Since 2008, the cyber-currency called Bitcoin has fascinated some cryptographers and Internet traders. It gained undeserved notoriety by mention in the FBI’s takedown of the illicit goods trading on Silk Road. Since then Chairman Bernanke’s positive comments added legitimacy and luster to Bitcoin and its exchange rate (over $1200 on 11/29/2013) earned it “above the fold” placement in respectable financial websites.
Bitcoins are accounting entries created as rewards from “Bitcoin mining” and from transaction posting fees. The physical Bitcoins shown in photographs can be purchased from a minter for a Bitcoin transaction of the face value plus a fee for casting the coins. Alternately Bitcoins can be “bought” on eBay.
Each Bitcoin transaction is posted to a global ledger (called the “block chain”) where each entry includes the amount, the identities (public keys) of payer and receiver, and the solution of a computationally difficult mathematical puzzle solved by Bitcoin “miners.” The entire ledger and updates are sent to all Bitcoin “miners” whose computers systematically hunt for a solution to the next mathematical puzzle. The first solver of each puzzle earns a reward in Bitcoins, that’s about $1.50 for a weekend’s work.
A Bitcoin’s value is not intrinsic. Its value stems from an emotional skyhook. On the plus side, Bitcoin is free from government manipulation, and except for a few highly improbable scenarios, the ledger entry-form of Bitcoin is immune to theft or manipulation because of the widely circulated and frequently vetted block chain.
On the downside, few merchants accept Bitcoin, despite some surprising government and commercial names that advocates cite. Bitcoin has been volatile, mostly upwards. But the specter of a collapse causes concern to some. Fortunately, there is a cap on direct damages. The Bitcoin architects imbedded into the system an all-time issuance limit of 21 million Bitcoins. At that maximum and today’s exchange rate, the direct damage from a complete devaluation of Bitcoins would be $25 billion. Total Bitcoin annihilation when Bitcoin is fully deployed would be tragic, but we can add perspective by noting that $25 billion is just 0.7% of the US Federal annual spending. Worse things have happened.
Alan Daley is a retired businessman who writes for The American Consumer Institute Center for Citizen Research