Starting next Monday, I will be contributing a regular column on Bitcoin for Nasdaq.com. The series will consist of a look at the week ahead each Monday and other articles on an occasional basis when there is relevant news or significant market moves. Before that series starts, I wanted to take a look at the controversy surrounding Bitcoin.
The sudden rise of Bitcoin, and in particular the much publicized volatility in the Bitcoin market, has seen many dismiss the currency as a fad, a bubble, or a scam. Adherents have replied with the kind of smug superiority that often accompanies early adoption of a technology; “...you just don’t get it!” is a frequently seen comment, but doesn’t really add much to the debate. As seems to be the case all too frequently in the modern world, that debate has become increasingly polarized. It seems that you must either see the advent of Bitcoin as inherently good or evil.
To me, as a near twenty year veteran of the interbank currency markets, it is neither; it’s just another currency. Bitcoin is a crypto currency, or virtual currency. It is created and controlled by cryptography rather than by a central bank, a distinction that many find hard to grasp. In reality, for those involved in the market, this is a distinction without a difference. Critics claim that the lack of central back backing makes Bitcoins essentially worthless, but that shows a lack of understanding about how currencies, and currency markets, work.
No currency has a value beyond that which users place on it. Ever since most countries followed the lead of the U.S. in 1971 and abandoned the gold standard, currencies have had value simply because they have value. It is the willingness of others to accept them in exchange for goods and services that makes them work. The simple fact that the two biggest Bitcoin payments processors, Bitpay and Coinbase, claim that over 75,000 businesses accept the currency (according to this Mashable article) makes it a currency, whether the critics like it or not. The fact that those businesses include household names such as Amazon, Target and CVS should make it clear that Bitcoins aren’t just some passing internet fad either.
That is not to say that buying and holding Bitcoins is without risk. Regulation of the market is being considered all over the world but is still light and can lead to problems such as those experienced by Mt. Gox. That story shows us that there are vulnerabilities in the system and maybe bad actors, but it says nothing about the currency itself. Does the cyber theft of millions of dollars every day or the occasional unmasking of the Bernie Madoffs of the world make us question the validity of the dollar? No, it just makes us strive to beat the thieves, and the same should be true with Bitcoin.
Critics can also be heard worrying that there is nothing to stop the mass issuance of Bitcoin and the subsequent devaluing of the currency. That is true, of course, but once again it just confirms the status of Bitcoin as a currency. History is full of examples of governments and central banks doing just that.
With all of that said, I am not a Bitcoin evangelist. I am agnostic on the concept and the currency in many ways. I don’t have an opinion as to whether it is a good or bad thing; I just don’t seek to deny that it is a thing, and a thing that is traded actively. I see my role in the coming weeks and months not as an advocate or detractor, but as somebody with decades of experience in currency markets who can help you better understand the Bitcoin market and the news and events that influence it. If I achieve that then I will have succeeded, whether you are a true believer, a skeptic, or simply, like me, a realist.
Edit: August 7, 2014, 2:45 p.m.:
In the light of the comments that followed the publication of this article, I felt that some clarification was needed. I was aware that the number of Bitcoin that can be issued is limited by protocol, but my intention was to point out that that, in and of itself, doesn’t differentiate it from other currencies. Maybe just the addition of the words “in theory” after “that is true” would have made my point somewhat clearer.
In the past, the supply of more conventional currencies has also been similarly limited and the consent of users would have been required in democratic nations to alter that. That, however, didn’t stop countries abandoning those protocols, for example by abandoning the gold standard. The point here is that protocols can be changed, but if you have faith in the U.S. Dollar, the Euro or any other currency, you can have at least the same measure of faith in Bitcoin. In fact, because the direct agreement of holders is needed to change that protocol, faith in Bitcoin maybe even more justified.
With hindsight, I should have included the fact that issuance is limited, if only for the benefit of those unfamiliar with Bitcoin and the history and protocols that surround it, and I apologize for not doing so. I made the classic mistake of assumption. I assumed that at least some degree of restriction was self evident. If not, why would Bitcoin have any value at all?