Digital currency labelled ‘the new gold’

Hold the front page: Yesterday’s Bitcoin story dominates coverage in the Financial Times

With conventional currencies like the Euro facing life-threatening crises, investors have turned to a radical alternative: the online currency ‘Bitcoin’. Is this the future of money?

You cannot put a Bitcoin in your wallet, or invest one in a high street bank. No central government issues or controls them, nor is their value linked to any resource in the real world.

Yet this week, after a spectacular boom, each unit of this online digital currency is worth almost £100, while the overall value of the global market soared to over £1 billion. Suddenly the media is overflowing with stories predicting a revolution in the way that we spend and understand money. So what exactly is this so-called ‘new gold’?

Bitcoins exist exclusively on the internet, each one composed of a unique string of digits which share rare and complicated mathematical qualities. Finding numbers that qualify as Bitcoins is so difficult that only a skilled programmer with a powerful supercomputer can run a search – a process known as ‘bit mining’.

Nowadays, however, it’s not only computer magicians who own Bitcoins. Anybody with enough conventional currency can buy them – and plenty of people have been doing exactly that.

There are several reasons why the Bitcoin might be desirable. For one thing, they are anonymously owned and almost completely untraceable. That makes them a perfect currency for criminals, black market traders and anybody who wants to avoid the eye of the law.

But you don’t have to be shady to want a Bitcoin: another feature that makes them attractive is that they are immune to government interference. In struggling Eurozone countries like Greece and Cyprus, where many have lost faith in traditional money, they are an increasingly popular alternative.

Finally there are speculators who buy Bitcoins simply because they believe they are a good investment. And in recent months they have been proved dramatically right.

Yet the frenzy of recent weeks has inflated the supposed value of the Bitcoin far beyond its real levels – a classic ‘speculative bubble’. Yesterday the Bitcoin lost about £15 of its value, and economists predict that it will soon fall further still.

The future of money

Some are now saying that we are on the brink of a new kind of money. First, humanity used commodities such as grain to buy things; then, precious metals such as gold and silver. Then governments issued ‘fiat’ money – coins and paper that represent a value based on a promise, unrelated to any intrinsic value. Now Bitcoin is a whole new type of super-fiat currency that is given value by the issuing crowd (made up of independent entities) rather than the state.

‘Fanciful!’, say the cynics. Unlike government fiat currency, Bitcoin’s value doesn’t even represent a share in the collective wealth of a nation. It represents nothing except a system of code. A memory. An arbitrary and faceless entity worth literally nothing at all.

You Decide

  1. Should all money be regulated by governments?
  2. Why might a virtual currency such as the Bitcoin be attractive to people in troubled countries like Cyprus and Greece?

Activities

  1. Write down three similarities and one difference between Bitcoins and gold as the basis for a currency.
  2. ‘Tulip mania’ was a famous speculative bubble that gripped Holland in the mid-17th century. Research this phenomenon and write a brief explanation of how it occurred.

Some People Say...

“Real power belongs to whoever controls the money.”

What do you think?

Q & A

How can I get hold of some Bitcoins?
Unless you are a computer whizz with a lot of time and a very powerful computer, you will have to buy them. To do that you’ll need to create your own ‘Bitcoin wallet’, then head to a Bitcoin exchange like Mt.Gox.
So is it worth jumping on the bandwagon?
Certainly not right now: even after yesterday’s hack, Bitcoins have an extremely inflated exchange rate at present, and their value is likely to fall sharply in coming weeks. Also, if you don’t know how to store your Bitcoins safely then nobody can offer you legal protection. If a hacker breaks into your account and steals your money, it is gone forever.

Word Watch

Digital currency
There are other digital currencies (such as the Amazon Coin), but most are linked to a conventional currency like the dollar. What makes Bitcoin unique is that it is based on a digital resource, making it less like paper money and more like an online version of precious metal.
Bit mining
These numbers are not infinite: there are thought to be about 21 million of them available. When every Bitcoin has been mined, there will be no way of replenishing the supply.
Anonymously owned
Money is transferred between online accounts for which no personal details are provided, making transactions very difficult to trace. Even the inventor of Bitcoins is known only by an alias.
Cyprus
The island is suffering from a debt crisis so severe that savings in the country’s banks have been frozen. To avoid total financial collapse, the government has even taken money from private investments. This is the kind of decision that makes some people mistrustful of national currencies.
Fiat money
From the Latin ‘let it be’, fiat money has value because governments pass laws that say it has. The essential contrast is with representative money which can be exchanged for something solid such as gold; or commodity money which can be used for something else (such as cows in some parts of Africa).

Subjects

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