Bitcoin: Beauty or bubble?

LAURA WALTERS
Last updated 05:00 28/12/2013
Bitcoin first emerged in 2009.
Bitcoin first emerged in 2009.

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He insists we communicate through Viber instant messaging.

After the initial communication we meet in a dimly lit bar in Auckland's CBD.

I struggle to hear him over the music but I daren't ask him to speak any louder in case the wrong person hears.

John (not his real name) comes across as a normal 22-year-old. He works a Monday to Friday office job and loves football. But the young professional spent more than 18 months earning a bit on the side by selling illicit drugs.

There's nothing new or different about this but John's method is interesting.

John is one of a growing number of people to use the untraceable virtual currency bitcoin to buy drugs online.

He says he was drawn to the anonymity of the currency. There's no intermediary, no transaction, no bank account details. "I'm not anti-government. It's just an entrepreneurial spirit."

However, in the past couple of months bitcoin has come out of the shadows as global financial institutions, entrepreneurs, investors, businesses and consumers weigh in.

The Bank of America released a research paper earlier this month saying bitcoin can become a "major means for e-commerce and may emerge as a serious competitor for money transfer providers".

However, the bank also says volatility is hindering general acceptance of bitcoin. It warns bitcoin's 100-fold increase in value this year is at risk of "running ahead of its fundamentals".

A Texas judge, Amos Mazzant, said in August that bitcoin was a legitimate currency.

"The only limitation of bitcoin is that it is limited to those places that accept it as currency."

Born out of the ashes of the global financial crisis, bitcoin is a nerd's way of flipping the bird at society. Bitcoin was devised and launched in 2009 by a mysterious crypto-inventor, who goes by the name of Satoshi Nakamoto.

The currency is "mined" by computers that unlock bitcoins by solving complex algorithms.

There are about 12 million bitcoins in circulation at the moment and only 21 million units can ever be mined.

ANZ senior manager of foreign exchange and quantitative analytics Sam Tuck says for bitcoin to be generally accepted, people need faith in the computer networks and their impenetrability.

There is no-one backing the currency, he says. It is not regulated by a central bank.

That means bitcoin cannot be manipulated by printing more of the currency or the rise and fall of economies. However, the lack of responsibility adds to the risks, Tuck says.

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Recent hype has led to high demand for the limited amount of bitcoins. The value broke through US$1000 (NZ$1200) last month.

Despite the pickup in demand, the bitcoin has had trouble shaking its shady past. Like John, opportunists here and around the world have used, and continue to use, bitcoin as a cloak of anonymity for their illegal deals.

Silk Road, an online marketplace of illegal goods hidden in the deep web - a lower level of the internet not indexed by standard search engines - was shut down by US authorities in October. However, similar online markets including Silk Road 2.0 have popped up in its place.

New Zealand Customs intercepted more than 500 packages between February and October containing drugs bought from websites such as Silk Road.

The underworld's association with bitcoin is not the only reason people are sceptical about the currency. An array of highly publicised attacks, hacks and blunders has put the spotlight on the risks associated with it.

In October a four-month-old Australian bitcoin bank was hacked, say media reports.

The service's operator, known as Tradefortress, said all A$1.3 million or 4100 bitcoins were stolen.

A Welsh IT worker was left digging through the rubbish after accidentally disposing of a hard drive containing 7500 bitcoins, then worth almost $9m.

Last month New Jersey acting attorney-general John Hoffman said online video gaming company E-Sports Entertainment entered into a US$1m settlement, resolving allegations it infected thousands of personal computers with malicious software code enabling it to illegally mine bitcoins.

IN AUGUST, the New York State Department of Financial Services said it was "vital" to bring virtual currencies out of the darkness and into the light of day through enhanced transparency.

New Zealand's Commerce Commission says bitcoin is covered by the Fair Trading Act and the Commerce Act. However, a lack of regulation isn't stopping those keen to jump on the bandwagon.

Technology commentator and e-business expert Stefan Korn says Kiwi software developers have been mining bitcoin and using it to pay and be paid for years.

"The fact that early adopters are some of the world's big corporate players should give people confidence," he says.

Last month serial entrepreneur Richard Branson's space travel company Virgin Galactic started accepting bitcoin. The Winklevoss twins, of The Social Network movie fame, plan to make US$20m (NZ$24.1m) by floating part of a bitcoin trust on the US stock exchange.

Hundreds of mobile apps are available for buying, trading and storing bitcoins and there are even bitcoin ATMs in Sweden, Canada and Turkey.

More than 12,000 businesses including Walmart, WordPress, Reddit and Kim Dotcom's Mega, the successor of seized Megaupload, now accept the currency.

And last month a Canterbury vineyard started accepting bitcoin.

Pyramid Valley managing director Caine Thompson says the vineyard is getting requests from international customers to pay with bitcoin because they don't want to worry about exchange rates and transaction fees.

Self-described polymath and bitcoin evangelist William Mook bought a bottle of wine from Pyramid Valley with the bitcoins he mines using his supercomputers.

"In January 2013 I had a supercomputer fresh through customs, a paper by a mathematics professor, a software programme I downloaded from GitHub and zero bitcoins."

The Christchurch-based American says he was able to predict the currency's movement to make a fortune.

He hopes to have 21,000 bitcoins in a year's time.

He acknowledges the currency has experienced spikes in its four years, but he does not think it is a bubble waiting to burst.

Korn agrees that bitcoin will continue to grow. "If it does work it'll transform daily life in the next 10 to 15 years," he says.

Now is the "tipping point".

If bitcoin makes it over the volatility hurdle it will stabilise and in about 50 years it could overtake the US dollar as a global currency.

"The biggest risk for financial institutions is they become irrelevant."

Tuck says there's no way bitcoin could replace the US dollar. Even when all bitcoins are mined it's unlikely there will be enough value for it to take over as the No 1 global currency, he says.

"It's only worth what people think it's worth."

However, Tuck says there's no reason why bitcoin can't become a "significant player".

But at the moment investing in bitcoin is a "highly-speculative leveraged bet", he says. "It's akin to gambling."

Former US Federal Reserve chairman Alan Greenspan labelled bitcoin a "bubble" earlier this month during a Bloomberg television interview. And China's government banned financial institutions from trading in bitcoins, leading to a drop in the currency's value.

Meanwhile, financial planner van Eyk Advice likens the virtual currency to gold because of its finite amount and lack of relation to economic activity.

"Neither really provides a solution to the problems of the fiat money system and for that reason neither is likely to replace money as we know it today."

However, bitcoin has no less claim to legitimacy than gold, provided people are willing to continue to accept it as a valid store of value, van Eyk Advice says.

Milford Asset management portfolio manager Felix Fok says bitcoin is a "massive experiment".

There is clear speculative demand, with buyers using it as investment for capital gains rather than currency. However, it is hard to predict when or why the bubble will burst, especially if merchant acceptance continues.

"This has the potential to threaten Visa, Mastercard and eBay long term if it becomes an efficient payment method."

It's this ever-growing bubble that led to John's exit from the world of bitcoin a couple of months ago after the price got away from him. "It outpaced me."

When John first bought into the market bitcoins were $40 a piece, he says. Last month they rocketed to a high of US$1242 ($1500).

There is no "textbook" way to deal with bitcoin, John says. He hasn't ruled out the possibility of investing in bitcoin but for now he is going to leave it to those who have everything to lose.

And there's the added bonus of letting go of the risk and paranoia associated with the illegality of his former bitcoin transactions.

On Monday, bitcoin prices were reported to be around US$375 (NZ$459).

BRIEF HISTORY

Bitcoin emerged in 2009 following the 2008 release of a research paper into crypto-currencies by mysterious programmer Satoshi Nakamoto.

There are about 12 million bitcoins in circulation, with a total possible circulation of 21m.

Bitcoins are mined or unlocked when a peer-to-peer network of computers solves complex mathematical equations.

The problems are becoming increasingly difficult as more bitcoins are released. This means they take longer to mine than before and more computing power is needed.

According to bitcoin data site Blockchain.info, the degree of difficulty and cost of power used means miners are currently operating at a loss.

In the past four years, the value of bitcoin has gone from virtually nothing to US$1242 (NZ$1500) last month. It then dropped to under US$400.

Blockchain.info says bitcoin went from a market value of US$143.8 million in January up to US$14.5 billion last month, an settled back to about US$11b.

Other virtual currencies include Namecoin, Litecoin and Peercoin.

- Fairfax Media

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