At this time last year, it seemed the world was falling in love with bitcoin, the alternative digital currency generated by a global computer network. Since then, the value of bitcoins has collapsed, falling 13 percent in just two weeks. Some of the digital prospectors who create the currency are shutting down operations.
But bitcoin loyalists remain as confident as ever in the future of digital money. Even a prominent bitcoin skeptic said the underlying technology will have uses far beyond finance.
“There are some breakthroughs in technology that are going to endure whether bitcoin survives or not,” said David Yermack, a professor of finance at New York University’s Stern School of Business.
Despite the currency’s travails, major investors continue to pour real money into bitcoin businesses. CoinDesk, an online publication that tracks the digital currency markets, estimates that investment in bitcoin startups reached $335 million in 2014.
On Tuesday, Coinbase, a company that helps people buy and sell bitcoins, received a $75 million investment from big-name institutions including the New York Stock Exchange and USAA, a giant insurance company that serves military veterans and their families.
Unlike traditional money, bitcoins aren’t issued by governments. Instead, they are generated by powerful computers that use complex math to create a “blockchain,” a record of all transactions made with bitcoins.
Because the blockchain is stored on thousands of computers around the world and is created using digital encryption, the record of each transaction can never be altered or erased. The people who run the blockchain computers, called “miners,” get paid in newly created bitcoins.
Back when bitcoins were worth more than $1,000 apiece, many people set up mining operations, using super-powerful computers costing hundreds of thousands of dollars. But bitcoins lost two-thirds of their value during 2014, partly because of a massive theft of bitcoins from Mt. Gox, one of the world’s biggest exchanges. In mid-January, the currency declined 34 percent in two days, though it has since rebounded. As of Sunday evening, one bitcoin was worth $255.10.
The value of bitcoin is determined just like that of a stock, by supply and demand.
And as the value of bitcoins has declined, many mining businesses are going broke and shutting down.
Meanwhile, only a handful of major companies, like Microsoft Corp., Dell Inc., and Overstock.com, accept payment in bitcoins, so the public has little reason to use the new currency.
Still, bitcoin believers say these are just teething problems.
“Five years ago, bitcoin was worth exactly zero,” said Jeffrey Tucker, a fellow at the Foundation for Economic Education in Atlanta. “The fact that it has any value at all is rather amazing.”
Tucker acknowledged there’s not much reason right now for the average American to use bitcoins. But he said the currency could make it much easier to do business internationally because bitcoin transactions don’t carry the steep transfer fees charged by banks. “Bitcoin takes cash transactions and makes them global,” he said.
Harry Yeh, managing partner at Binary Financial LLC in San Francisco, a hedge fund that trades in bitcoins, predicted the currency’s value will be more stable when the bitcoin market becomes more sophisticated. For instance, Yeh said his firm plans to start trading in futures contracts, in much the same way that currencies and other investments are traded, as a way to protect against fluctuations in the value of bitcoin.
Meanwhile, venture investors Cameron and Tyler Winklevoss, best known for their legal feud with Facebook Inc. founder Mark Zuckerberg, are setting up the first bitcoin exchange to be regulated by the US government. The brothers told The New York Times last week that the exchange, to be called Gemini, will boost confidence in the currency.
Yermack, from New York University, remains skeptical, noting how little interest bitcoin has received by the public.
“The penetration has really been quite small, relative to the media hype,” he said.
Yermack did say the blockchain has great promise to safeguard other vital information. For instance, the title to your home or car is recorded on a piece of paper and on a computer in a government data center.
“It can be altered, forged, burned down, and lawyers have to be paid to go looking for it,” Yermack said. But putting the same data on a blockchain computer network would be cheaper, far more secure, and easier to access, said Yermack, who predicted the blockchain technique will become the standard method of recording many important transactions.
Hiawatha Bray can be reached at firstname.lastname@example.org.