Bitcoin is a virtual currency exchanged electronically. Nobody is quite sure who exactly created it but it appears to have emanated originally from a group of developers working under a pseudonym. It was first launched in 2008/9 and initially used to carry out online transactions in the gaming community.

The currency was created to automatically increase its circulation based on algorithms running on a finite number of servers. Coins are issued continuously at set intervals using encrypted alpha-numeric strings which are then harvested by private computers and smartphones equipped with bitcoin mining software optimised to compete for new coinage by solving mathematical problems. Mining software is readily available in the marketplace and the more efficient the software, the more expensive it is thus coins are most easily gained by those who already have the most money and processing power. Money supply is increased in an ever decreasing geometric curve until it reaches a hard limit some time in 2140. Each transaction is verified by a timestamp and recorded in a logfile stored on every device on the network. It synchronises around the network every few minutes to keep up to date. 

There is no central bank. The currency flow is controlled solely by an automated process independent of any outside factors or economic fluctuations. When I began writing this last week bitcoins exchanged for around US$60 each but with wildly varying values however the trend is rapidly upwards and they now appear to have passed the US$100 barrier. 

Since its creation the bitcoin has expanded in appeal. Its usage has moved beyond its intended purpose (if indeed it ever had one) onto the online silk road and thence into the terrestrial black market where it’s been used for drug transactions and money laundering among other things. Now it has started to become more mainstream. Increasingly bitcoin is becoming a tangible currency with notes and coins being produced in various places and is not-surprisingly seeing its greatest growth in usage in places such as Cyprus and Spain where traditional currency is becoming harder to come by. It has also become a haven for anti-capitalists; a subversive, anarchist currency. 

The problems here are beginning to look obvious. Bitcoin has no central bank controlling flow. It has no state to back it up; no gold reserves; nothing. It maintains its value solely by users’ belief that it is worth something. Its value is increasing rapidly as more and more people buy into it; either because they have to or because it’s “cool”. At the same time the increasing supply is slowing down due to the ultimate limit to which the programme is working. As the value increases sharply it is at the mercy of hoarders sitting on it whilst its value increases further thus reducing the amount in circulation which brings the risk of stimulating hyper-deflation in the bitcoin zone. 

Now we have the absurd situation of anti-capitalists speculating on a currency created for gaming which is being used by the poor to buy bread. It has had its first crash and at least one hedge fund is dealing in it. What could possibly go wrong? Here is a currency which was seen by many as the antidote to the current financial situation but it is still a currency and behaves like any other. Only this is a currency which now appears to have more in common with a Ponzi scheme than its advocates would care to admit. What happens when its fragility becomes apparent and its users lose faith in its purchasing power? Shares in the South Sea Company anyone?

 

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