Bitcoin: Currency or Commodity?

Earlier this month, a US Senate committee described virtual currencies as a ‚Äúlegitmate financial service‚ÄĚ and since then the value of a single bitcoin has surpassed $1,000. In January, it was trading at $20.

There has been continued debate about whether bitcoin is a a ponzi scheme or poised to change the world. Earlier this week, The Guardian reporter Alex Hern explained, ‚ÄúUntil now, what pundits called in a rolling-eye fashion ‚Äėthe new peer-to-peer cryptocurrency‚Äô had been seen just as a digital form of gold [and silver], with all the associated speculation, stake-claiming and even ‚Äėmining‚Äô; perfect for the digital wild west of the internet, but no use for real transactions.‚ÄĚ

The Senate Hearing

This month, The FBI and Justice Department‚Äôs Criminal Division warned the committee about the increasing use of such currencies by ‚Äúmalicious actors‚ÄĚ including drug dealers, pornography traffickers and perpetrators of large-scale fraud.

Committee chairman, Senator Thomas Carper, observed, “Virtual currencies, perhaps most notably Bitcoin, have captured the imagination of some, struck fear among others, and confused the heck out of the rest of us.”

But the Senate committee described virtual currencies as a ‚Äúlegitmate financial service‚ÄĚ and since then the value of a single bitcoin has surpassed $1,000. In January, it was trading at $20.

Bitcoin offers unprecedented flexibility and now PC Game Supply, an online retailer specializing in the digital delivery of game and gift card products, accepts Bitcoin via Bitpay. Target, America’s third largest retailer accepts Bitcoin via mobile gift card startup, Gyft. Bitcoin may likely become part of our future economy.

The chairman of the US Federal Reserve Ben Bernanke, the Bank of England, and other key players like law enforcement officials, regulators and economists are starting to take Bitcoin more seriously, even after last month‚Äôs shutdown of Silk Road‚ÄĒwhich let users buy drugs anonymously over the internet using Bitcoins. One step towards Bitcoin‚Äôs legitimacy is Bernanke‚Äôs intention to make it part of US currency regulation.

In October, the world’s first Bitcoin ATM opened in Vancouver, Canada, which allows users to exchange bitcoins for cash and vice-versa. The Chicago Federal Reserve said the currency was “a remarkable conceptual and technical achievement, which may well be used by existing financial institutions or even by governments themselves.”

Indeed, the virtual currency was quickly adopted in China, where one exchange – BTC China – is said to be the most active globally. Bitcoin’s popularity in China is based on its reliability of getting money out of the country.

Writing about why the Chinese are paying premiums for their Bitcoins, Forbes contributor, Gordon G. Chang, points out, ‚Äúthere are a number of reasons why Beijing undoubtedly likes the new currency. For one thing, digital money can undermine the dollar‚Äôs status as the world‚Äôs reserve currency. Bitcoin is on track to becoming the world‚Äôs first trillion dollar non-fiat form of money.‚ÄĚ

While Bitcoin differs from conventional currencies, the idea of virtual currency for the Internet has taken hold. Hern says, ‚Äúthe only reason people are willing to pay money for the currency is because other people are willing to as well.‚ÄĚ But while widespread adoption is possible, Bitcoin would need to develop a banking system akin to conventional money.

How it works

Once you have installed a Bitcoin wallet on your computer or mobile phone, it will generate your first Bitcoin address and you can create more whenever you need one. You can disclose your addresses to your friends so that they can pay you or vice versa. In fact, this is pretty similar to how email works, except that Bitcoin addresses should only be used once.

In terms of processing, mining is a distributed consensus system that is used to confirm waiting transactions by including them in a block chain, a public record of Bitcoin transactions in chronological order. To be confirmed, transactions must be packed in a block that fits very strict cryptographic rules that will be verified by the network. A block is a record in the block chain that contains and confirms many waiting transactions.

All confirmed transactions are included in the block chain. Bitcoin wallets keep a secret piece of data called a private key or seed, which is used to sign transactions, providing a mathematical proof that they have come from the owner of the wallet.

Exchanges often reveal different values because of difficulties related to exchanging bitcoins for real currency, which requires funds to be transferred through several banks in different countries, each with their own transaction fees.

According to Bitcoin developer Mike Hearn, ‚ÄúThe web came to dominate because it was flexible and open, so anyone could take part, innovate and build interesting applications like YouTube, Facebook or Wikipedia, none of which would have ever happened on the AOL platform. I think the same will be true of Bitcoin.” Even so, Bitcoin has a long way to go in dealing with its problems and future challenges. Earlier this month, Hackers stole over a thousand Bitcoins from the European payment processor valued at over $1 million.

Alternatives to Bitcoin such as Litecoin, which provides faster transaction processing, and Freicoin, which tries to stop money hoarding are based on the same technology. Hern adds, ‚ÄúThere’s even nothing to stop a nation state declaring its own version of Bitcoin as legal tender.‚ÄĚ Still, Bitcoin’s monetary policy is not likely to be adopted by an entire economy any time in the near future.

Nearly every question regarding Bitcoin is being asked and answered over at Reddit. The Bitcoin subreddit is described as follows:

Bitcoin is the currency of the Internet: a distributed, worldwide, decentralized digital money. Unlike traditional currencies such as dollars, bitcoins are issued and managed without any central authority whatsoever: there is no government, company, or bank in charge of Bitcoin. As such, it is more resistant to wild inflation and corrupt banks. With Bitcoin, you can be your own bank.

Only time will tell if Bitcoin is the future of money or a bubble waiting to burst. If you are interested in Bitcoin, don’t miss the Inside Bitcoins conference and expo in Las Vegas this December 10-11, which explores the future of Bitcoin and cryptocurrency.