Many may not have heard about Bitcoin. Bitcoin is an internet-based cryptocurrency that uses peer-to-peer technology called the blockchain to issue coins, manage transactions, and make counterfeiting impossible. The current price of Bitcoin sits at around $630, the highest it has been since July. Why Bitcoin has a value in the first place puzzles many economists and financial analysts, but there is a reason behind this value. It is best known for being used by the criminal underworks for making untraceable transactions, but I believe there is much more potential for Bitcoin in the future. I will make a case for Bitcoin as a legitimate currency.
To understand how Bitcoin works, it is important to understand how the blockchain, the technology behind it, works. The blockchain is a peer-to-peer network of computers running together keeping it decentralized. A peer-to-peer network is a network in which computers communicate with each other directly without going through a central computer. The blockchain keeps a public ledger of transactions that can be verified by users, but no one individual or group controls it. Participants in the system collectively keep the system running. The Economist explains it here:
Blockchains are also the latest example of the unexpected fruits of cryptography. Mathematical scrambling is used to boil down an original piece of information into a code, known as a hash. Any attempt to tamper with any part of the blockchain is apparent immediately—because the new hash will not match the old ones. In this way a science that keeps information secret (vital for encrypting messages and online shopping and banking) is, paradoxically, also a tool for open dealing.
Unlike with a central bank, there are a limited number of Bitcoins that can ever exist. Bitcoins exist in “blocks” of 50. Users can mine Bitcoins by solving a cryptographic puzzle to get the code for the block. In its infancy, with few blocks being mined, the mining process is quick, but as more people begin to mine, the time and power it takes to solve that puzzle will increase. Bitcoins are stored in wallets on computers.
Bitcoin was invented by a man who went by the pseudonym Satoshi Nakamoto. On November 1, 2008, Nakamoto published a paper titled Bitcoin: A Peer-to-Peer Electronic Cash System on a cryptography mailing list. Nakamoto remained active online for a while to get Bitcoin started. He released the open source software in January 2009 and continued to help make decisions about it until he complete vanished without a trace in 2011. Nakamoto’s identity still remains a complete mystery, but all of his actions are no doubt absolutely genius in design.
Why does Bitcoin have value at all? What makes it feasible?
The same question could be asked of the US Dollar, too. What gives it value? The Dollar has value because the government says it is legitimate. Businesses all over the country accept it as currency. The value obeys the laws of supply and demand.
In many ways, the value of Bitcoin is similar. It obeys the laws of supply and demand. The supply is constantly increasing as more people mine it (the difference is there is a fixed supply possible), and demand is continuously increasing as the media talks about it and more people and businesses start to accept it. Overstock.com, for example, accepts it as payment. For a currency to have value, it must be durable, secure, divisible, portable, uniform, and recognizable. Bitcoin already hits five of those, and as it grows, it can become more recognizable.
As Bitcoin grows in popularity, its value will rise with it. The value was over $1,000 in 2014 before the Mt. Got exchange was hacked, resulting in the theft of millions and a sharp decline in value that continued for months before hitting a low of a little over $200. It has slowly tripled since that low point, and there is nothing suggesting it will stop growing. Predicting the growth of something new and unknown like Bitcoin is difficult, but I would not be surprised to see it reach $1,000 by the beginning of 2017.
Why would Bitcoin be a superior alternative currency to the US Dollar or another government-backed fiat currency?
When I mentioned above that the US Dollar “obeys the laws of supply and demand,” I have to look at the Federal Reserve’s increasing of the money supply. In 2008, the Fed introduced a concept known as quantitative easing, where new money was printed to “stimulate the economy.” The government’s fiscal policy left people untrusting of its ability to handle the economy. The price of gold began to rise. The Federal Reserve and the government have a long history of meddling with the economy and screwing things up. The fact that the government can print Dollars at will without using something physical to back it is also an issue. The only reason the US Dollar has a value is because the government is backing it on its own credibility, but as we print more money and increase the money supply even more, inflation becomes a serious issue.
Bitcoin comes with no such problems.
Because Bitcoin has a fixed supply, which means inflation will never be a problem. And because the blockchain itself is decentralized, there is no central bank influencing the economy by changing the money supply or adjusting interest rates. The value of the currency comes 100% from the free market. But what about the value? A Bitcoin costs money to create. To mine a Bitcoin, it requires a computer, electricity, and time. Furthermore, the network of computers that make up the blockchain network costs money to maintain. A Bitcoin may be completely digital, but it has real value to users because it requires real resources to create.
Many of the founding fathers warned of central banks. Andrew Jackson took the opportunity he had and ended the central bank in the US. Central banking is unfortunately prevalent across the entire world, from the Dollar to the Euro, and we continue to feel the effects of this on our economy today. Bitcoin will break us away from this. It is the future of currency. The mass adoption of Bitcoin will be the betterment of the economy across the entire world. As Bitcoin is more widely-adopted, it will inevitably continue to increase in value.
Cope, James. “Peer-to-Peer Network.” Computerworld, Computerworld, 8 Apr. 2002, http://www.computerworld.com/article/2588287/networking/peer-to-peer-network.html.
“The Trust Machine.” The Economist, The Economist Newspaper, 31 Oct. 2015, http://www.economist.com/news/leaders/21677198-technology-behind-bitcoin-could-transform-how-economy-works-trust-machine.
Wallace, Benjamin. “The Rise and Fall of Bitcoin.” Wired, Conde Nast, 23 Nov. 2011, http://www.wired.com/2011/11/mf_bitcoin/.
“Who Is Satoshi Nakamoto?” The Economist, The Economist Newspaper, 2 Nov. 2015, http://www.economist.com/blogs/economist-explains/2015/11/economist-explains-1.