Unravelling the Mystery of Bitcoin

Warning: The future is volatile

Professor Jennifer Kelber, Assistant Professor of Economics at St. Anselm College in Manchester, NH, believes there will be a viable decentralized digital currency like Bitcoin in the future, but that Bitcoin, itself, may have a short shelf life.

With the news this week that its largest exchange, Mt. Gox of Tokyo, suffered the theft of $350 million worth of bitcoins over several years as a result of flaws in its payment software, Kelber says investors are looking at Bitcoin very wearily. Mt. Gox ceased operation and is expected to file for bankruptcy. Having handled approximately 80% of the exchange of bitcoins worldwide, its demise was a huge setback leading to the loss of nearly half of Bitcoin’s prior value.

“The Bitcoin idea has a good deal of merit and is probably the way of the future,” said Kelber. “Bitcoin has lower transaction costs than credit cards, for example; it provides almost complete anonymity to its users and is a true financial innovation, but there are major challenges.”

Bitcoin has no central location and it is not backed by a central bank like the currencies of most nations. It operates via a decentralized payment system and is not regulated.
Bitoin does not meet the following criteria for a currency to be considered money: the existence of a medium of exchange, a store of value and a unit of account.

Its anonymity means the currency may be used by those operating outside the law – terrorists, drug dealers, black market commodity brokers – anyone wishing to move huge amounts of money without being traced.

Bitcoin users are not completely anonymous, but they are certainly able to act with more secrecy and less traceability than those using conventional payment methods

“Bitcoin users are not completely anonymous, but they are certainly able to act with more secrecy and less traceability than those using conventional payment methods,” said Professor Kelber. That presents a threat to the safety and security of major economic systems; it also poses a physical threat to nations.

While bitcoins can be transferred from user to user without the parties being known to each other, each transaction is recorded in a public register. There is a deterrent to using bitcoins for illegal activities because the transactions are discoverable, though the participants are often hidden through software programs that protect their identity.

Satoshi Nakamoto

Created in 2009 by a software developer who goes by the name Satoshi Nakamoto, Bitcoin is a digital currency created through a complex computer process known as mining. Coins are released into the marketplace via “miners” who are able to unlock their code, winning themselves a monetary award. The system was designed so there would be a finite amount of bitcoins – 21 million – the last of which are scheduled to be released in 2140.

The value of Bitcoin has fluctuated greatly based on supply and demand. At the beginning of 2013 the coins were worth less than $15 each; by the end of 2013 they were worth over $1000.

“This created a typical bubble,” said Professor Kelber. “With the events of the past week, there seems to be an even bigger bubble than previously thought.”

Ultimately, Professor Kelber believes there will be a currency like Bitcoin in the future that may be a substitute for the currencies of nations, or one may exist alongside other currencies. She says a virtual currency could exist without the backing of a central bank, but some sort of regulation must exist for complete viability.