Bitcoin isn't about to die. It may, however, be about to grow up.
The digital currency is in crisis following the collapse of the large Mt. Gox exchange in February and growing concern about bitcoin's use in money laundering. The value of a bitcoin has plummeted from over $1,100 (U.S.) in December to about $600 today. Adding to its woes is the growing clout of one so-called "mining pool," which now controls roughly half of the computing power on the bitcoin network, giving it the ability, if it so chose, to counterfeit bitcoins.
These are problems indeed. But they're not entirely unknown issues in the money market. And they could be setting the stage for a more robust bitcoin in years to come.
The real issue is how committed bitcoin enthusiasts are to their vision of a currency free from the heavy hand of authority.
Many members of the bitcoin community are libertarian and reject government intrusion into their bailiwick. Maybe that attitude sprouts from genuine philosophical conviction about the proper limits to authority; maybe it reflects the more prosaic concerns of folks who would like to avoid the prying fingers of people who want to tax them. Whatever the reason, bitcoin has always trumpeted its outsider status and decentralized structure as a key selling point.
For a fledgling currency, still in its adolescence and used only by a small band of devotees, that attitude could work. It's not enough, though, for a currency that wants to establish itself as a mature payment system.
What bitcoin really needs now is the functional equivalent of a central bank – a powerful authority that could prevent counterfeiting and maintain confidence in the buying power of the currency. While advocates of digital money insist the architecture of the system gives bicoin built-in stability, the plunge in its value over the past few months suggests something more is needed.
Building a bitcoin central bank while preserving the essential anonymity of the network would be a challenge but not impossible. It would involve an authority willing to adjust the bitcoin supply in circulation as demand waxed and waned; it would also mean a body willing to crack down on threats to the system.
Among the current threats is GHash.IO, the British mining pool that recently controlled nearly 51 per cent of Bitcoin computing power. Bitcoin miners earn new bitcoins by verifying blocks of transactions on a virtual public ledger, known as the blockchain, to ensure no one can spend the same bitcoin twice. Doing that involves intense computations and the new coins are basically a reward for undertaking the onerous task.
The problem is that when one miner controls more than half the network's computing power, it also gains the power to confirm false transactions – to, in effect, counterfeit the digital currency. That has led to concern that GHash could undermine bitcoin, if it so chose.
GHash has fired back, arguing that its intentions are purely honourable. Its pleas sound reasonable, since any action that devalued bitcoins would hurt GHash's own holdings of the currency.
Still, the furor over GHash, which helped drive down bitcoin's value by 10 per cent over the past two weeks, demonstrates that bitcoin, like any other currency, has to maintain confidence among its holders or face an exodus. It's tough to achieve that confidence in the absence of a central authority.
There is a good reason why decentralized currencies aren't found elsewhere in the world: They simply don't work in the long run. The U.S. soldiered on without a central bank for decades but eventually founded the Federal Reserve in 1913 after a series of financial panics. The Bank of England began as a private institution but morphed into a public one as it became clear that someone had to act as the lender of last resort during a financial crisis.
To many bitcoin enthusiasts, the idea of a central authority contradicts the essential appeal of the digital currency. But it could be the vital element that would allow bitcoin to appeal to a much wider audience.
Ian McGugan