Are crypto-currencies the future of money?

 
A sign saying Bitcoins accepted here

The creditors of the collapsed Mt Gox have agreed to support a group of US investors who are trying to re-establish the Bitcoin exchange.

Despite these problems, can crypto-currencies, such as Bitcoin revolutionise the way we pay for goods and services in the digital age?

After all, money is anything that can perform three basic functions: a medium of exchange to be used in the purchase and sale of goods and services; a unit of account to measure the value of goods and services; and a store of value that can be saved and spent at a future point in time.

Bitcoin was founded in 2009 although nobody knows by whom, only that he, she or they took the pseudonym Satoshi Nakamoto.

Since then a plethora of other crypto-currencies have since sprung up, including Ripple and Litecoin.

Each Bitcoin, like other forms of crypto-currencies, is simply a long string of computer code protected by a personal key which provides both ownership and security.

All Bitcoins in circulation and their transactions histories are recorded in a giant ledger known as the blockchain. This prevents each Bitcoin from being spent twice.

The crypto-currency is a very simple way of transferring value from one person to another. Once the personal key code has been entered the Bitcoin value can be transferred to another address.

No middleman is required to verify the transaction so they are quick, secure and cheap to use.

A decentralised currency

Start Quote

Even if Bitcoin itself does not become the Internet of money, its technology could provide the platform for future online payments systems”

End Quote

Bitcoin is described as a decentralised money system because the ultimate supply of coins is fixed and not controlled by a central bank.

Instead the coins are created by computers which perform number crunching exercises akin to trying to crack a password by running through every possible permutation one at a time.

Each time a password is cracked new Bitcoins are added to the blockchain.

This process is designed to mimic the behaviour of mining for precious metals. The value of Bitcoins is derived from the value of difficulty and proof of work requirements needed to produce them.

So far Bitcoin miners are only just over half way towards the cap of 21 million and it is expected new coins will continue to be mined up to 2030.

The supply cap means that the eventual value of Bitcoin cannot be eroded through inflation and this might explain the popularity of the currency in countries where the central bank lacks credibility.

Boom and bust

So, if Bitcoin is an efficient medium of exchange and an effective long run store of value, what's holding it back?

Firstly, a currency becomes a useful medium of exchange if it is widely accepted by a large number of merchants. Although Bitcoins can be used in a variety of transactions, it is still generally thought of as money for computer geeks rather than the ordinary citizen.

At present the commercial use of Bitcoin is small, especially compared to the rampant speculative trading in the currency. Since 2009 Bitcoin prices have been 7 times more volatile than the price of gold and 8 times more volatile than the S&P 500 stock exchange.

If you happened to buy a Bitcoin at the start of 2013 it would have cost you $13. At the start of November the value had increased to $211 and then one month later to a peak of $1231. It goes to show that there is a lot of real money to be made trading in a virtual currency.

Part of the problem is that nobody really knows what the fair price or intrinsic value of a Bitcoin should be so there is little to quell speculation.

A photo of a machine that can be used to buy and sell Bitcoins Various companies have been looking to cash in on the growing popularity of crypto currencies
Regulation

By mid December the value of Bitcoin had plummeted to less than $500. Up until that point Bitcoin and its rivals had been relatively freely traded in China, but it was clear that the authorities had felt it had become a speculative investment rather than a medium of exchange and clamped down.

Declaring it not to be a currency, the Chinese state stopped financial institutions from dealing with Bitcoin exchanges making it almost impossible to buy and sell Bitcoin using the yuan.

The Chinese were also concerned about the potential for the currency to be used in black market activities and money laundering through a process known as bitwashing.

It is clear that regulators around the world are unsure about what to make of Bitcoin and are still in the process of making up their mind if and how it and other crypto-currencies should be regulated.

Theft

Despite the December wobble Bitcoin prices were back above £1000 by the New Year.

But by late February the price had crashed once again to below $260 when it was announced that Mt Gox, a major Bitcoin exchange, had lost 850,000 Bitcoins valued at $600 million and subsequently filed for bankruptcy in Japan and the US.

Possession of the key is everything as it allows the currency to be permanently transferred somewhere else.

Lose the key, whether through hardware failure, software failure, amnesia or theft and you lose the value.

A TV reporter found out the hard way when he flashed Bitcoin gift certificates on air only for a viewer to scan the code with his smart phone and make off with the value.

Bitcoin transactions are irreversible and lack a practical system of resolving disputes, so it is almost impossible to recoup Bitcoin value once it has been transferred elsewhere.

The future?

Given its recent problems there are doubts as to whether Bitcoin and its contemporaries can become fully-fledged currencies.

It is unlikely that the credit card faces an imminent threat to its dominant position in online payments.

However, even if Bitcoin itself does not become the internet of money, its technology could provide the platform for future online payments systems.

One possibility is that these might be developed through the major banks, and JP Morgan has recently filed a patent for an online payments system with Bitcoin characteristics.

But with the development and adoption of all internet-based technologies, we can only wait and see whether it takes off or not.

 
Linda Yueh Article written by Linda Yueh Linda Yueh Chief business correspondent

Is Putin right?

Most analysts say Russia can afford its debt repayments for the next couple of years, but Mr Putin will have to stem the tide of money leaving the country.

Read full article

More on This Story

More from Linda

Comments

This entry is now closed for comments

Jump to comments pagination
 
  • rate this
    0

    Comment number 9.

    To answer the question: No. Cryptocurrencies as they exist now are deeply flawed. Most of them promote hyperdeflation, which may appeal to Randites who want to make money by doing nothing, but don't to anybody with a lick of economic sense. The current strain of cryptocurrencies are inherently technically flawed. Few people want a move towards cryptocurrencies except for head-in-the-clouds geeks.

  • rate this
    0

    Comment number 8.

    More to the point:

    Corrupt bankers NEVER go to jail:

    http://www.bbc.co.uk/news/world-europe-27185641

    It's 01:10hrs...do you know where your money is...???

  • rate this
    0

    Comment number 7.

    Who, in their right mind, would entrust their wealth, savings, capital; to an anonymous computer-based system? Can you spell "counter-party risk"? Google "Mt. Gox" - I dare you!

    For millennia, humans have relied on gold and silver, forged in the heart of dying stars.

    Money must satisfy three criteria: a medium of exchange; a unit of account; a store of value. Crypto-currencies are not money.

  • rate this
    0

    Comment number 6.

    until some crypto robber dose a runner with £ billions of crypto money, bit like what the banks do every day.

  • rate this
    +1

    Comment number 5.

    How is it an effective store of value (long run or short run for that matter) when there is nothing behind it? It is just thin air.

    It may be a medium of exchange but that is the only one of the three "basic functions" that it may perform. Even then, if someone paid me in bitcoins I'd want to convert them to a normal currency asap.

  • rate this
    +1

    Comment number 4.

    A currency also has to be acceptable and inspire confidence among the vast majority of users.
    I won't be selling Sterling and buying Britcoins and neither should anyone else who isn't a sandwich short of a picnic.
    Alan

  • rate this
    +1

    Comment number 3.

    I'm slightly confused here. What's the backing for Bitcoin - besides the fresh air out of which they were created? In the case of a national currency, whilst they are no longer on a gold standard or such like, they still have the the output of the country concerned as a form of backing. Hence there's a bit more confidence in the currency. Bitcoins themselves seem to be the emperors' new clothes

  • rate this
    +1

    Comment number 2.

    "Mining" is not the correct analogy, and it's not correct to say that there is no middleman. New units are created as a commission paid for the clearing of transactions ("adding them to the blockchain"). Once the supply of new units is exhausted in 2030, commission will have to be explicitly charged. Bitcoin will compete with Visa, but with a vast, inefficient IT infrastructure to support.

  • rate this
    +1

    Comment number 1.

    Much of the information in your article Linda is very out of date. And if you sincerely believe that , after the recent heart-bleed disclosures, normal on-line banking accounts are safer and more long-term secure than private key protected bitcoin cold storage wallets - then I have worries about your objectivity ? ... but then , I'm just a mere Rat !

 

Features & Analysis

From BBC Capital

Programmes

  • HoverboardClick Watch

    Testing the hoverboard's magnetic levitation - but will it ever replace the bicycle?

BBC © 2014 The BBC is not responsible for the content of external sites. Read more.

This page is best viewed in an up-to-date web browser with style sheets (CSS) enabled. While you will be able to view the content of this page in your current browser, you will not be able to get the full visual experience. Please consider upgrading your browser software or enabling style sheets (CSS) if you are able to do so.