Bitcoin – Confidence, Speculation, Hacks and Demand

Bitcoin – Confidence, Speculation, Hacks and Demand

Fellows and Associates’ independent correspondent Oliver Cox discusses the reputation of the bitcoin and whether it deserves a legitimate standing in the world of currency.

Bitcoin is the most influential of the online crypto-currencies which have been coined recently. People use it for purchases in increasing volumes, while traders exploit its high volatility to generate large returns. Bitcoin’s reputation is bipolar: representing freedom from borders, exchange rates and central banks; being associated with fraudsters, extreme unpredictability and devastating hacks. Inasmuch as a conventional currency maintains veracity by making the units difficult to forge, bitcoin’s workings are encoded meaning that individuals cannot make their own¹. National currencies are supported by their governments and by complicated national and international mechanisms, whereas the value of a bitcoin depends on demand. In this way, bitcoin is regulated by a freely determined relationship between individuals, while being more vulnerable to confidence bubbles and hacks.

The Ears of Authority are Pricked Up

This June, the Bitcoin Foundation received a cease and desist letter from the California Branch of Financial Institutions , after being accused of trading without a licence. This – while somewhat misplaced given that the Foundation does not touch bitcoins – signals that governments are starting to take notice of the new currency. A month earlier, the Costa-Rican authorities closed down the Liberty Reserve transfer company, which had laundered $6 billion’s worth of crypto-currency for a variety of crooks and hackers.

This attention jeopardises one of the central aims of the bitcoin: independence from the restrictions of government and the borders which they erect between each other. Bitcoin’s central contradiction means that these liberal and utopian intentions are hijacked by people whose goals are insalubrious; the crux being: can governments make things tough for the illicit bitcoin without hurting its legitimate counterpart? The corollary of which is: do they want to?

Other Advances

Within the borders of the national currency system, many companies have released payment systems which quicken and simplify the process of making a purchase or transferring funds. For example, NatWest’s Pay Your Contacts application enables customers to send money to an individual via their mobile number. No conventional bank will accept a balance in bitcoins, which is understandable given its lack of regulation. In addition, the incentive to invest in bitcoin is not present as with regular currency given that its value is (currently) appreciating. At present, bitcoin users can make payments in the wild by scanning a QR-code into their wallet application – of course, only in outlets which actually accept bitcoins. It will mean a regulatory migraine for the authorities when the banks start accepting bitcoins – which they may have to – while meaning an explosion of freedom, anonymity and internationalism when one can pay by bitcoin through the contactless method, a debit card or a phone.

Confidence, Speculation and Hacks

Bitcoin’s passivism in certain respects leaves it vulnerable to the attacks from which nations are used to defending their own currencies. Apparently (the situation is complicated by the hacking from which bitcoin exchanges suffer) this currency has suffered two confidence bubbles, one in October 2011 and one in April 2013. The most recent market carnage saw bitcoins traded at above $250 each then falling to $120 in a few hours. These crashes were both proceeded by rollercoaster ramp confidence climbs in which the currency gained new interest and publicity, seeing the price grow from around $40 in after the first week of March to above $200 after the second week of April. In many ways, the performance resembled something like the ‘.com-bubble’, as investors went manic over novelty. However, during the four months after April the price has been parked around $100.

As mentioned earlier, huge hacks were a major contributing factor (or catalyst) of these price crashes. In April, the dominant Mt. Gox exchange was bombarded with a huge Distributed Denial of Service attack, meaning that users were unable to access their funds and required a 12-hour period of recuperation before the exchange’s operators were confident enough to turn it on again. The identity of those responsible for the attack is not known, though it is probable that certain hackers wished to crash the price now and buy, so as to exploit rises by selling later: cyber-speculation.

It must be noted, however, that national currencies can be susceptible to spectacular falls. For example during the Mexican currency crisis of 1994, the peso shed 44 percent of its value against the dollar; during the South East Asian crisis, the South Korean won lost 53 percent of it’s value against Uncle Sam. As such bitcoin’s fluctuations are astonishing but not absurd, and are understandable given the circumstances. Bitcoin does not yet benefit from the stability of demand enjoyed by all national currencies but people are spending more and more, and when individuals in large numbers spend it as their main currency it should increase its reputation as a legitimate means to an end. In addition, new entrepreneurs plan to set up their own exchanges – a market no longer dominated by Mt. Gox would be far harder to crash by hackers.

Almost every technological advance has meant new ways to engage in felonous practices as well as noble ones. Bitcoin is well publicised in the former and very good at the latter. Thus, bitcoin’s survival and prosperity depends on the extent to which people spend it, advocate it and build applications for it. These rest upon that illustrious index: demand, which seems abundant.