Money that does not exist

Image from: Antana

The exchange rate of bitcoin over US dollars has reached over 1000:1 this month. You need to spend more than $1000 to buy 1 bitcoin, a virtual money that worth only several dollars one year ago.

Bitcoin is the first currency based on cryptography instead of central authorities, which debuted in January, 2009. Compared with US dollars, there is no agent playing the role of the US government for Bitcoin. Instead, it keeps a public ledger and log known as “blockchain”, which is maintained by “miners” distributed throughout the Internet. The miner solves the complicated mathematic puzzles to verify transactions and add the information to the blockchain. Just like the miners for gold, the miners here get the newly issued bitcoins for reward. A miner can simply be a personal computer. Recently, some machines that are specifically made due to the fast-rising price.

Bitcoin has been called the “gold of tomorrow” by the chief financial officer from the University of Nicosia, the first university that accepts Bitcoin as payment for tuitions. Indeed, Bitcoin is designed to be “gold”. The algorithm it adopted to generate new coins has an upper limit for the total coins available. As time goes on and more bitcoins become available in circulation, the mathematic puzzles in Bitcoin mining will become increasingly difficult. This means the salary for miners will reduce. Hardly any new coins could be generated when the number reaches 21 million, which is the total amount available according to the Bitcoin protocol. With the crazily rising price, bitcoin mining is now like the replay of the golden rush in 1800s.

Gold had been the ultimate money until 100 years ago. In the economic theory, what made gold the favorable money across culture are that first it has a limited amount available and hard to get; second it stores value. Obviously, Bitcoin possesses the first character but it is a serious problem whether it stores any value. It won’t be valuable unless it is widely accepted as the medium for exchange. 

Until recently, the largest market accepting bitcoins has been the blackmarket. A study from Carnegie Mellon University showed about 4.5~9% of all bitcoin transections had been used to buy illegal drugs from Silk Road, the “eBay for drugs” that was shut down by FBI in October this year. Other illegal transactions include gambling and money laundering. Real stores and business groups are now picking up the trend to accept bitcoins, most notably WordPress and Baidu, the searching giant in China. A Bitcoin ATM also became available recently at a coffee shop in Vancouver. Following this link, you will see more available thing to buy with bitcoins.

http://www.washingtonpost.com/business/a-few-things-to-buy-with-bitcoins/2013/11/21/a61983c2-52c7-11e3-a7f0-b790929232e1_gallery.html#photo=1

Nevertheless, the growth of popularity of bitcoin in exchange is much slower than that in investment. The fast-rising price is largely due to speculations instead of transection needs. Another major risk for the price to fall is whether it could become financially legal. Recently, both People’s Bank of China and the Federal Reverse in US stated that they don’t accept bitcoins as currency, nor do they deem bitcoins illegal. “People are free to buy and sell bitcoins as normal electronic goods,” according to Gang Yi, the vice president of People’s Bank of China, “it is very inspiring but we have no plan to admit its legal status as currency.” Yet not all countries are hesitating. There are also countries admitting Bitcoin, like Germany, France and UK, while there are also countries that have banned it, like Thailand.

While bitcoin is at this hot situation with an uncertain future, another alternative has also been released to share the cake, the Litecoin. It seems Bitcoin needs to be prepared for competitors, and perhaps the non-authority based cryptography currency could also compete with dollars in the future.

(Update) Chinese government has banned Bitcoin as currency in financial activities, although Bitcoin markets are still allowed as a normal digital good market.