In the past few years, a curious new economic fad has swept across the world, spurred by the rapid rise of one simple piece of software. You’ve heard about it on the news, you’ve read about it on the Internet and if you’re bold, daring and wealthy enough, you may have actually bought something with it. I am speaking of course, about bitcoin.
Bitcoin is a digital currency that was released as open source software in 2009 and which has led to the meteoric rise of digital currencies in every corner of the globe. As lucrative as they are dangerous, in their short lifetime, digital currencies have seen stunning rises and destructive implosions – making and breaking millionaires faster than the regulated markets ever could. The volatility of bitcoin and other currencies is worrisome, but their popularity and rise cannot be denied.
As I write this, one bitcoin is worth US$582. What one will be worth when you read this is anyone’s guess. And therein lies the true question: Do digital currencies represent the future of economic transactions; is the rise of currencies such as bitcoin an inevitable part of the future, or just a temporary fad?
Certainly, varying forms of digitised currency have been in existence for years. PayPal is still one of the most popular forms of payment worldwide, but PayPal is not a currency in itself and it acts within the regulated markets of the nations that it operates in.
In Brazil, a couple of ingenious economists made clever use of digital currency to save the nation from hyper-inflation that had plagued it for decades. In order to stop the runaway prices, Brazil began to pay people not in the regular cruzeiro, but in the URV (Unit of Real Value) which was in fact a virtual currency.
By listing all prices and monetary information in URVs and by paying all Brazilians in URVs – an entirely fictional currency – the central bank could control the exchange rate between the URV and the cruzeiro until stability was achieved. In 1994, the URV was converted into the real, Brazil’s current currency, and the cycle of hyperinflation was broken.
In theory there is nothing wrong with companies such as PayPal virtualising payments or Brazil’s inspired use of digital currencies with the URV. But bitcoin, is essentially unregulated.
In most modern nations, the national currency is tightly regulated and has a complex web of backups and insurances to back it up in case of collapse. When things go wrong, when companies go bankrupt or stock markets crash there, there is some retribution for those affected.
The lack of regulation and consistent government acceptance, and the lack of a safety net truly make the future of bitcoin a scary prospect.
Recently, one of the major bitcoin exchanges went into bankruptcy. Known as MtGox, this bitcoin exchange was the victim of a hacking attack which cost them US$460 million. Frighteningly, speculative markets have even sprung up around the the money tied up in the bankruptcy of MtGox, paradoxically creating entirely new possibilities for calamitous failure. Perhaps even more worrisome though, is the rise of competitors and imitators. Cryptocurrencies, as they are technically known, have sprung up all over the world with names such as litecoin, peercoin, namecoin and megacoin.
Perhaps it is from Brazil that we can learn the strongest lesson about bitcoin and these other “startup” currencies. Despite using electronic currency to save their economy, just last month the Central Bank of Brazil released a statement warning about the dangers of bitcoin. In essence, they warned that unregulated digital currencies lack one of the most important features a currency must have: trust of the players involved. Without the trust of governments, corporations, financial institutions and the people at large, I believe bitcoin will always remain on the periphery of legitimacy.
As with almost every other aspect of our lives, digitisation is inevitable and therefore digital currency as an idea will not die off. However, I do not think that the current incarnation of digital currencies will live on much longer.
Bitcoin and its imitators will eventually lose out in favour of new alternatives that are either government sanctioned or government sponsored, giving them stability, a safety net and the trust of the people. Digitising currencies across the globe could lead to greater market stability, and even the eventual adoption of a single world currency.
So back to the central question: Are digital currencies the future, or just the fad of the moment? Well, I think that digital currencies do represent the future but bitcoin and its rivals are the fad of the moment, eventually to be replaced by regulated, trusted institutions.
