A Bit of a Do

You walk into a bar, order a pint, scan a QR code and sit down. This is not only the beginning of a tedious joke but also how you pay for booze with Bitcoins.

But did you really pay for that pint? What on earth is a Bitcoin? As you sip the spumous ale, consider what normally occurs: you’d hand over a sheet of paper, you’d get a handful of metal discs back. You’d sit down as if nothing was weird about that transaction.

Bitcoins are a digital form of money with a twist. The twist comes later; first, some history. Once upon a time, we’d buy our goods and services with valuables made of gold, perhaps, or shells, salt or pelts. This is commodity money: its value lies in the object.

The next step is to deposit your commodity money with a bank or a merchant in exchange for a redeemable receipt. Soon, the receipts themselves make acceptable forms of payment: paper money is born. Now let’s introduce the ‘gold standard’ and get rid of commodity money altogether; your paper money is backed up by an equivalent weight in gold.

After World War II, countries introduced currency lacking any intrinsic value (fiat money) but fixed to the US dollar which in turn was backed up by gold. The final step is to decouple your cash from the dollar, as the dollar eventually decoupled from gold. Now, the only thing giving value to the coins in your pocket is a guarantee from your government that those coins can be swapped for stuff. In itself, your money means nothing. Only government order (or, fiat) gives it value. Money, ultimately, is a promise. Money is wishful thinking.

Here’s the twist: Bitcoin goes one abstract step further – it doesn’t rely on a central bank for regulation. It takes away the government promise.

A large network of computers process all Bitcoin payments. Anyone can take part, helping to add records to the public ledger of transactions — a procedure called ‘mining’. This means Bitcoin transactions function like the peer-to-peer file sharing of BitTorrent, and like BitTorrent, this digital medium of exchange is dogged by controversy.

On 2 October 2013, the FBI shut down Silk Road, an online black market known as “eBay for drugs.” The site, skulking in a hidden corner of the internet —  the darknet, allowed users to trade illicit materials with Bitcoins. The currency is particularly suited (and maligned) for dodgy activities because of its decentralised and encrypted nature.

There is more to Bitcoin than fraud, treachery and drugs. For a start, there’s alcohol: consider the pint you bought eight paragraphs ago. You can do this in a real pub – the Pembury Tavern in Hackney. Bitcoins will also buy you subscriptions to social news site Reddit or the dating service OkCupid. You can even spend Bitcoins on an entire street in Berlin.

And there are more serious uses. Some Argentinians have taken on Bitcoins as an alternative to their over-inflated, over-controlled national currency. In a similar way, the digital currency allows Iranians to circumvent economic sanctions as the value of the rial plunges.

I’ve referred to Bitcoins as a currency several times, but is it really? If everybody considers it money – a medium of exchange — then, yes, on some level it is. But to be a worthwhile currency, Bitcoins must also act as a store of value. This is where things become less clear. Their price fluctuates wildly. Over a 48 hour period in November 2013, one Bitcoin exploded from £328 to £511 before plummeting back down to £322.

Bitcoins are at the mercy of speculators, dogged by association with criminal activities, and regularly hoarded, stolen or altogether lost as virtual exchange after exchange – sometimes just a bank run from a basement – shuts down.

Reputation matters. Without trust, Bitcoins lose their value and become hard to buy or sell. In the parlance, they would be illiquid.

However there is hope. Big-name funders such as Peter Thiel and the Winklevoss twins – famed for early investments in Facebook – are throwing money behind the venture. On top of this, the US Department of Justice recently referred to Bitcoins as “legitimate financial instruments,” while the UK’s HM Revenue and Customs suggests that Bitcoins will soon be taxable.

Maybe Bitcoin will amount to nothing more than an experiment: a radical attempt at an egalitarian, unregulated, citizen-driven currency. It’s still too early to say whether the Bitcoin bubble will pop, leaving the currency, like your figurative beer, a little flat.

Further reading:

Wired’s (techie) introduction: http://www.wired.co.uk/news/archive/2013-05/7/bitcoin-101

The Economist’s (more fiscally-minded) introduction: http://www.economist.com/blogs/babbage/2011/06/virtual-currency

The Bitcoin pubs: http://www.individualpubs.co.uk/

How to mine for Bitcoins: http://startbitcoin.com/