In last week’s article we suggested alternative currency was one of the "next big things” for the new economy. In particular, Bitcoin has enabled an explosion of interest in alternative currency. But what can Bitcoin’s approach and scale teach us about the future of such currencies? While Bitcoin has been successful, local currency movements have never truly taken hold. So what are the drivers of Bitcoin’s success?
For those of you following along at home, Bitcoin is a new breed of currency (this is a great primer). After a series of failed Internet-currency dotcoms in the 1990s (Beenz anyone? Flooz?), Bitcoin has seemingly solved one of the core problems: Who controls an alternative currency?
The Achilles heel of these startups was actually their own existence; if they failed, the currency doesn’t just lose some value, it stops working completely. And the landscape for an alternative currency is fraught with peril. The earlier attempts all were centralized startups, each proposing a competing faux-currency to ease online (providing simplicity and improving trust) transactions and slowly build a virtual currency of sorts. Their business plans generally involved taking margins from the transactions or cost differentials. The early Internet currency attempts ran into regulatory problems (most countries frown upon private companies setting up alternate currencies, it turns out), and had to evolve their offerings to avoid getting shut out.
Bitcoin provides something different. Instead of a currency that has evolved from being backed by precious metals into fiat currencies, Bitcoin is backed by cryptographic algorithms, and has no company--or even an identifiable person--behind it. This shared system provides an amazing openness for a currency: Every transaction is part of a public, collaborative log. However, the people behind those transactions are known only by their account numbers, in a world where you can create as many accounts as you like.
This is, of course, great for all sorts of things. First and foremost, it provides a peer-to-peer currency that is borderless and decentralized. As Ars Technica’s Timothy Lee has noted, Bitcoin might be primarily a threat to Western Union-style money transfer agents as a meta-currency that allows quick, fee-free transfers of value, requiring only someone who will exchange Bitcoins for your preferred local currency. It’s also a boon to activists worldwide, providing a secure and private way for anyone to contribute effectively anonymously. For all we know, the U.S. Attorney General could be personally donating to Wikileaks via Bitcoins, despite the fact that his public job requires a somewhat more aggressive stance. Well, we can hope.
Like any other good privacy technology, this cuts both ways. Bitcoins are also being used to purchase illegal drugs from a website only accessible through the privacy-protecting TOR network, and you can imagine other nefarious uses for which a nigh-untraceable currency could be used. These were also problems for the proto-currencies--just under 20% percent of Flooz’s currency flow was fraudulent credit card charges before the service shut down.
While Bitcoin doesn’t technically rely on a central company to succeed, it did almost bite the dust this past summer. Bitcoin, like any currency, relies on spaces to host transactions (not unlike banks). In June, the largest hub for Bitcoin transactions was hacked. This resulted in the loss of $500,000 worth of Bitcoins. This underlines two things--first, Bitcoins are not just some crypto-geek fantasy currency being used by a handful of people, but a currency valued at over $130 million before the hacking incident. Second, that it is proving to be resilient against these early hiccups. Bitcoin trading has rebuilt some of its value and is stabilizing around $5 per Bitcoin:
But the ultimate question: Whether this is replacing one fetishized commodity (gold) for another (computing power) is unclear. Bitcoin lacks the community support that local currency alternatives provide, while still facing the challenge of finding vendors who will accept it as payment. This is balanced by its openness, privacy, and potential for easy, secure, cashless, and immediate virtual transactions. In the global betting pool that is currency, though, I’d put some money on Bitcoin continuing to be a fascinating disruptive, decentralizing technology.