The Uncertain Future of Bitcoin

The new virtual currency is still a very limited means of exchange and unit of account compared to the majority of currencies. Its value has increased despite high volatility.

First of all, it is important to make a distinction between Bitcoin with a capital letter and bitcoin with a small letter. The first refers to a peer-to-peer decentralized payment system with no financial or banking intermediaries, based in a very sophisticated open-source software run and developed by volunteer experts called “miners.” The latter is the unit of account of this payment system.

Bitcoin and bitcoin were created in 2008 and were operational in 2009 by a/some very sophisticated and unknown programmer/programmers whose pseudonym was Satoshi Nakamoto. His/Their operational system is based on a mathematical proof and “miners” using the software programs follow the same mathematical formula when it comes to producing bitcoins. This formula and its software are public and free.

“Miners,” those who create bitcoins, are people or institutions that use highly sophisticated computing systems when doing increasingly complicated calculations to create and verify the transactions among their users. That is to say, merchants are the legitimate owners of bitcoins and every single transaction is supposed to be properly written down in a common register called block chain.

These “miners” create the blocks that shape a growing block chain and contain hundreds of transactions, as well as a random group of numbers and letters — hash — that is produced when applying a complex mathematical formula to the data of every transaction. In addition, they include the previous transaction hash and some final added data — nonce. Around 100 volunteer “miners” are rewarded for completing every block with 25 BTC, about $16,000.

Likewise, there is a maximal finite amount of bitcoins that “miners” can manage to produce, up to 21 million. The required mathematical calculations to reach that amount become increasingly complex. It is reckoned that this amount may be reached by 2041.

Bitcoins can be obtained either by creating them, which turns out to be impossible for any person or institution not already a “miner,” or by purchasing them with a credit card or cash in different markets or bitcoin exchanges. There are around 100 exchanges all over the world, the most important one today being BTC China, followed by Mt. Gox Japan up to February 2014 and now by Bitstamp in Slovenia, BTCe in Bulgaria, Huobi in China and Bitcoin Central in France. Since 2013, there have been some individual ATMs that are proliferating despite being scarce and costly.

Transactions can be made if both parties have accounts in the Bitcoin system in those exchanges. These accounts are called bitcoin wallets and are equal to physical wallets or banking accounts. There are two types of wallets: hot and cold. The first are stored in devices with Internet connections — computers or smartphones — and can be entered or stolen by hackers. The latter are offline. For regular use, many bitcoin owners keep the largest amounts offline and smaller amounts online.

Likewise, credit is not allowed, and participants cannot get into debt within the Bitcoin system. Payments can only be done in a single account, either the paymaster’s or the recipient’s.

Bitcoins can be used for purchases in some bitcoin shops such as BitcoinStores or Bitcoinshops or in some online shops such as WordPress, Overstock.com, Zynga, Tesla, Virgin, Reddit, OKCupid, etc. However, nowadays, the greatest worldwide use of bitcoins is, by far, online gambling.

From July 2010 up to today, bitcoin has undergone many attacks. For instance, in June 2011, a hacker attacked the Mt. Gox exchange in Japan and stole $500,000. In April 2013, Mt. Gox stopped operating for a day. In February 2014, Mt. Gox customers were unable to withdraw their balances due to hacker attacks; as a result, it collapsed and shut down.

China has made two decisions that will have a negative impact on the future of bitcoin: As of December 2013, the People’s Bank of China is no longer recognizing bitcoin as a currency and is forbidding banks to use it. Moreover, BCT China, the largest bitcoin market, will be unable to accept payments made in renminbi.

On March 27, 2014, the Internal Revenue Service, the United States fiscal agency, announced that it would treat bitcoins as property, not as a currency, for tax purposes. It did not recognize their existence and applied tax on capital gains to them, reaching a maximum of 20 percent. Many bitcoin users and merchants think it is good news that the existence of bitcoins is officially recognized.

Any currency or legal tender must play three roles: as a means of exchange that can be swapped by goods and services, as a security deposit that keeps its purchasing power in the medium and long term, as a unit of account by which all transactions and economic statistics can be measured.

The bitcoin is still a very limited and volatile means of exchange and unit of account compared to the majority of currencies. Its value has increased despite high volatility. It has swung from less than a dollar in June 2012 to $1,117 on Dec. 4, 2013, and back to only $398 today. This volatility is higher than most currencies, including emerging currencies and its main competitor, gold.

As it is not legal tender nor has it been backed by any state or central bank, nobody is forced to accept it by law, which is something fundamental for any currency. The bitcoin might be viable among those consumers who have limited or no access to the banking system, around 600 million people in the U.S. Nevertheless, its unit cost would be very expensive for them.

Finally, as expected, since it is a virtual currency, the transactions of which are secret, it is being used in many illegal transactions, especially in money laundering within drug trafficking.

Charlie Shrem, CEO of BitInstant, one of the most important American bitcoin exchanges, was arrested by the FBI for selling bitcoins to people who used them to buy illegal drugs on Silk Road, an anonymous black market that sold illegal drugs and was shut down by the FBI in October 2013.

A growing number of dealers and arms and human traffickers are trying to use bitcoins for their illegal activities instead of using high-denomination bills in dollars or euros, whose transaction costs are even higher.

Illegal transactions in bitcoins worth $100 million have been seized by the FBI. However, this figure will be increasing just as the FBI resumes its inquiries. South Korea and Thailand have already banned the use of bitcoins.

As of March 2014, the Financial Crime Enforcement Network, a U. S. bureau for the prevention of money laundering, is demanding entities that use bitcoins to register themselves as monetary services stores that will have to be monitored.

In short, bitcoins are unlikely to become a recognized currency because they are not supported by any state or central bank. Their technology is so sophisticated that it can turn the currency into an opaque “black box.” They might have a future as a means of digital payment since their transaction costs are still smaller than that of banks or credit or debit cards. However, their costs will also increase because they have to meet the transparency requirements imposed by the majority of states.