Recently, the NYSE launched Bitcoin futures. That move would suggest some faith in prospects for Bitcoin. But is Bitcoin a valid currency or a simply a fad? Bitcoin has provided a heady brew of technology and anti-institutional ideology that thrills some and prompts eye-rolling in others. The market in Bitcoin has jumped and crashed and jumped again, all on the suggestion of its promise. If you are not familiar with Bitcoin, here is a brief explanation.
Bitcoin is not physical cash. It is an alternative “currency” based on a fascinating technological innovation. Bitcoin itself is what is termed a cryptocurrency, a digital asset and a kind of value-holding tool based on the ability of third-party participants to rapidly validate a transaction. A Bitcoin is earned when a transaction--say, hypothetically, a sale of a cup of coffee paid for in Bitcoin--is validated by sending a code that unlocks the cryptography and, thereby, confirms the authenticity of the Bitcoin. Two parties use Bitcoin in the exchange and the independent, validating party is paid for the confirmation, in Bitcoin. In a way, this is not unlike when you use a credit card to pay for the coffee. The credit card company validates you have the credit available for the purchase and confirms this with an encrypted communication to the digital end-point, the cash register. Unlike the credit card company, however, Bitcoin does not require the proprietary confirmation of the credit card company. It relies instead on a distributed network of validators who want to increase their store of bitcoins by getting better and more efficient at validation. Perhaps someday, the theory goes, the holder of these earned stores of bitcoins can exchange them for real things or experiences, just like old fashioned cash.
Part of the excitement around this cryptocurrency is that it leverages the mysteries of cryptography with the dynamics of online videogaming with the voluntary participation of successful internet sites like Wikipedia. Gathering (“mining”) bitcoins is driven by fast-computing and requires an extensive, decentralized computer network to function. It also carries a dash of anti-establishment flair. Some people mine to make a profit, others to make an ideological point, still others as a pastime. If you get enough people to participate, it can succeed at least in theory.
Blockchain is another term associate with Bitcoin. Blockchain is that underlying set complex mathematical methods for validating a record of an event. In other words, the cryptography that protects and confirms a sale or creation of contract. We might compare blockchain to solving a Rubik’s cube. Whoever solves the cube the fastest gets to claim a dividend. Blockchain uses complex math to secure and unlock code at hyper-fast speeds without the need of a central authority.
Blockchain is powerful, because it removes intermediaries from transactions. Let’s take the example of logistics company that needs to track packages. A traditional system required a paper receipt and a signature. The receipt was returned to a hub, where it was further processed and an invoiced. Barcoding was an improvement because I helped package tracking more efficient by reducing the ambiguity around handling. In a way, blockchain resembles barcoding but at a hyper-complex, hyper-fast level. Every transaction contains a security lock that can immediately confirm delivery without the need for
Together, Bitcoin and blockchain have the potential to make obsolete many powerful, deeply-rooted traditional intermediaries, like central banks.
How can Bitcoin go wrong? The things that make Bitcoin exciting are also those that feed investment volatility. The pitfalls of cryptocurrency are well-documented, but here are three significant drawbacks:
- It is expensive to run. Bitcoin cannot exist without high-speed computers and the infrastructure used to run them, including electricity.
- Bitcoin is not regulated, and in its purest form may not be regulatable. The fact that it cannot be regulated makes it highly risky and volatile. Because it is not regulated, Bitcoin a favored currency for criminals and terrorists.
- • Most ominously, Bitcoin users could themselves form a cartel that could attack the system or hold it hostage. Presently, the process of Bitcoin mining is pseudonymous. One user cannot tell who another is. But a powerful enough computer could crack the security. Or a group could develop an exploit that allows them to steal identities within the system or share identities in methods outside the network.
The large companies that are beginning to experiment with Bitcoin or proprietary cryptocurrencies (Facebook, Starbucks) are mitigating these risks by providing users with cash-outs in dollars. The use of Bitcoin in these circumstances is part marketing cache, part desire to reduce transaction costs further.
What can blockchain do well? Blockchain represent a quantum improvement in data-management. With it, companies could quickly, cheaply and effectively solve transaction-validation problems. Large logistics companies are investigating it to confirm shipment arrival and issue payments automatically, without human intervention. This use of blockchain can open up margins or help create news ways to monetize activity. For example, imagine an agribusiness where seed is paid for when it injected into the ground. Or medicines that self-track consumption. Or contracts that don’t require teams of lawyers to negotiate.
Conclusion Bitcoin will not flourish until or unless something occurs that is antithetical to its core identity, at least as some proponents see it: regulation. In a sense, that is precisely what the establishment of futures trading in Bitcoin by the NYSE is (probably) intended to do. Or the recent introduction by Facebook of its own cryptocurrency, the Libra. But the historical fact is that appropriate regulation stabilizes markets a very large-scale level. Regulation often rankles the creative business mind; it is a constraint on efficiency or on personal expression. But arms-length exchange guaranteed by laws and contracts go to the heart of modern capitalist economies. What makes Bitcoin an alchemical super-fuel for some is that it was founded on the promise of freeing currency from the monopoly of governments. Whether this freeing represent a leap into the future or a plunge back into the bronze age is a matter of outlook. As of this writing, eight Nobel economists have asserted that Bitcoin is a bubble. If your goal is to build an efficient company or compound personal wealth, investing in Bitcoin will not be the surest route. Blockchain, on the other hand, could very well be.