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Editor’s blog – The Bitcoin bubble, an alternative investment to gold and the euro?

By Dean Carroll

Have you ever heard of ‘Bitcoins’? If not, you are probably in the majority but the digital currency first developed by anonymous hackers in 2009 has rapidly reached lofty heights. In the last few months, the value of each single Bitcoin climbed higher than $1,100. Market volatility is a problem due to the lack of liquidity but billions worth of Bitcoins are now in circulation in the virtual world. At a time when the gold price has collapsed and the euro and dollar look far from healthy, are we seeing a new investment opportunity coming to the fore?

Bitcoins can be used to make online purchases via mobile phones or other devices. Popular with the techno tribe, the currency is seen as being beyond the reach of government regulation – the coins are simply strings of numbers produced by complex algorithms – as it is not administered by a central bank. New Bitcoins are acquired initially by solving complex mathematical problems – a process known as ‘mining’ and usually achieved by having multiple high-powered computers running at once; all of the ‘easy ones’ having already been found.

There is no doubt that Bitcoins have the establishment worried. The virtual money is traded heavily on the difficult to penetrate ‘dark net’ websites like Silk Road. They sell myriad illegal bounty including class-A drugs by way of Bitcoins – all beyond the reach of the authorities due to the encryption and cross border transactions that bounce from country to country and can, therefore, never be traced. Rogue regimes like Iran also reportedly use Bitcoin to launder money and circumnavigate the tough financial restrictions introduced by the likes of the United States. However, hackers are known to target Bitcoins and theft is a perennial problem.

Other legal sites – including Reddit and WordPress – also accept Bitcoin payments. Fees are far less than credit card companies charge and transactions cannot be reversed so retailers never fall victim to fraud. But the currency is in a legal no man’s lands. It is neither illicit nor legally established; it just exists in the digital ether.

As Harvard Professor Chris Robert puts it: “It would really be something if intelligent people chose to invest more trust in a currency system built and managed in large part by anonymous computer hackers than they did in currency systems built and managed by governments of the people, by the people. Fortunately, we are not there yet. Today, Bitcoin is mostly just a matter of media speculation arising from the continuing financial turmoil and growing distrust in the global financial system. This media speculation may well lead to a protracted period of financial speculation, however, during which techies are joined by increasing numbers of financial sophisticates seeking a new bubble to exploit.

“Compared with corporate securities, futures, or even derivatives, Bitcoin is even less inhibited by any underlying sense of value. The bubble can just grow and grow so long as demand increases faster than supply – and so long as the network doesn’t crash, a new cryptographic exploit doesn’t unravel everything, the fundamental lack of anonymity doesn’t bother anyone, those who lose private keys and thus potentially small fortunes don’t complain too loudly, improvements or hacks to ‘mining’ don’t lead to sudden shocks to supply etc. Profiting from a bubble of any sort can be a risky business but our global economy is not at all lacking in people willing to give it a go. Thus, as a potentially exciting new vehicle for financial speculation, Bitcoin may be with us for some time.”

No doubt the early adopters are hoping that one day legitimate stock exchanges will start to trade the virtual currency and they will become overnight millionaires. Another scenario is that governments introduce their own virtual currencies and Bitcoin crashes, as a result. We know from history that every bubble has to burst eventually. Like much on the internet, the future is unclear but the possibilities seem endless.

Dean Carroll is editor of Policy Review

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