A Bitcoin for Your Thoughts

The best performing currency year-to-date has no home country, no central banker and no physical scrip; it is the online-only ‘Bitcoin’ and as we noted recently, it is becoming more mainstream.  BTC, as the currency is known, up 130% year to date in dollar terms, thanks to rising demand from a wide variety of adherents, which ConvergEx's Nick Colas notes, includes libertarian activists, small businesses, online drug dealers and gambling sites.  That makes the Bitcoin a controversial subject, to be sure, but Nick notes we can also learn from this unique case study a lesson in global economics.  Bitcoin ‘Money supply’ growth is capped at a slow rate – far below its current levels of demand.  That makes it prone to boom-bust cycles.  It also has no sovereign sponsorship, which means it works outside any nation’s security apparatus.  Lose your bitcoins to hackers?  Tough luck – there is no FDIC in these parts.  Still, Colas concludes, in the creation and growth of the Bitcoin it is not hard to see the online future of currency, especially as real-world alternatives continue to struggle with sluggish economies.


Via ConvergEx's Nick Colas,

Every journalist knows that the epithet “Secretive billionaire” catches most readers’ attention like the landing hook on an F-16 making a carrier landing.  If someone is rich and not in the public eye, what are they hiding?  Are they crooks?  Or just so happy with their lives that they don’t want to inspire any more jealousy than necessary?  Inquiring minds (always) want to know...


Let me introduce you to Satoshi Nakamoto, secretive central banker.  OK, truth is that he (it is probably a man) only uses that nom du guerre when writing research papers; no one knows his real name.  And he isn’t so much a central banker as a technologist and architect of something called Bitcoin.  Yeah, I hadn’t really heard of it either until I read an article on zerohedge about a “Bitcoin ATM” yesterday.  I spent most of the day reading about Mr. Nakamoto and his virtual monetary construct, and there is much to learn from this first online success story in the world of stateless currencies.


Here’s a primer on the “Who-what-wheres” of Bitcoin:

  • The elusive Satoshi Nakamoto published a research paper back in November 2008 outlining the structure for an Internet-only currency he dubbed bitcoin.  Confidence in global currencies and financial system were at low points around the world.  Why not try something new?
  • Rather than have one central database of user balances and transaction history, Nakamoto’s design distributed the database to a network of third parties.  Each one keeps the “Ledger” of owners and also runs hugely complex programs to solve cryptographic puzzles.  Crack the puzzle, and you get fresh bitcoin currency for your trouble.  The puzzles have grown so complex that people interested in working on them now band together online to share their computing power and hopefully earn a few bitcoins for their trouble.
  • The overall supply of bitcoin in the system therefore grows at a slow and pre-ordained rate.  There are currently 10.8 million bitcoins in the system, and this will cap out at 21 million coins in just over 125 years (2140, to be precise).
  • To use bitcoin, you need a “Wallet” which allows you convert your local currency into BTC and back again.  There are many available options online, as well as BTC “Exchanges” to execute the conversions.  The distributed database which manages the system is anonymous, so there’s no central record of what you own or where you spent your money.


So what we have is a stateless currency, with essentially no government oversight, run by a bunch of nerds cracking puzzles, with an anonymous architect who (by the by) hasn’t been heard from in over a year.  Yes, in other words a recipe for massive success.  Some recent statistics:


  • Those 10.8 million bitcoins in circulation are worth $345.6 million as of today. (See this and other stats here: http://bitcoinwatch.com/).  The velocity of this money is astounding: 1.6 million bitcoins have changed hands in the last 24 hours, or over 10% of the existing money stock.
  • The U.S. dollar value of a Bitcoin is up from just shy of $5.00 a year ago ($4.87, to be precise) to $31.09 today.  It has appreciated by over 100% from the end of 2012 alone, when the quoted price was $13.48.   And back during most of 2010, you could buy all the BTC you wanted for less than a dime.
  • Over the last 24 hours, there have been +61,000 transactions using BTC.  This is almost double the 30,000 transactions in January 2013, and more than 6x that of March 2012.
  • That distributed ledger of BTC owners has one pitfall: it takes about 8 minutes to clear a Bitcoin transaction.  The good news is that this is down from the +10 minutes of just a few months ago.


So at this point your BS-meters should be quivering – what’s going on here?  Huge swings in value combined with growing adoption for a system which (aside from anonymity) seems more a step back than a great leap for mankind.  The answers are part pulp fiction, part elegant case study on the real utility of “Money.”  A few points here:


  • While Bitcoin may not get much mainstream finance love, the FBI and various U.S. legislators are paying close attention.  Turns out that some bitcoin-accepting online vendors (look up “Silk Road market”) with good anonymity software allow customers to buy illegal drugs using the similarly no-names-please Bitcoin.
  • Online casinos who wish to cater to U.S. customers accept Bitcoins, again for the anonymity of the currency.  The folks that run BTC “ledgers” do release aggregate financial information – where the money is going.  And it is going to online gaming, with an unknown number of U.S. customers in the mix.
  • At the same time, scores of legitimate businesses are also beginning to take BTC, in addition to dollars and euros.  You can buy everything from socks to sneakers to precious metals to baklava online, all with Bitcoins.  See here for a more complete list: https://www.spendbitcoins.com/places.
  • When incremental adoption meets relatively fixed supply, it should be no surprise that prices go up.  And that’s exactly what is happening to BTC prices.  What’s interesting to note is why BTC prices plummet, which they did in the back half of 2011.  The cause was a very short-lived hack attack on one Bitcoin “Wallet” company out of Japan, which caused the price to drop from $27 down to $2 in a few months.  Confidence in money as a store of value is the ultimate driver of its value, both in the cyber and real worlds.


I have no idea which way Bitcoins will trade in the next 2 days or 2 years, but the whole process of starting a new Internet currency is a great case study in how real people use real currency.  Limiting supply has clearly been a huge plus for the BTC.  Becoming known as a currency for illegal drugs and gambling is more problematic, of course.  But let’s not forget that the U.S. Treasury printed 3 billion $100 bills in the 2012 Fiscal Year.  Most of those (the Federal Reserve estimates 80%) go overseas and many of them simply facilitate the global drug and arms trade, not to mention tax evasion and human trafficking.  So the BTC’s growing role in the same types of business might qualify it for “Reserve currency” status sooner than anyone thinks.