During the past four months, the best performer among the world’s currencies, and across just about every imaginable asset class, has been Bitcoin, a country-less digital exchange medium invented in 2008 by someone who remains anonymous to this day. In fact, he hasn’t been heard from in over a year.
Bitcoin.org describes itself as “an open source [peer-to-peer] digital currency.” At the end of 2012, one Bitcoin traded for around $15. Last week, it briefly broke $200 before a roller-coaster trading session left it closer to $100 on Friday. How can this be? Bitcoins have no intrinsic value, no guaranteed exchange rate, and aren’t backed by gold or silver. Then again, the same could be said for that dollar in your pocket.
Both amount to “fiat” currency — coins and notes that have no intrinsic value but simply rely on the good faith and credit of the issuing authority. The West didn’t invent the idea; historians seem inclined to give that distinction to the Chinese. But during the 20th century the United States worked to perfect many of the institutions upon which our fiat currency is based: things like the Federal Reserve, the Bretton Woods Accord, and really fancy printing presses.
The mathematical framework for Bitcoin was published under the pen name Satoshi Nakamoto in November 2008. The system went live in 2009 using a network of third parties that maintain transaction ledgers and solve complex computing puzzles that determine how new coins are created. Users store their dough in digital wallets on computers or mobile devices. The software design rigidly controls the total number of coins. In 2140, total circulation will max out at 21 million. The 11 million coins in circulation today are worth roughly $1.5 billion. Not bad for a four-year experiment.
Establishing an ironclad limit on the number of coins is crucial to maintaining confidence in the currency as a store of value. Unlike its counterparts around the globe, the Bitcoin supply is not subject to government interference, monetization of debt, or the inflationary pressure of devaluation. To date, the only threat to Bitcoin’s steady rise was a hack on a digital wallet company in Japan. Hacking may appear to be a weakness, but the attack was contained, the currency recovered, and the system is more secure than ever.
The system has both champions and critics. Listen long enough, and the phrase “Ponzi scheme” will come up eventually. But the track record of the world’s central banks is nothing to brag about. Prolific and destructive currency collapses are spread throughout the past 100 years: Weimar Germany in 1923, Argentina in 1932, Mexico in 1994, Thailand in 1997, and Russia in 1998. Who knows whether today’s euro crisis will end in a similar place?
Currency exists for one reason: to facilitate commercial transactions. To the extent that Bitcoin effectively serves this function, it will continue to thrive. Critics contend that a high number of Bitcoin transactions go toward online gaming — or more sinister purchases. But the list of commercial sites and products accepting the digital currency continues to grow rapidly.
Since January, the Bitcoin transaction rate has doubled to 70,000 per day. The currency can be used to buy music and electronics, take yoga lessons in Vancouver, or contribute to a candidate for Congress in North Dakota. Reaching a few hundred thousand transactions a day by year’s end would not be unthinkable. At that point, an observer might argue that the system is no longer “experimental.” Digital currency could be here to stay.
Of course, countries aren’t lining up to jettison their own currencies (although the idea may appeal to more and more euro members every day). The forces of technology that guard against forgery and political manipulation may be particularly attractive in unstable regions around the world. Although Bitcoin.org recommends against using the system for bank-like “savings,” the technology to securely protect larger amounts of Bitcoin wealth can’t be far away. That would put it in direct competition with “real money” for the first time.
And what of the US dollar — still the world’s reserve currency? The Federal Reserve has set interest rates at 0 percent. It owns a massive balance sheet, and continues to purchase bonds at and unprecedented pace. President Obama’s budget takes the national debt to over $17 trillion by 2020. The uncounted liabilities of Social Security and Medicare will burden our children with trillions more. That’s a lot of pressure on something with “no intrinsic value.”
Echoing the words of Churchill: Never have so many put so much confidence in so little.