Inside the Bitcoin bubble

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The price of bitcoin, which has gained wider acceptance in recent months. Picture: Leon Muller

London - Is Bitcoin the currency of the future or just the latest internet bubble? Ambivalence about the virtual coinage is illustrated by two very different stories.

The first is that the Royal Mint is holding talks with the Channel Island of Alderney over producing the first physical Bitcoin, a move that would appear to lend an air of official acceptance to the currency, which is not recognised by the UK government.

The second story has a more sinister ring. An operation called Sheep Marketplace on the ‘dark net’ – a parallel online universe where users are anonymous, allowing drug dealers and other criminals to ply their trade – was shut down after more than £3m of Bitcoins were stolen.

To its advocates, Bitcoin is a currency for an era of online trading without global borders, and one mercifully free of fee-gouging bankers, manipulative forex dealers, politicians and even central banks. To critics, however, it is a bubble waiting to burst.

“I sit broadly on the positive side of the Bitcoin debate,” says Professor Jon Rushman of Warwick Business School. “Exchanging soggy bits of paper and dirty bits of metal has already been replaced by electronic cash, credit cards and contactless payments. It is a currency designed for today.”

The phenomenon began in 2008 when Bitcoin was launched by an anonymous group of software developers, including a mysterious figure calling himself Satoshi Nakamoto.

Bitcoins are created in a process known as “mining”. An army of geeks, known as “miners” are incentivised to join in by solving cryptographic puzzles in order to receive new Bitcoins.

The number of Bitcoins that can be found in the “mines” is designed to tail off over time, so the total number will be limited to 21million. Currently, there are around 12 million in issue.

The fear is that Bitcoin will turn out to be a 21st century version of a long line of delusions, with a few who got in at the bottom making a fortune and many more losing their shirt, as with the original Gold Rush, Tulip Mania and countless others littered through history.

Alternative currencies are not new. Second Life, a virtual reality world, has its currency, the Linden dollar, and in the real world, towns and cities have their own money, including the ‘Brixton pound’ that can be exchanged for goods and services in that part of South London.

But the Bitcoin “exchange rate” has risen to dizzying heights in recent weeks, breaking through the thousand-dollar barrier last month – despite the fact the crypto-currency is not legal tender, and is accepted by very few mainstream retailers and businesses.

“Bitcoin is an experiment, it is absolutely not an investment,” says Jon Rushman.

A Bitcoin bubble, he adds, is “eminently possible with Bitcoin because the market is driven by sentiment, there is not much reality behind it”.

There are also concerns that the anonymity of Bitcoin will attract international money launderers, drug barons and other criminal users, though it must be said that big global banks, including HSBC, have been awash with dirty money for years.

Bitcoin was launched at a time when the crisis had shaken trust in the conventional financial system as never before. The world’s biggest experiment to date in creating a new currency, the euro, is buckling under the strain and many fear quantitative easing is debauching mainstream currencies and storing up inflation.

To free-spirited software developers, it is a currency created and run by the people, independent of governments, central banks and rapacious commercial finance houses.

In one sense Bitcoin is no different from other modern currencies, which are “fiat money”, not backed by any physical store of value such as gold, but dependent on retaining the trust of users. But in a Bitcoin universe, anonymous and unaccountable software developers have usurped the role of the central bank.

In theory, it is highly improbable that an individual or group could take control of Bitcoin for their own ends, but neither are the geeks answerable under any democratic process.

If we had Bitcoins instead of sterling, there would be no Bank of England and no QE – and even the harshest critics concede the recession would have been far worse without the first bout of money printing in 2009.

Bitcoin poses a challenge to the authorities, because it is not regulated and there is no government or central bank to act as a lender of last resort or to offer deposit protection insurance.

“The lack of official involvement in Bitcoin is potentially a fatal flaw,” says Julian Jessop of Capital Economics.

And as James Howells, from Newport in Wales, found out last week when he threw away a hard drive containing £4m of Bitcoins, it is the digital equivalent to keeping money under the mattress.

Bitcoins may be the wealth of the future or they may be a dangerous fantasy. For the unfortunate Howells, they have been an old-fashioned nightmare. - Daily Mail

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