Are cryptocurrencies the future of economics? The value of Bitcoin has rocketed over the past year. But Jordan Belfort, the “Wolf of Wall Street”, has called it “the biggest scam ever”.
Very simply, what is bitcoin?
A digital currency created and held electronically.
Why is it in the news?
The value of bitcoin has jumped by a factor of five in the last seven months. On March 25th this year, one bitcoin was worth $964.69. Now it is worth $5,518.85, and its value is predicted to keep on rising. Some believe it could reach a value of $10,000 by 2019.
What explains this rise?
The rapid rise from April onwards can partly be explained by Japan’s landmark decision to legalise it as an official method of payment. This was a major step in pushing bitcoin away from the fringes of society and towards the mainstream. Asia is the key driver of the cryptocurrency boom, but Europe, and especially the UK, is not far behind.
How does it work?
Unlike normal currencies, bitcoin has no central authority like a central bank. Instead it is underpinned by a computer network made up of its users’ machines. Coins are mathematically generated in a complex process known as “mining”.
The mathematics of the system were set up so that it becomes progressively more difficult to “mine” bitcoins over time, and the total number that can ever be mined is limited to around 21m. Around 15m are currently in circulation, amounting to a value of about $75 billion. There is therefore no way for excessive amounts of new bitcoins to be generated, devaluing the currency.
Bitcoin runs on a technology called blockchain; completed “blocks” (the most recent transactions) are added to a constantly growing record downloaded to each connected computer. The record is secure and permanent.
What is it used for?
The roughly 5.8m people who have cryptocurrency wallets use it for a huge number of purposes. They include funding companies and transferring and investing money without incurring any fees. It is also accepted at a handful of retailers.
Two weeks ago a house in west London went on the market valued at £17m — unusually its owners would only accept payment in bitcoin.
But the most common answer, for now, is nothing. Many people simply hold their bitcoins, hoping they will accumulate in value and prove to be a lucrative investment.
Isn’t bitcoin a bit dodgy?
As it is almost impossible to tie a bitcoin wallet to an individual, it is very hard for the authorities to trace payments. This means that it is commonly associated with criminal activity such as drug dealing, cyber crime and money laundering. It is also a common way of illegally purchasing firearms on the deep web.
The majority of bitcoin payments, however, are innocent.
Is it stable?
The currency’s rapid rise has led many to believe that we are in a “bitcoin bubble” which cannot last. Its rise has been volatile. Back in May its value actually fell by $400 in one day.
Bitcoin has also been the focus of hacking attacks, resulting in owners selling their bitcoins in a panic, bringing down the price. The hackers then jump in and buy them before the price stabilises. But all this creates uncertainty around bitcoin. This deters more ordinary people from investing and ensures the continuance of the cloud of suspicion.
Will it last?
There are two major reasons it might not.
First, its volatility does not suggest that the private currency’s trading price is reflective of its fundamental value. Second, bitcoin strikes at the root of the centuries-long monopoly over money held by governments, which are likely to regulate it heavily.
But Adam Davies, a major technology consultant, believes we could be “about five years away” from it being used as much as orthodox currencies, although its form may have changed by then.
- Could Bitcoin replace orthodox currencies?
- Imagine that you bought 75 bitcoin on January 1st 2017 when one bitcoin was worth $972.50. Now it is worth $5,518.85. Work how much bitcoin you have in US dollars, and calculate your percentage profit in that time.
- Countries’ legal response to the growth of bitcoin varies wildly. In the UK, it is effectively treated as private money, meaning VAT is not charged on the value of the Bitcoin transaction. But the currency’s appeal is probably stronger in emerging markets. In Venezuela, for example, the country’s rapid economic downturn has meant that bitcoin is more reliable than official currency.
- There are other types of digital currency, such as Ethereum, with its digital money, ether, the second-biggest cryptocurrency after bitcoin. Ethereum was designed to be more than a payment system, described as “a decentralized platform for applications”.
- Central bank
- An institution with functions usually established by national law to manage monetary policy, issue bank notes and cash, and regulate commercial banks. The UK Bank of England and the US Federal Reserve, for example, are described as instruments of the government but act independently, eg, setting the base interest rate.
- Deep web
- A part of the internet which cannot be reached by ordinary search engines.