a crackdown by government authorities.
Intuitively, an encrypted P2P virtual currency is highly attractive to purveyors of vice wishing to escape the tracking capabilities of various world governing bodies and law enforcement institutions. To the average individual, Bitcoin currently represents an en vogue anonymous currency with which to engage in money laundering, sex trafficking or the sale of illicit drugs. For politicians looking to appear tough in the war on crime, the Bitcoin is fast becoming an attractive target regardless of the merit of such targeting.
3) The Bitcoin is neither as secure nor as private as many would believe.
Jeff Garzik of Bitcoin recently delivered the following quote to the news media:
“With bitcoin, every transaction is written to a globally public log, and the lineage of each coin is fully traceable from transaction to transaction. Thus, /transaction flow/ is easily visible to well-known network analysis techniques, already employed in the field by FBI/NSA/CIA/etc. to detect suspicious money flows and "chatter." With Gavin, bitcoin lead developer, speaking at a CIA conference this month, it is not a stretch to surmise that the CIA likely already classifies bitcoin as open-source intelligence (no pun intended).
Further, if Silk Road truly permits deposits on their site, that makes it even easier for law enforcement to locate the "hub" of transactions.
Attempting major illicit transactions with bitcoin, given existing statistical analysis techniques deployed in the field by law enforcement, is pretty damned dumb. :)”
Victor Grishchenko concludes the following (full analysis here):
“In terms of peer-to-peerness, privacy, security and usability it might actually [be] worse than the present-day real-world legacy banking system.”
I tend to agree.
-JT
Sometimes you simply amaze me.
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