In October 2013 the world’s first Bitcoin ATM opened for business in Vancouver, Canada. The move signified the cryptocurrency’s transformation from the digital world to the mainstream and since then the floodgates have opened.
The US got its first Bitcoin ATM in February with the UK following suit a month later. A film – The Rise and Rise of Bitcoin – was released in April and four months later the ultimate recognition came when the US Consumer Financial Protection Bureau issued its first advisory on virtual currency.
“I think the idea of grass-roots, people created currency appeals to many, especially given the dysfunction of the financial system and recent political events,” explains Bitcoin developer Mike Hearn. “But ultimately it’s popular because it’s cheap and relatively easy.”
Success breeds imitation and the world of cryptocurrency is no exception. Inspired by the progress of Bitcoin, similar currency methods such as Dogecoin, Monacoin and Litecoin have entered the market over the last few years, each seeking to bring something slightly different to the table. But do any of them pose a threat to the Bitcoin dominance?
“There are several hundred cryptocurrencies traded on the market and new ones launched practically every day,” says economist Peter Surda. “However, many of those that existed were abandoned or were launched but didn’t trade.
“Most of them are almost identical to Bitcoin with only minor parameter changes. If there are cryptocurrencies that have more advantages than Bitcoin, they may become more successful one day but there are many factors that can hypothetically affect this decision so we cannot predict it accurately.”
“There are several hundred cryptocurrencies traded on the market”
Bitcoins are created mathematically through a process described as mining. Each time a bitcoin is traded or mined, that transaction is broadcast across the peer-to-peer network that underpins the system, helping to establish the current price of each bitcoin.
The cryptography in-built into bitcoins is supposed to insulate them from theft and counterfeiting. However, several high-profile security breaches have raised concerns over the safety of Bitcoin and the online wallets people use to store them.
In November 2013 hackers made off 1,295 bitcoins, worth nearly $1m at the time, by raiding free online wallets provided by the Danish company Bitcoin Internet Payment System (BIPS). Even more catastrophic, the world’s most prominent Bitcoin exchange Mt Gox was forced to close down after it lost 850,000 of its clients’ bitcoins with a street value of $395m following a cyber attack in February.
“The Bitcoin protocol itself is very safe but it can be also used in an unsafe way,” says Surda. “Some service providers like Mt Gox become overwhelmed and confused and don’t know how to use Bitcoin in a secure way. Many of the solutions that are theoretically possible are not available yet in a way that can be used by non-experts and even experts make mistakes.
“Individuals should not keep bitcoins at an exchange or in a shared wallet. Larger sums should be kept in cold storage – a device that is not connected to the internet. Multi-signature wallets have also started to appear in solutions that are accessible for normal users. They allow control of a balance to be split across several people and devices.
“For smaller amounts, a wallet on a mobile phone provides a good balance between security and usability. I do not recommend using general purpose computers such as a Windows or a Mac though, unless you use an additional security device.”
“In 2013 hackers made off 1,295 bitcoins, worth nearly $1m at the time”
Financial markets like to see stability in their currencies and this is one area where Bitcoin seriously fails against its more established rivals. In just over twelve months the value of a bitcoin has fluctuated from $100 to $1,200 and back down to its current price of $565.
“Bitcoin exhibits extreme price volatility because its future is uncertain and few of the outstanding e-coins are traded,” says Mark T Williams, risk management practitioner and master lecturer at Boston University. “On an average day it is not uncommon for less than 1% of outstanding bitcoins to trade.
“Bitcoin’s future is uncertain and few of the outstanding e-coins are traded”
“Also there is excessive hoarding by owners, over 90%, which undermines one of the essential ingredients needed for a healthy market. Without fluid trading, even a relatively small sell order can cause prices to crumble. On 14 February 2014, one trade of 6,000 e-coins caused a flash crash, momentarily knocking prices down by 80%.”
“Bitcoin is also volatile because it is not legal tender and there is no requirement that businesses have to accept it to settle debts. Its value is highly speculative and linked to hopes it will be widely accepted in the future. However there is no requirement that it has to be accepted or used to settle transactions so the true value is a guessing game about the future, level of regulation, adoption and safety for consumers.”
Who’s in control?
Bitcoin prides itself on the fact that unlike traditional currencies, it is decentralised and not beholden to the whims of a bank or other controlling authority.
However, researchers from Cornell University said in June that they believed a single mining pool known as GHash had managed to gain control of 51% of Bitcoin’s crytptographic output on several occasions.
“A 51 percenter can control which Bitcoin transactions happen,” says Ittay Eyal, a post-doctorate researcher in Cornell’s Department of Computer Science. “It becomes a monopoly. It can set arbitrarily high transaction fees, for example, or even extort someone to allow them to perform transactions. It could block or delay all transactions but its own.
“One of Bitcoin’s goals was to be a free system, independent of anyone’s control. With small pools, no one has this kind of control. With a 51 percenter, there is.”
“A 51 percenter can control which Bitcoin transactions happen”
Preventing dodgy business
Billed as anonymous and untraceable, it is little wonder that Bitcoin has attracted the attention of the criminal classes. With the currency having reportedly been used to buy drugs and other undesirable items on the Silk Road – an online black market – governments around the world are growing concerned that it might be the perfect way for criminal organisations to launder their money.
Several countries – notably China – have already placed restrictions on the use of Bitcoin and in January the New York Department of Financial Services said it plans to create a BitLicense for some Bitcoin-based businesses in an attempt to clamp down on suspected criminal activity. This hasn’t gone down well with some of those closest to the cryptocurrency.
“Bitcoin is already heavily regulated,” says Hearn. “Any entity that interacts with the financial system is. More regulation a la the BitLicense can only hurt, in my opinion.
“When people say ‘we need regulation’ what they normally mean is ‘the existing regulations are so vague we don’t know if we’re breaking the law or not, so we need clarification and possibly new rules as a part of that process’. In fact the regulation is creating the uncertainty and if there was none at all, that uncertainty would go away too.”
“Several countries have placed restrictions on the use of Bitcoin”
The path to mainstream
Debate about the future prospects of Bitcoin is fierce. Many commentators believe that without mainstream rules and regulations, the cryptocurrency will never to truly rival more established currencies like the dollar and the pound.
“Bitcoin will remain only a fringe currency and not meaningfully compete with hard currencies unless it gains legal tender status and succumbs to greater regulation and tighter oversight,” says Williams. “Currently there is no legal protection for consumers that buy and sell bitcoins. In this current unregulated environment the mass public will remain hesitant about using Bitcoin.”
However, Surda believes that Bitcoin has the potential for growth in emerging territories and the B2B sector whilst Hearn offers a pragmatic view of the future.
“I would like to see it become widely used,” he says. “But I suspect it’ll be analogous to the internet: that didn’t kill books, but people do read a lot online that wouldn’t have made sense to publish as a book. So it will be with Bitcoin.”