This boom-bust cycle has already happened once before for Bitcoin. It hit nearly $31 in June 2011, then crashed, hitting $2 five months later. In essence, Bitcoin is similar to the “gold standard,” the monetary system in force before modern central banking started to take root in the 1930s. Under the gold standard, each unit of currency was worth a certain amount of gold, leaving governments few means to increase the amount of currency in circulation. No country uses the gold standard today, but some libertarians want to revive it, and see Bitcoin as a modern-day alternative or complement. “If you wipe away the misguided economics courses that we have, deflation doesn’t have to be a negative,” says Jon Matonis, a board member of the non-profit Bitcoin Foundation, created last year to foster and protect the system. “It’s not a bad thing when a citizen’s purchasing power increases.”
What is Bitcoin, exactly? Proponents will tell you it's a nonfiat currency. It's a way to do transactions in the modern age free from the government, bank, and regulatory restraints of our current fiat system. They'll tell you it's the future of commerce. It's a panacea from financial oppression. Others will tell you that Bitcoin is a flash in the pan asset, not a currency at all. It's a tulip bulb. It's a series of ones and zeroes being traded -- no, speculated upon -- without any underlying value or practical application. There is even a website devoted to maintaining the current Bitcoin-to-tulip bulb exchange rate (690 at the time of this writing, if you're looking to trade your leftover Thanksgiving orange tulips).
Like it or not, bitcoin is wrought with fraudsters, schemers, and other clever bad guys. The New York Times has reported of several instances of such schemes, including Boiler Room-style pump and dumps executed using Twitter. Earlier this week the Chinese central government barred the nation's banks from accepting bitcoin. The Bank of France issued warnings as well. Despite these soft actions, the fraudsters still act without fear of repurcussion. From the Times article:
Fortune magazine's Stephen Gandel spent a good amount of his time this week attempting to short Bitcoin. Gandel, a very smart financial mind, couldn't figure out a reasonable method to achieve the trade. Traditionally, a short trade requires shares to be borrowed from a current owner. Besides the fact that no mechanism to allow borrowing exists, would you be comfortable letting digital cowboys borrow your money in the Wild West? Gandel was able to buy put options, derivative contracts that did allow him to bet against a rise in bitcoin value, but the costs involved with executing the trade didn't make economic sense. The trade would have lost money even if the value of a bitcoin plummeted 55%! Hard to justify losing money when a price moves 55% in your favor. Does this sound like the silver market to you? Me either.
Would you consider illegal drugs as a viable investment? Drugs are in demand, and as the War on Drugs raging on, the product is in short supply. But the economics don't matter in that example because of government intervention. Your entire investment could be scooped up by the DEA at any time (and also, there is the whole legality/jail time issue). The same is true of Bitcoin. With the Chinese government all but banning the currency from mainstream adoption, a significant portion of the market is wiped out overnight. The New York Times estimated that about 30% of global bitcoin purchases come from China.
Bank of America should be applauded for attempting to stay ahead of the curve. Unfortunately, this report provides no real value to investors or even bitcoin speculators. The assumptions built in are simply erroneous at this point in bitcoin's evolution. Perhaps time will prove me wrong, but for now I won't be buying any bitcoins and I'll only be buying tulips for Mother's Day.
Damn it. This next article really bothers me because it makes a lot of sense and has several valid points, particularly micropayments. It makes a strong argument for legitimizing Bitcoins. My two main concerns still remain though. First, the fluctuation of the market. If I am a vendor and I sell a product for two Bitcoins and then I go to restock my supply but have to pay four Bitcoins to my supplier because the value wildly decreased in the last few days, then I will lose money on the transaction. If I instead convert it to cash immediately rather than keeping the Bitcoins for future transactions, then why would I bother with the expense needed to maintain an accounting /processing system for that type of alternative payment? I'm not really concerned about privacy or masking the customers identity.
Second, what happens if the whole Bitcoin ledger disappears? I admit, I'm a bit uncertain about how the process works from a computing standpoint but if the whole system is based on computer code, what is to keep it from being unwritten? We know nothing about the identity of the system founders. Who's to say they aren't fiscal terrorists who want to move everyone to a new form of currency and then erase that system once everyone is dependent upon it. Yeah, I know I'm a bit paranoid but again, we know hardly anything about the developers of the system or the permanence of the currency. So far, it remains an intriguing and scary endeavor.
Each bitcoin is represented by a string of numbers and letters. To verify that every transaction is legit, a worldwide network of computers constantly checks these cryptographic signatures.
Those computers are also locked in a contest to solve cryptographic puzzles. This is called mining. Many participants join mining pools to combine their computational power for faster solving.
The winner gets a block of 25 new bitcoins. Over time, that bounty is set to decrease in size, limiting the total number of bitcoins in circulation. As more computers join the network, the puzzles get more difficult.
Miners serve a vital role: They add bitcoin transactions onto a public ledger called a blockchain. This database allows anyone to follow bitcoins from transaction to transaction.
Once mined, new bitcoins go into circulation. People can buy them through online services like Coinbase or directly from another user. (In a few North American cities, bitcoin ATMs dispense them.)
Once acquired, btcoins must be stored. Some users keep their cryptocurrency in digital wallets on their computers or smartphones with apps like Bitcoin-Qt and MultiBit. Others store them in the cloud, relying on services like Coinbase.
The number of individuals and businesses accepting bitcoins is exploding. Today they can be spent everywhere from independent restaurants and hotels to major retailers like Overstock.com.
Once a transaction has occurred, other computers on the network then validate and record it on the official bitcoin ledger—the blockchain. The network groups several transactions together and assebles a new cryptographic puzzle. Miners then begin attacking the new problems, which for now are designed to be solved in about 10 minutes.
he new bitcoin millionaires are a weird breed: government-hating libertarians rich enough to hack the systems that make Washington, DC, function. In that town they even began to sound a little like VCs themselves. “Setting regulatory certainty is very important for bitcoin,” Ver says. “I’m opposed to the regulations, but the bitcoin businesses need to know the rules of the game in order to move ahead.” Neither venture capitalists nor crypto-libertarians will win the fight for bitcoin’s soul if the currency’s fledgling system implodes. And it could. Companies in the emerging legitimate bitcoin industry—wallet builders, exchanges, payment-processing services—can’t get banking services because bankers still have no clear idea how regulations apply to these companies. On top of that, the bitcoin network itself is struggling to deal with its own rapid growth. It can process only seven transactions per second (Visa can handle 10,000). But some clarity may be coming. This year the superintendent of the New York State Department of Financial Services, Benjamin Lawsky, expects to spell out a set of guidelines for plugging bitcoin companies into the financial system. These rules are likely to influence states across the US. If they’re too stringent, bitcoin companies will probably close their doors or set up business offshore. This is the risk that playing nice with regulators presents: They might regulate you out of existence. Meanwhile, Mt. Gox represents the risk of the Wild West approach: Without safeguards, a centralized authority, or some way to protect people’s digital holdings, the whole thing may be seen as fundamentally unstable and collapse on itself.