During the depths of the worst economic downturn since the Great Depression, an engineer decided to rethink one of the fundamental cornerstones of the modern economy.
He envisioned a brand new decentralized digital currency, where payments went directly from one user to another – no central banks, no middlemen. The currency, called Bitcoin, would be guided by mathematical models, not politics or speculation.
Four years since its creation, Bitcoin has suddenly become one of the fastest-growing and most polarizing phenomena on the Internet. Two years ago, the value of an individual Bitcoin was less than $9 (U.S.). Today, a single Bitcoin trades for more than $160. Indeed, the currency has almost doubled in value over the last 30 days alone, as it begins to attract serious attention from currency analysts, major financial media and even U.S. lawmakers.
The Cyprus banking crisis appears to be part of the recent interest in Bitcoin. A spike in Bitcoin value matches up with worries in parts of Europe about the stability of traditional bank deposits. Once dismissed as a fringe currency with limited users and usage, Bitcoins are now ubiquitous enough that the U.S. Treasury Department issued a new set of guides last month that would essentially require some Bitcoin businesses to register with the government.
Depending on who you ask, the Internet-based currency is a revolutionary alternative to government-regulated financial systems, a poorly conceived pyramid scheme or a hotbed of criminal activity. The ballooning price of Bitcoins has already made theoretical millionaires out of those who invested early, but others are starting to question how sustainable the world’s most controversial new currency really is.
“I do not think a sufficient number of Bitcoin users exist to call the market ‘a bubble’ in the sense that a higher high in the price will not ultimately be reached,” said Anthem Blanchard, CEO of gold and silver bullion dealer Anthem Vault. “However, I would say ... that any time I see a parabolic chart, I think a correction or, at the very least, a temporary levelling off is due.”
Bitcoin was created in 2009 by an engineer named Satoshi Nakamoto, according to the currency’s official history. Later, a group of engineers took over development duties.
The creation of new Bitcoins is predicated entirely on pre-determined mathematical models, rather than the decisions of a central bank. Basically, users help validate Bitcoin transactions by donating their computers’ processing power to solving very difficult mathematical equations – a process called mining. As a kind of payment for that computational work, those users are rewarded with new Bitcoins, which they can then circulate into the network by making purchases. The number of Bitcoins in the network at any given time tends to adhere to a predictable mathematical formula.
In a 2011 interview with The Globe and Mail, Jeff Garzik, one of the computer programmers on the Bitcoin development team, described Bitcoin as a “startup currency, much like a startup business.
“I joined the Bitcoin project because Bitcoin is a totally new concept in currency, different in a number of ways from anything that has ever been tried before.”
Even though every transaction ever made using Bitcoins is logged and publicly viewable, the identity of the users making those transactions is kept relatively private. The Bitcoin network is also completely decentralized, with payments flowing directly from one person to another. As such, shutting down the network is much more difficult, given that there is no central hub. Bitcoins have become popular with users who don’t want their purchases to be easily traceable – be it for legitimate or criminal reasons.
In the past couple of years, Bitcoin’s developers have been working to address some of the criticisms levelled against the currency – for example, the extent to which users who own more powerful computers can more easily create new Bitcoins, and the general security of Bitcoin hubs, some of which have been hacked in the past. During its recent meteoric rise in value, Bitcoin has also been criticized for its limited usefulness – the argument being that, if Bitcoins continue to spike in value, it makes more sense to horde them than to spend them, limiting their value as a currency of trade.
“One should always be concerned about the long-term value of any currency that is not also money,” said Mr. Blanchard.
“With that said, the value of several attributes of the Bitcoin decentralized network, such as limited production of Bitcoins forced by mathematical algorithm and a novel method for clearing transactions, has resonated with tens of thousands of users.”