The Rise of Bitcoin

Is It Real Money If It Doesn't Come From the Mint?

Utah Software Engineer Mints Physical Bitcoins

Bitcoins introduced a lot of people to the idea of computerized money. Now the digital currency, which set off a minor frenzy when it broke into public consciousness in 2013, is trying to grow up and turn into something useful. Novelty has given way to the hard slog of starting and funding new companies, like brokerages and bitcoin storage sites, that can be boring and profitable. Utopian fantasies have subsided as consumers remain unconvinced of the value of swapping their cash for bitcoins, or using it to buy goods and services or for transferring money.There are plenty of people in Silicon Valley, Wall Street and other tech or money hubs around the world working on it, but no definitive answers are in sight. With price swings that have shown that owning bitcoins isn’t a sure path to riches — the currency lost half its value over the course of 2014, a worse showing than the ruble —  you have to believe in the brainpower invested in bitcoins if you want to believe that the reality will eventually match the rhetoric.

The Situation

Even as entrepreneurs look for new business models, the bitcoin community has been working through some legacy issues, like the 2013 indictment of the operator of Silk Road, an anything-goes online market where drugs were peddled for bitcoins or the bankruptcy filing by Mt. Gox, a Tokyo-based exchange, after hackers pilfered 850,000 bitcoins. Regulators are proving to be a bigger challenge than many entrepreneurs had hoped. Benjamin Lawsky, the New York state superintendent of financial services, proposed rules on digital currency companies that drew often-unprintable reactions from bitcoin entrepreneurs before being scaled back. European banks were warned against handling bitcoins until new EU regulations take effect. The U.S. Internal Revenue Service ruled that bitcoins would be treated as property, not currency — meaning that buying a $2 cup of coffee with bitcoin you bought for $1 could trigger a capital gains tax. And the Bitcoin Foundation is fighting an internal battle over whether supporters should focus on advocacy or improving the software that makes transactions in the currency possible.

Source: Bloomberg
Source: Bloomberg

The Background

Virtual currencies aren’t new — online fantasy games have long used them — but the development  of a secure digital currency without a central issuer  rightly turned heads. The pseudonymous creator of the bitcoin system, Satoshi Nakamoto, solved a problem central to any currency: how to control its issuance, i.e., prevent counterfeiting. He also solved one specific hurdle for digital money — how to stop users from spending the same unit of currency twice. His breakthrough idea involves an online ledger that records every single bitcoin transaction, one maintained by a network of bitcoin “miners” whose computers perform the calculations that validate each transaction, preventing double-spending. The miners earn a reward of newly issued bitcoin. The pace of creation is limited, and no more than 21 million bitcoins will ever be issued. Bitcoins can be used to buy an ever-expanding list of things, including a Tesla sports car. That’s still a fraction of the fiat currency economy, but a band of well-funded startups with names like Coinbase, BitPayXapo and Bitgo are making it easier to exchange and store bitcoins safely.

The Argument

A bitcoin boom early in 2014 led some to call it a bubble with no intrinsic value. But entrepreneurs in the field say that focusing on the price of bitcoins is missing the point — the currency’s value is as the basis of a new kind of payment system. Dreams of replacing the dollar aside, putting bitcoins to work is a matter of applying enough time and money, they say. Convincing applications of the bitcoin system include moving money abroad and as a medium for micro-payments in emerging countries. Tim Draper, a legendary Silicon Valley venture capitalist, bought about 30,000 bitcoins from the U.S. government (they had been seized from Silk Road) and aims to help people break free from weak local currencies. But even some of the currency’s canniest boosters realize there is no guarantee that bitcoin ever will break into the monetary mainstream. Mike Hearn, a member of the core team that updates the bitcoin software, said that the “most plausible outcome” is that it retains only a niche appeal.

The Reference Shelf

First Published Oct. 3, 2013

To contact the editor responsible for this QuickTake:

John O'Neil at joneil18@bloomberg.net