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Bitcoin has been in the news a lot lately, and it is described in many ways: as a form of payment, as an investment, and as the flagship example of a recently adopted name: CRYPTOCURRENCY. One word often missing from these descriptions? Money.
Developed in 2009, Bitcoin is a form of digital currency wherein units of value, Bitcoins, are exchanged via a peer-to-peer network (a peer-to-peer network involves users sharing and exchanging information without a centralized body). The name cryptocurrency comes from cryptography, which is the secure measure used to protect Bitcoin transactions online.
Well, volatility for one thing; the value of Bitcoins has fluctuated from mere cents all the way up to over $1,000. It’s also still rather rare in the marketplace, there are currently just over 13 million Bitcoins in existence. But Bitcoin is growing, and fast. In August, one of the largest Bitcoin providers, Blockchain, announced that they had over 2 million users. How popular will Bitcoin have to be before we start recognizing it as real money? To help make sense of this fairly new technology, let’s look at Bitcoin from both sides. Here are some pros and cons to this increasingly popular cryptocurrency.
Ordinarily, it is the role of a government to control, regulate, and maintain a nationwide currency. In the United States, the US Treasury and Federal Reserve take on the responsibility of our dollar. Bitcoin, however, has no such centralized agency or ownership. By definition it is decentralized, and operates as a peer-to-peer network that is open and transparent to all users. The decentralized nature of Bitcoin transactions is described on Bitcoin.org, “Behind the scenes, the Bitcoin network is sharing a public ledger called the “block chain”. This ledger contains every transaction ever processed … allowing all users to have full control over sending Bitcoins from their own Bitcoin addresses. In addition, anyone can process transactions using the computing power of specialized hardware and earn a reward in Bitcoins for this service.”
While detractors may use its decentralization as a negative, Bitcoin enthusiasts actually see it as a positive. In their view, interference by governments and self-interested investment banks lead to the problems in our current economic system. Enthusiasts would also argue that we are trusting our monetary regulation to people who cannot be trusted. In the words of The New Yorker, “Hence the sudden appeal of bitcoins, which appear, for the moment, at least, to be immune to the machinations of inept or crooked bankers and politicians.”
Unlike most money, you can’t spend Bitcoin at your corner store. Because Bitcoin is currently unregulated, many merchants are hesitant to accept them as a form of payment. It isn’t yet insured by the FDIC, or Federal Deposit Insurance Corporation, so should any fraudulent activity occur involving Bitcoins, it is nearly impossible to have that “money” recovered. Can you call it money if you can’t spend it?
Part of what stops many economists from declaring Bitcoin “money” is its volatility. As of yet, it has not demonstrated sustained value. Take a look at the extreme peaks and values of the Bitcoin in the chart below (2009-2014). Sure, some people struck gold if they cashed in their Bitcoins at the $1,100 mark.. but with swings like those, who knows what it will be worth tomorrow?
Some, like the Winklevoss twins, of Facebook fame, say big bucks (they are heavy investors who are looking to start a Bitcoin based ETF). Doubters, on the other hand, say Bitcoins are worth a much lower $0, and expect that crash to happen soon. To that end, it is true that confidence in Bitcoin has suffered some serious blows as of late, most notably with the FBI shut down of the Silk Road last year. The Silk Road was an online community where users trafficked drugs and other illicit materials using Bitcoin for transactions. The take down exposed how, at that time, a huge percentage of Bitcoins were being used specifically for illegal activity. On top of that, more bad news struck when the Mt. Gox Bitcoin exchange, which was once the largest of the exchanges, went bankrupt in February.
The truth is that Bitcoins can be earned, and there are people out there who make a living doing so. Bitcoins are earned via solving complex mathematical equations; new equations are created at set intervals, and the first computer to solve them “wins” 25 Bitcoins. The process is often called “mining,” and is often likened to the process of “mining for gold.” In the early days, this could be done by people like you and me using personal computers, but now the speed and computing power needed to solve the equations first is so intense that only massive computers can get the job done.
*In fact, if you want to start “mining” tomorrow, you would need dedicated hardware that Bitcoin pros call “ASIC” (application specific integrated circuits). ASICs are incredibly fast and powerful circuits that are customized specifically to mine Bitcoins. They are also pretty expensive, ranging from hundreds to thousands of dollars, based on their amount of computational power.
The bottom line is, Bitcoin provides real income, both to “miners” who create Bitcoins, and investors who have seen their Bitcoins appreciate. And herein lies perhaps the chief argument that Bitcoin is money- you’ll be taxed on it! Although the US government hasn’t yet fully regulated Bitcoin, it will certainly be taxing you on your Bitcoin gains. As of March 2013, Bitcoin earnings are considered capital gains, and must be included on your tax return.
Despite their outlandish interest rates, most of us enjoy using credit cards as a means of spending because of the security they afford. Want to return a pair of shoes you bought? That balance can be returned to your card almost instantly. Victim of identity theft? Your credit card provider quick ensures that you won’t be charged for those transactions. It’s nice to have that security, and we have become accustomed to our “money” leaving a traceable, and correctable, path behind us. Bitcoin, however, is exchanged completely anonymously. Once your bitcoins are gone, they are GONE, even if taken from you fraudulently.
In fact, many of the arguments against Bitcoin can also be applied to good old fashioned “cold hard cash.” They are both spent anonymously. They are both impossible to recover if stolen. And they are both used by criminals for illicit activity. While these aspects might make Bitcoin slightly less desirable, they certainly don’t make it “not money.”
Let’s be real. Of course the idea of Bitcoins feels a little weird. Bitcoin is, at its core, simply software code and not directly tied to anything of value. You don’t get to touch it, lots of merchants don’t accept it, and your boss is certainly a long way from paying you with it. Bitcoin may be growing, but it is a long way from replacing dollars and cents.
In all fairness, commonly accepted currency hasn’t been tied to a source of actual value (i.e. GOLD) for ages. In fact, gold was officially removed from connection to the American dollar in 1971. But although it’s simply sheets of fancy paper, the use of money persists, because we all share a commonly accepted faith in its value. Bitcoin believers would argue: in today’s digital age, why shouldn’t that faith be shifted from a physical form of currency to a digital one? Although you can argue over whether or not Bitcoins are “money,” you cannot argue about how fast they are growing. Will they ever truly be a universally accepted currency? It depends on how quickly people like us start adopting them. So let us know in the comments, are you a Bitcoin believer?
[…] Bitcoin has captured the attention of news outlets, governments, hackers, entrepreneurs and regulators. It has the potential to transform the world of international payments forever; but given that nearly two-thirds of Americans don’t know what Bitcoin is, a good question to ask is: What is Bitcoin? […]Reply