Is Electronic Currency the Next Big Thing?

I recently came across Bitcoin and, being more and more interested in Economics, found the idea very exciting. Bitcoin could be described as a cryptography-based peer-to-peer currency, created in 2009 by Satoshi Nakamoto. People have an electronic wallet, which can contain a number of public addresses (one of mine is 1NgRqMgGu4BFVwBn8yEMPZgLdK5PXpBeRa, if you feel generous). Transactions between two addresses are public and stored across the peer-to-peer network. this structure has a number of advantages, such as for instance limiting the ways to cheat the system, and providing an alternative privacy model. Please don’t hesitate to have a look at Satoshi Nakamoto’s original article.

Another very important aspect of Bitcoin is the way the currency is itself generated. Any member of the network can participate in the creation of coins by solving a particular cryptographic problem. Some people are now even buying motherboards, graphic cards by the truckload to create ‘mining rigs’ dedicated to the generation of these coins. Some have apparently been busted by the police, who became intrigued by the unusual amount of electricity used by these ‘miners’. The difficulty of the problem that needs to be solved to generate the coins is regulated so as to increase every two weeks, which provides a very effective way to control the rise in the supply of coins. Production is scheduled to stop once the number of coins reaches 21 Millions, which is a very important point, as it means that (unlike fiat currency) bitcoins will be a scarce asset, in a way like gold or silver.

With the fall of the dollar, the economic collapse of 2008, and persistant warnings about the imminent collapse of the economy of a large number of american and european countries, more and more people are losing confidence in the ultra liberal banking system and look for ways to protect their assets against inflation, by for instance purchasing gold or silver.



The price of gold and silver have been rising at a steady pace over the last ten years. Although I do not want to oversimplify the reasons why this might be the case, this could be seen as an indicator of the loss of confidence in the dollar, and more generally in a money which is ultimately backed by billions of bad debt, ultra-leveraged financial products and wheelbarrow after wheelbarrow of quantitative easing. Gold and silver have the advantages of being as real as can be, relatively scarce, and known to have been used as currency for thousands of years. Not so long ago, most countries’ currency were backed by gold and silver, and some are now thinking about reverting to the gold standard.

Bitcoins seem to share a number of similarities with gold and silver: their quantity is limited, and they have been drastically increasing in value over the last few years. The network on which the Bitcoin currency is built is designed to provide a high level of trust to its users. However, the price of these commodities is greatly influenced by the existence of leveraged position, which renders it particularly volatile: what happened to the price of silver at the beginning of may could be seen as a good exemple of that. But at the end of the day, what makes a good currency? First, people who use it need to have trust in it. Second, they should be able to easily exchange this currency with goods or services, and vice-versa. These two aspects of trust and liquidity are found in fiat currency and, to a lesser extent, in gold and silver.

Technology has provided increasingly more sophisticated ways of performing monetary transactions, and we went from exchanging coins of silver or gold to swiping our credit or debit cards, or sending money through PayPal. More recently, The idea of using one’s mobile as a paying device is becoming more and more prominent, and we could assume that it won’t be long before this is possible: At the time I am writing this article, one of the trending topics on twitter is ‘Google Wallet’. In regards to what’s happening online, a bunch of services have been acting as a form of virtual currency, PayPal being one of the most prominent examples (It is interesting to note that a service proposing to sell bitcoins on PayPal got banned pretty quickly).

Bitcoin however goes beyond that in the way it actually implements a certain economic theory into a usable, robust system. Coins have gone from costing pennies to the respectable value of $7, and are accepted by more and more providers of goods and services. The Bitcoin community is very active and the ‘end user’ software allowing people to use bitcoins is becoming more and more usable as this project evolves. Coins can be exchanged against dollars and other currencies on various markets, one of the most prominent being Mt Gox. People have started building and selling physical ‘notes’ holding a particular value in bitcoins.

But will Bitcoin survive? It seems that the fact that it reduces the need for intermediaries. is relatively hard to manipulate and allows anonymous transactions to be performed would make it a pretty good candidate to be made illegal if it starts to seriously concurrence fiat currency. On the other end, there are numerous examples of successful virtual currency out there, from Entropia Universe‘s PEDs to World of Warcraft ‘Gold’. Let’s hope Bitcoin is allowed to fulfil its potential!

This is quite a fascinating subject, and I will try to add to this article in the next few days. In the meanwhile, I would love to read your comments.

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