0
Vote Up Vote Down

Ask The Experts: A Bit about Bitcoin

by John S Kiernan on February 18, 2014

bitcoinIn an era dominated by digital technology it should come as no surprise that someone has developed a digital currency. Paypal is a digital payment system but Bitcoin, developed in 2009, is an actual digital currency that, in the last several months, has generated excitement and interest – and yes, a little concern --  in the financial services industry.

Bitcoin uses crytography to create and transfer money. Any country's currency can be transformed into bitcoins so users can make payments. To use a bitcoin you need wallet software that runs on a computer or mobile device.

Like any other currency, bitcoins can be traded on currency exchanges. During the latter half of 2013 trading in bitcoins became quite volatile. Traders made a lot of money buying and selling bitcoins last year but some lost a lot of money as well.

Behind the excitement

So what's the appeal? We turned to some economic experts for answers.

“My guess is that Bitcoin has a ‘coolness’ factor that has attracted a strange collection of libertarians and other anti-government types – including people who want to conduct illegal transactions, and others who see it as a great speculative opportunity,” said David Parsley, an economics and finance professor at Vanderbilt University.

John C. Alexander, Jr., a professor of investments at Clemson University, is skeptical of the argument that Bitcoin represents a new currency. He sees it more as a new payment system.

“We have metrics relative to payment system valuation in the our public equity markets, such as Ebay, and in the past Paypal,” he said. “Despite these valuation metrics, ultimately the value of a Bitcoin transaction and the value of the Bitcoin equity is whatever the last person was willing to pay.”

Appealing anonymity

Nicolas Christin, assistant research professor in electrical and computer engineering at Carnegie Mellon University, believes the degree of anonymity provided by Bitcoin transactions is part of the appeal. He also sees some drawbacks to its use in normal, day-to-day transactions.

“The fact that Bitcoin payments take around ten minutes to be confirmed -- and basically one hour for being completely vetted -- is a real problem for quick, face-to-face transactions,” he said. “It is not unsolvable -- all you need is an escrow or insurance system built on top of the existing mechanisms to make this work well -- but this will add costs, and whether or not this will be a really practical solution compared to the alternatives remains to be seen.”

Parsley is also skeptical that Bitcoin has much practical value as a currency.

“Most people still tally in dollars, euros, yen etc.,” he said. “I don’t see that going away.”

Some governments and their institutions appear leery of the Bitcoin as well. Russia's central bank has expressed deep reservations about Bitcoin transactions, saying they may be useful to terrorists and run counter to the country's laws. In December 2013 the People's Bank of China stepped in to block merchants from accepting bitcoins and barred banks and payment processors from converting bitcoins into the Chinese currency.

Finally, law enforcement seems to have a concern with the anonymous nature of bitcoin transactions. The U.S. Justice Department recently announced the arrest of Charlie Schrem, CEO of Bitcoin payment processor BitInstant and vice chairman of the Bitcoin Foundation on money laundering charges in connection with the Silk Road anonymous black market for drugs.

Ask the experts

  • Bitcoin, the open source peer-to-peer payment network and digital currency, has captured the imagination of Wall Street. Why has it become so popular?
  • How practical is a digital currency? Do you think this is the way we'll pay for things in the future?
  • Some people who traded in Bitcoins have made a lot of money as its value has risen. Doesn't that suggest there are downside risks? Are there other reasons consumers should proceed cautiously?
  • Could Bitcoin find its niche as one of these systems?
  • Why has Bitcoin come under so much legal fire? Are the company's days numbered as a result?
  • What types of criminal activities could theoretically be facilitated with the use of Bitcoin?
< >
  • Joshua Fairfield Professor of Law, Washington and Lee University School of Law
  • Aric Steven Frazier Chairman/Professor of Law Enforcement, Vincennes University
  • Ernest E. Allen President and CEO, International Centre for Missing & Exploited Children
  • James L. Swofford Professor, University of South Alabama, Mitchell College of Business
  • John M. Veitch Professor and Associate Dean of Graduate Programs, University of San Francisco, School of Management
  • David Parsley E. Bronson Ingram Professor in Economics and Finance, Owen Graduate School of Management, Vanderbilt University
  • John C. Alexander, Jr. Breazeale Professor of Investments, Clemson University, College of Business and Behavioral Sciences
  • Nicolas Christin Assistant Research Professor in Electrical and Computer Engineering, Carnegie Mellon University, College of Engineering

Joshua Fairfield

Professor of Law, Washington and Lee University School of Law
Joshua Fairfield
Why has Bitcoin come under so much legal fire? Are the company's days numbered as a result?

Bitcoin has come under fire supposedly because it is secret. That makes no sense. The blockchain is a public, distributed record of every transaction. The currency is therefore particularly public. The only anonymity involved is the pseudonymity of the Internet. And that's not anonymous at all.

Bitcoin has really come under fire because it bypasses established banking structures. Law enforcement is worried about Bitcoin because it does not pass through institutions with which law enforcement and intelligence have ongoing working relationships.

Bitcoin is not a company--there is no central issuing authority--and so I can't say that the company's days are numbered. Bitcoin is a protocol. And that protocol will survive in some format. The idea of a decentralized registry is simply too powerful. And the protocol can be used for much more than currency. Bitcoin, the specific implementation itself may or may not survive, depending on how much it is targeted by regulators and how much it is in demand as a medium of exchange. Sustained regulatory attention and decreased demand might crash the currency. Certainly the recent arrests of people who are simply selling Bitcoin indicate that the currency is in trouble. But derivatives are already in the works.

What types of criminal activities could theoretically be facilitated with the use of Bitcoin?

Any criminal activity that could be facilitated with the use of cash, could be facilitated with the use of Bitcoin. And there are a few more. Because Bitcoin is intangible, it avoids the stacks-of-cash problem faced by marijuana businesses in Colorado, for example. Because Bitcoin is easily transferable across long distances, it bypasses borders and could be used in threat finance. Or at least it might be, if it weren't so public.

But that just raises the question: is cash inherently bad because people use it in many crimes?

Aric Steven Frazier

Chairman/Professor of Law Enforcement, Vincennes University
Aric Steven Frazier
Why has Bitcoin come under so much legal fire? Are the company's days numbered as a result?

From what I see, there is no 'government or national' backing for the currency here. That makes it very strange for most and a complete concept of its own. From that there is no public -understanding. It is like a gamble on what people think it is worth individually and how it may or may not be accepted by certain governments, commodities, businesses or people then.

Ernest E. Allen

President and CEO, International Centre for Missing & Exploited Children
Ernest E. Allen
Why has Bitcoin come under so much legal/regulatory fire? Are the company’s days numbered as a result?

Decentralized “cryptocurrencies” like Bitcoin are a relatively new phenomenon. They are attracting attention from policy makers and regulators because their use is growing, becoming more mainstream, and because they belong to no nation and are overseen by no central bank.

They can be bought and sold at prevailing exchange rates and then used to purchase both real and virtual goods and services. They are referred to as currencies with “bidirectional flow,” differing from other digital currencies which may be purchased at a specific exchange rate, but may not be exchanged back; i.e., Facebook credits, Amazon coins, or frequent flyer points.

Today, there are Bitcoin exchanges where one can exchange bitcoins for conventional currencies. All Bitcoin transactions are visible and transparent. The challenge for law enforcement is in going from those transactions to an actual person.

We do not think that Bitcoin’s days are numbered. In fact, we are enthusiastic about the potential of digital currencies like Bitcoin for achieving social good, particularly in bringing about financial inclusion for the 2.5 billion adults on the planet today without access to banks, credit cards or the mainstream financial system. In addition, a digital economy is attractive to tech-centric young people, and has particular appeal in light of the global movement to mobile technologies and mobile payment systems.

Nonetheless, we are concerned about the risks and trying to address them. That is a primary reason why we and Thomson Reuters created a Digital Economy Task Force which includes the Bitcoin Foundation, the Tor Project, law enforcement leaders, etc.

For the past year I have consulted with law enforcement and financial experts worldwide. There is consensus that various commercial criminal enterprises are increasingly moving to a new unregulated, unbanked digital economy. There are three primary reasons for this migration: (1) anonymity; (2) the lack of policy and regulatory oversight; and (3) the fact that most countries have not yet begun to apply existing laws and regulations to digital currencies at the exchange level (i.e., the point at which digital currencies are traded for dollars, euros, pounds, yen, etc.).

One official told us, “the more virtual currencies function like real currencies, the greater the illicit finance threat.” Yet, few countries are addressing this emerging threat.

We believe that the key is to treat the exchanges as money services businesses under existing law, and require them to comply with anti-money laundering rules and regulations. Bitcoin users who merely use the currency to purchase goods and services are not required to register. But the Bitcoin exchanges should be required to register. We believe that this is not only a positive step for the issues we are concerned about, it is also a positive step for Bitcoin.

The U.S. has begun to do that. Most of the rest of the world has not. We are going to promote and advocate for a consistent, uniform approach worldwide.

What types of criminal activities could theoretically be facilitated with the use of bitcoins?

Bitcoin is a decentralized digital currency which can be used for good or evil. Our primary concerns right now stem from Bitcoin’s use as a currency on the so-called “Deep Web,” the anonymous Internet facilitated by anonymizing tools like Tor. Tor was developed by the U.S. government for noble, high-minded and laudatory reasons, to protect political dissidents against retaliation by repressive regimes. Users who employ Tor do not leave behind an IP address, and thus, are effectively anonymous. And Tor is also valuable for journalists, stalking victims, etc. However, in practice Tor is not just used by political dissidents and journalists. It is also being used by traffickers, child pornographers, and other organized criminals.

The anonymous “Deep Web” is populated by notorious sites like Silk Road, called “the Amazon for drugs,” sites for the purchase of illegal weapons, hiring assassins, purchasing stolen credit card information, acquiring fake passports, etc. It has also become a pedophile’s playground, including notorious sites like Lolita City, PedoEmpire, and others. All of these sites accept payment in Bitcoin.

We are working hard to develop new law enforcement investigative techniques and interventions, and seeking to prevent the misuse of innovative tools and technologies by organized criminals. We are promoting global dialogue on the difference between privacy and anonymity. Nonetheless, it is a challenge.

James L. Swofford

Professor, University of South Alabama, Mitchell College of Business
James L. Swofford
Bitcoin, the open source peer-to-peer payment network and digital currency, has captured the imagination of Wall Street. Why has it become so popular?

I suspect Bitcoin has become slightly popular because it is new and interesting. You say it is popular, but have you found a single person who has adopted Bitcoin and given up all governmental currencies? I suspect not.

Bitcoin does have several ready made group of "fans” including:

• Those who think a private money system is more stable than a government backed money system. Among these are those who follow the Austrian school of economics.

• Those who are generally suspicious government. According to the polls that is a growing number of people.

• Those who like privacy. Though, how private Bitcoin transactions are is unclear to me.

How practical is a digital currency? Do you think this is the way we'll pay for things in the future?

Very practical in fact government money is to a great extent digital now. That is what the debit card did and they are quite popular. What makes Bitcoin different is not its digital nature, but that it is a private money not a government money. Of course governments may tax Bitcoin out of existence as the US did to privately owned bank notes of the 19th century.

Some people who traded in Bitcoins have made a lot of money as its value has risen. Doesn't that suggest there are downside risks? Are there other reasons consumers should proceed cautiously?

Certainly if the value of something can rise, it can also fall. That Bitcoin value fluctuates undermines its role as a money. This is true of all monies whether private or government issued.

People will proceed cautiously with Bitcoin because people are naturally cautious. People proceeded with some caution when the euro was introduced and the euro and the old currencies circulated side by side for a period of time to build up the confidence in the public in the euro. The euro was introduced by a number of stable governments who the public knew the track record of. Bitcoin has only the track record of Bitcoin and the public has a short track record of "owners" of the Bitcoin market.

The above is what if it is to ever become widely used bitcoin will need to slowly develop a track record and build up public trust. Unlike gold, the producers could at anytime produce any amount more they want of Bitcoin.

John M. Veitch

Professor and Associate Dean of Graduate Programs, University of San Francisco, School of Management
John M. Veitch
Bitcoin, the open source peer-to-peer payment network and digital currency, has captured the imagination of Wall Street. Why has it become so popular?

Digital currency isn't supposed to capture the imagination. Money is supposed to be a solid means of payment and a stable store of value. The popularity of a currency has to do with its ability to hold its value in real terms, i.e. in terms of how much in the way of real goods and services one unit of that currency purchases over time.

Bitcoin fails spectacularly in this regard. Its value whipsaws around in ways that make it spectacularly bad money but a hugely attractive speculative investment. That's why segments of Wall Street like it - it is the ultimate speculative investment that can be talked up because it is so loosely anchored to anything of real value. It has become popular because it's the ultimate "penny stock" whose value is subject mostly to the vagaries of human greed and fear.

Go back two years to articles on Bitcoin and you will see that retailers were reluctant to use it because it was not widely accepted and its value fluctuated from day to day, putting them at risk of loss when they accepted it in payment.

How practical is a digital currency? Do you think this is the way we'll pay for things in the future?

Hate to say this but we already have a digital currency - it's called the US dollar and people seem to use it on their phone in front of me at Starbucks all the time. And the bonus is, that you pretty much know how many dollars it will take to buy a latte tomorrow. The same is not true about Bitcoin.

How practical is a currency that is not backed by a government and a central bank? Well that's a separate question. My answer would be that digital money, like fiat money, requires credible backing so that it will be accepted as a means of payment. Bitcoin fails this test. Long-term its not a viable currency, only a speculative vehicle that people will leave behind after they are exhausted by its inevitable boom and bust cycles.

Do criminals and people wanting to hide from government scrutiny like Bitcoin? Absolutely, as long as they can eventually shift it into a currency that they can use. So to the extent that there is honor among thieves, I suppose Bitcoin is viable in a limited way. Of course that assumes that governments are willing to let criminals and others hide their activities in this way. Do you think that's what will really happen? It certainly doesn't seem so given the recent arrests in the US and crackdowns on exchanges in China, but what do I know?

Some people who traded in Bitcoins have made a lot of money as its value has risen. Doesn't that suggest there are downside risks? Are there other reasons consumers should proceed cautiously?

The answer is of course yes, and many people have lost through Bitcoin's gyrations. As I argued above, consumers shouldn't proceed at all in my view as Bitcoin isn't any type of reasonable approximation to a currency.

It's like arguing that tulip bulbs were currency during the Tulipmania episode. Did tulip bulbs have value during the mania? Absolutely. Did some people make money from holding and then selling the bulbs during the mania? Yes some did, most however didn't. When the mania subsided, and the value of the bulbs fell to sustainable levels, were the losses to those who held the bulbs catastrophic? Absolutely.

So if you want to appear cool, take an amount of money you are willing to lose and speculate in Bitcoin. Its great cafe conversation over your latte.If you want to be able to buy a latte tomorrow, or the day after and the day after that, hold dollars - in your hand or on your phone.

David Parsley

E. Bronson Ingram Professor in Economics and Finance, Owen Graduate School of Management, Vanderbilt University
David Parsley
Bitcoin, the open source peer-to-peer payment network and digital currency, has captured the imagination of Wall Street. Why has it become so popular?

That’s a great question. My guess is that bitcoin has a ‘coolness’ factor that has attracted a strange collection of libertarians and other anti-government types – including people who want to conduct illegal transactions, and others who see it as a great speculative opportunity.

How practical is a digital currency? Do you think this is the way we'll pay for things in the future?

No. You have to think of what functions money is supposed to perform. First, is medium of exchange; on that account, as long as more and more people adopt it, it will be useful. However if legal restrictions are imposed, as China has, and others will surely follow, it will not be very useful – except, again, for crooks. Second, a currency is supposed to be a unit of account – that is, do we measure things in terms of it. Most people still tally in dollars, euros, yen etc. I don’t see that going away. Moreover, as a unit of account Bitcoin is particularly bad since the value fluctuates so much in terms of the underlying real goods and services. The third function of money is a store of value. Again, Bitcoin’s fluctuations pretty much negate that function since value rises and falls dramatically.

Some people who traded in bitcoins have made a lot of money as its value has risen.

Doesn't that suggest there are downside risks? Are there other reasons consumers should proceed cautiously?

Absolutely. With currency in a bank, for example, if the bank gets robbed, or the manager or clerk runs off with the money – your money is safe up to $250,000. Not so with bitcoins. Similarly, that’s one reason why we have banks – to keep our money safe. Bitcoins are stored electronically – and there have been many cases where they have been stolen. Who are you going to call? They are not insured and my guess is that you’d have a hard time of getting your local police to investigate. I see Bitcoin as just another bubble. Some people make a lot of money in Ponzi schemes too! But, of course some lose. Bitcoin is supposed to be unique. However, by its very success it will (and has) stimulated other e-currencies. Now, you may not be able to counterfeit bitcoins,but other e-currencies serve exactly the same function as Bitcoin. So, in effect bitcoins are just one e-currency. We have dollars, euros, yen, etc. We also have bitcoins, ripple, QQ coins, litecoin, etc. So, the supposed benefits are actually illusory.

Also, think about who are the players/traders in Bitcoin. The very lack of transparency is the problem. We had similar problems in financial markets before all the regulatory apparatus was set up requiring banks and firms to open their books to investors, auditor, and regulators. These basic consumer safety nets are not present in Bitcoin.

John C. Alexander, Jr.

Breazeale Professor of Investments, Clemson University, College of Business and Behavioral Sciences
John C. Alexander, Jr.
Some people who traded in Bitcoins have made a lot of money as its value has risen. Doesn't that suggest there are downside risks? Are there other reasons consumers should proceed cautiously?

Bitcoin is a fiat currency that represents a U.S. dollar, but it is not backed by any treasury or government. Because of that, in my mind its real value should be less than a dollar. Ultimately Bitcoin is just a payment system. We have metrics (PE, PS, etc.) relative to payment system valuation in the our public equity markets, such as Ebay, and in the past Paypal. Despite these valuation metrics, ultimately the value of a Bitcoin transaction and the value of the Bitcoin equity is whatever the last person was willing to pay.

Nicolas Christin

Assistant Research Professor in Electrical and Computer Engineering, Carnegie Mellon University, College of Engineering
Nicolas Christin
Bitcoin, the open source peer-to-peer payment network and digital currency, has captured the imagination of Wall Street. Why has it become so popular?

It's hard to tell. The decentralized nature of Bitcoin -- where you don't have central banks or mints -- has certainly played a role in its popularity. It may also have been at the right place, at the right time. There is an increasingly vigorous debate about online tracking, anonymity, and, essentially, control, and Bitcoin fits very well in this debate. (Even though the anonymity claims are actually very questionable.)

How practical is a digital currency? Do you think this is the way we'll pay for things in the future?

Digital payment systems have been around for a long time, and we already use them a lot -- PayPal is a good example of a successful digital payment system. Now, there is definitely a growing interest in digital wallets, particularly when integrated with mobile devices. Digital wallets have been very popular in Asia for a while now; public transit electronic passes there can often be used to purchase goods in stores or vending machines. We start seeing similar digital wallet technologies being deployed in the US. Google Wallet is probably one of the better known alternatives, but they're not the only one.

Could Bitcoin find its niche as one of these systems?

It is possible, although the fact that Bitcoin payments take around ten minutes to be confirmed -- and basically one hour for being completely vetted -- is a real problem for quick, face-to-face transactions. It is not unsolvable -- all you need is an escrow or insurance system built on top of the existing mechanisms to make this work well -- but this will add costs, and whether or not this will be a really practical solution compared to the alternatives remains to be seen.

Some people who traded in Bitcoins have made a lot of money as its value has risen. Doesn't that suggest there are downside risks? Are there other reasons consumers should proceed cautiously?

Bitcoin is still a highly volatile asset, as it's been for most of its relatively short life. The fact that it significantly appreciated in the past twelve months doesn't change anything to the fact that drops of 30% or more in a day occur once in a while. It was the case at $17/BTC, it's still the case at $500+/BTC.
Author
User
John Kiernan is Senior Writer & Editor at Evolution Finance. He graduated from the University of Maryland with a BA in Journalism, a minor in Sport Commerce & Culture,…
1301 Wallet Points