Bitcoin by Bitcoin

You might never have heard of Bitcoin. But there’s a good chance that we might be using it for our online shopping soon—indeed, some people are already doing that. Its usage isn’t limited to the online domain either. Certain Subways in the US are already accepting Bitcoins as payment[1], and many small businesses are following suit. Someone even bought a ticket to space with it.[2]

Image courtesy of Zach Copley, © 2012, some rights reserved.
Image courtesy of Zach Copley, © 2012, some rights reserved.

There is also a possibility that Bitcoin would crash and all this hype would just be put down to the human tendency to behave like magpies when things seem ‘innovative’.

The first question we have to ask is obviously, ‘What is Bitcoin?’ According to its website, ‘Bitcoin is an innovative payment network and a new kind of money’. Just a new virtual currency? Not quite. Unlike virtual currencies like QQ, which at its height was estimated to account for 13% of its native Chinese cash economy, Bitcoin doesn’t have a central controlling authority such as a central bank, making it much harder to control. That said, its decentralized nature is one of the reasons why it’s so popular, as the reputation of financial institutions suffered considerably in the wake of the financial crisis.

Bitcoin functions through a Peer-to-Peer network that connects ‘Bitcoin wallets’, which can be downloaded free of charge. Its users ‘collaborate on a vast ledger of all transactions’[3] which prevents double spending. In order to gain BItcoins you could accept it as payment, buy it with ‘hard currency’, or participate in a ‘mining pool’[4]. ‘Mining’ is a process in which computers (or usually more sophisticated set-ups) individually or jointly discover ‘blocks’ by solving a complex algorithm, which can then be converted into Bitcoins. The rate of block creation is generally constant over time, while ‘the number of Bitcoins generated per block is set to decrease geometrically… so that the number of Bitcoins in existence will never exceed 21 million’[5]. In other words the more miners there are the harder it will be to get Bitcoins.

I won’t be going into the nitty-gritty economics of the matter— there is a burgeoning body of literature on that accessible through a simple Google search. Instead I will be looking at possible IR implications of the use of a decentralized currency like Bitcoin on transnational crime, transnational corporations and national image.

Countries reacted to Bitcoin differently. The US held a Senate Committee hearing on the 18th November titled ‘Beyond Silk Road: Potential Risks, Threats and Promises of Virtual Currencies’ specifically to address whether or not Bitcoin is a threat. The mention of Silkroad, an online drugs retailer, highlights concerns of governments across the world at Bitcoin’s potential to be used for illegal purposes.

Silkroad was an online black marketplace where people could buy, amongst other things, narcotics anonymously by using Bitcoins. It was shut down by the FBI and its founder was arrested, but it is up and running again at the time of writing. During the hearing, Mythili Raman, the acting assistant attorney general of the Justice Department, claimed that the decentralized nature of Bitcoin makes it difficult for law enforcement to ‘follow the money’ when investigating cases of drug purchase or online pedophilia.

However, blaming Bitcoin for facilitating illegal activity and putting it under tight regulation might not be the wisest move to counter transnational crime. First, Bitcoin itself is not responsible for such criminal activities—regulating it would do little to curb such activities, as people could just switch to older methods such as anonymous pre-paid credit cards. Second, over-regulation would just drive its servers to other countries with laxer regulation, which would make it even harder to monitor[6]. The Senate hearing seemed to recognize this and most reactions were positive.[7] However, the epicenter of the Bitcoin market seems to have left the US already—China recently overtook the US in terms of downloads of the Bitcoin client[8], and its Bitcoin marketplace BTC China accounts for 35% of global Bitcoin transactions. The first BItcoin ATM was opened in Canada, not the US. While it makes sense to be cautious, this phenomenon definitely affects the image of the US as a hotbed for innovation. Indeed, China was quick to assert its free-market credentials. Yi Gang, the deputy governor of the People’s Bank of China said ‘it would be impossible to recognize the Bitcoin as a legitimate financial instrument in the near future […] but people are free to participate in the Bitcoin market and he would personally adopt a long-term perspective on the currency’[9]. A favourable report run by CCTV, the state television channel, also suggests implicit support from the central government.

Another worrying implication has to do with Bitcoin’s volatility and the potential for it to be used by transnational corporations (TNCs) for wage payment. Bitcoins, with all its merits, remains a highly volatile currency, easily affected by the speculation of countries and investors. The Bitcoin exchange rate to ‘hard currency’ fluctuates on an hourly basis. Long term changes are even more drastic— Bitcoin went from a 453.3 USD low on 20th November to a 869 USD high on 23rd November.[10] Due to its volatility many treat it as an investment rather than an actual currency—‘Researchers found that 64%of all bitcoins are being hoarded in accounts that have never been spent.’[11] It is interesting to speculate on whether TNCs that accept Bitcoins as payment might start using it to pay wages to workers in foreign subsidiaries, instead of immediately converting it into ‘hard currency’. After all, one of the major strengths of Bitcoin is the lack of transaction fees. This in itself is unproblematic. However, it is plausible to assume that most workers under these conditions would not be aware of the volatility of the financial product they’ve been given, and consequently would be especially vulnerable to its fluctuations if they used Bitcoins as savings.

The Senate hearings and Chinese responses confirm that Bitcoin will be here to stay. Will it attain widespread usage? At this stage its future popularity is anyone’s guess. If usage reaches a certain volume some have argued it would become the IMF’s responsibility to protect Bitcoin’s stability should it come under a speculative attack. Either way, Bitcoin will force countries and consumers alike to reconsider their views and ways of spending money. I’ll put my money (or Bitcoins) on that.

2 Replies to “Bitcoin by Bitcoin”

  1. While innovation is always a good thing, the possible abuse and illegal use of this new currency medium, in my opinion, should limit its widespread use for some time. Speculation is the primary threat for Bitcoins, as the violent price swing during November has shown. Basing a payment system on such an unstable “currency” presents a real danger for any business. Can you imagine the economic implications, if the British pound went from US$1.60 to US$3.20 in one month? Money laundering is also a very real possible use of Bitcoin, which would be a nightmare for law enforcement.

  2. Bitcoin crashed 30% before finally settling at a 20% down. “This is worse than the tulip mania,” said Nout Wellink, former president of the Dutch Central Bank. “At least then you got a tulip [at the end], now you get nothing.”

    “Bitcoin Crashes” –

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