Bitcoin: bubble or the future of currency?

In the past weeks the value of the virtual digital currency tripled before falling 50% in a few hours. Bitcoin has a global circulation worth more than $US1.4B, yet it belongs to no nation and is issued by no central bank. It can be used to buy gold in California, a hamburger in Tel Aviv or a house in the US. An important aspect of Bitcoin is that it offers untraceable transactions. This makes it the currency of choice on black market site Silk Road, an illegal underground eBay-like site whose url is only accessible via the Tor encrypted web-browser and network.

z 500866Bitcoin_Silkroad4

Opinions diverge about Bitcoin. Techno enthusiasts and libertarians see the future in it, whilst other dismiss it as a bubble: eg Paul Krugman sees its value “conjured out of thin air because contrary to traditional currencies backed by the power of the state, which defines them as legal tender and accepts them as payment for taxes, Bitcoins, however, derive their value, if any, purely from the belief that other people will accept them as payment.”

Both views could be valid:

1) In the short-term it is likely to be a bubble. It follows a speculative pattern, fuelled by media frenzy, as illustrated by the correlation between a Google Trends search on “bitcoin” and its price chart.

bitcoin-pricechart

2) In the long-term, whatever the Bitcoin market will look like in 5-10 years, it serves as a proof-of-concept for a decentralized crypto-currency, which cannot be manipulated by governments nor changed by monetary policy. Bitcoin shows something entirely new: a true, stateless, virtual currency rooted in nothing other than confidence in the set of rules that surround it. It could open a third chapter in the history of money: after commodity based (e.g. gold), politically based (e.g. dollar), this would be a math based currency (because it’s minted by a computer algorithm). This would be a response to falling confidence in the soundness of government backed ‘fiat’ money in an era of quantitative easing. Notwithstanding the many risks and issues, the algorithmic approach to controlling the money supply used by Bitcoin could go a long way to creating a sound store of value.

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