Tech Tuesday: The Future of Money

In recent years there has been a growth of alternative cash schemes, for instance with towns and villages instigating a barter system of some kind where work is exchanged for goods and services. This is hardly a leap forward as bartering is as old as human civilisation, and it’s not particularly techy either. So instead, as today is Tech Tuesday, I will be talking about an internet phenomenon called bitcoin. Right now there are people working for bit coins and using their computers to “mine” for them.

So, what are bitcoins?

Bit of What?

Bitcoins are the result of a project to create an open-source, decentralised, peer to peer network for making and tracking transactions. Bitcoins are generated by bitcoin miners, these people use their computers to solve extremely complex mathematical problems or algorithms. As each algorithm is solved 50 bitcoins are generated and given to one of the miners that was working on the problem; the more processing power the miner uses the greater their chance of being awarded bitcoins.

Generated bitcoins are then stored in the miners bitcoin wallet and can be used in transactions with others.

The value of the bitcoins comes primarily from two sources. The first is scarcity; there will only ever be 21,000,000 of them (by 2017 ¾ of the total possible number will have been generated, the rate that they are generated will halve every 4 years) and the other is cost of production. In order to generate a good number of bitcoins a miner needs to have high spec computer equipment. It was discovered early on that a certain brand of computer graphics card was particularly well suited to generating the coins and so there was a rush to buy them up and Amazon ran out on a number of occasions earlier in the year.

The other factor that gives them value is people’s willingness to use them, and speculate on them. They are an effectively anonymous way of carrying out online transactions and as such are as close to a cash analogue as the internet has so far had.

Erm, that’s nice dear, but why?

Does money really need reinventing? Surely if you want to pay someone you can give them cash, if you want to buy or pay for something online you can use a credit/debit card, or PayPal or one of the other virtual currency solutions (including charging to your phone bill). I think the answer to that can be seen in the financial market of the past 3 years. Central banks are no longer the safe bet that they were seen to be in the past, and in the off-line world the price of gold is rocketing as people see currencies being devalued as a result of banking failures and bailouts. With even the USA losing its AAA credit rating, it is not surprising that the nature of money is being examined.

Bitcoin, or a system like it, removes the control of a currency from any central bank or government and instead the users decide on its absolute value. It also allows people to spend money online in the same way as in the offline world, without leaving a paper trail.

And that’s a good thing?

Many of bitcoin’ s positives are also negatives. The two most obvious features are anonymity and its decentralised nature. The anonymity of bitcoin has attracted criminals; the Silk Road (a hidden online marketplace) is used to sell everything, legal and illegal, and bitcoins are the currency of choice. If someone is selling illicit items over the internet a credit card transaction is best avoided; bitcoins provide an alternative.

Decentralisation means that there is no regulatory control. It is possible to set up a bitcoin exchange without having to pass any checks. When the third largest bitcoin exchange went off-line with no warning in July a lot of people were worried that the anonymous owner of the site had just done a runner with their bitcoins. It is possible that this is exactly what happened, although the sites owner claims that technical difficulties destroyed all the bitcoins held by the site. As there is no regulatory body to appeal to, the law is unlikely to provide much help either as governments are, at best, wary of bitcoin.

Earlier this year PayPal stopped accepting donations for Wikileaks and the organisation is currently the subject of a banking blockade, however donations can still be made using bitcoins. The decentralised and anonymous nature of bitcoin means that it is harder for governments to silence dissenters.

So, what’s it worth?

At the moment bitcoins are trading at around $7 per bitcoin. Initially they started at around $1 at the beginning of 2011 and built to $29 in June but were then hit by a number of scandals and scams and the value dropped 50% overnight. Confidence is slowly returning and it is looking like it will settle down at about $6.

If you want to get some bitcoins you first have to download the software and then once installed you can start mining your own bitcoins. Be warned that unless you have a computer set up specifically for mining you are likely to spend more on electricity running the computer than you will make from generating bitcoins. You can get 0.02 bitcoins for free. You can buy bitcoins for cash from one of the exchanges or you could find someone local to trade with.

The future?

Bitcoins are interesting but limited and mistakes made in the initial creation of the system are likely to stop it from ever being entirely mainstream. Hoarding and lost coins are the two main problems that it will face. Once it becomes sufficiently difficult to mine the bitcoins it becomes more profitable to just sit on the ones you own rather than use them as currency.  As there is a cap on the total number of bitcoins that can exist, new ones cannot be generated to replace lost ones. This means that over time more and more bitcoins will disappear from the system until it can no longer function as a currency and becomes more of a commodity or curiosity.

Further ahead it is likely that some system akin to bitcoin will become mainstream. We are living in a connected world with more business being carried out online and a peer-to-peer transaction network makes sense for the connected age. It just isn’t going to be Bitcoin. For the foreseeable future property looks like remaining a much safer and more profitable prospect for investment than any virtual currency.