Is there a future for Bitcoins?

What is Bitcoin?

Bitcoin is the first decentralised electronic currency; as it is electronic, it allows one person to transact a payment to another person anywhere in the world without the need for an intermediary. This has the advantage of offering a global network for multiple currencies, which is cheaper, quicker, and disregards any limits brought about from Country regulations or intermediaries, including the size of the payment or the need to open a bank account. It also means there is no way of applying income tax on deposits or earned income, or through capital gains on disposals.

How do Bitcoins work?

Bitcoin is a network which can be downloaded via a computer application called ‘The Bitcoin miner’. The application allows you to earn coins as you mine, at a limited rate in order to avoid excess supply. The earned Bitcoins are stored in a secure electronic wallet held on a miner’s computer, ready to be anonymously transferred by means of payment. The wallet appears very similar to what users of internet banking might use, making it user friendly and instinctive.

Is it safe?

The so called ‘crypto-currency’ is referred to as such as it is backed by military grade key access and cryptography, meaning the transactions are highly secure; it is impossible to determine how many coins are held within another miner’s encrypted digital wallet.

When making a payment an electronic signature is required to authorise the payment to another miner, and as all payments can be made anonymously, it is impossible to track or trace a payment to the address of the originator, unless a miner wishes to make this information public.

The network deters any digital forgery of Bitcoins by use of intricate sequences and time related authentication.

This supports the view that the Bitcoin network is more secure than the average bank account, which has the potential to leak personal data to third parties, or be hacked by authenticating a few security questions. This is topical given the news this week that the Royal Mint plans to introduce a new £1 coin deliberately aimed to prevent counterfeiting.

The disadvantages

As with all things, there is a downside as reinforecd by Warren Buffett, who recently warned for users to ‘stay away from Bitcoin’. The main ones being that the currency is still in its infancy and although the outlets that accept Bitcoin as form of payment are increasing, it still remains an underground revolution.

Without Government intervention, the Bitcoin is valued solely by supply and demand; as the number of Bitcoins is capped at 21 million, the greater the demand for Bitcoins, the more they are valued. This causes large and unpredictable volatility with users selling whilst the value is high, and eventual deflation when the demand is low. Past values have ranged from $9.9 to $1 at periods during 2011. This causes issues when looking for accurate valuations, or refunding items where the price has fluctuated away from the original purchased value.

The macroeconomic effect of widespread Bitcoin usage is that Governments will suffer due to reduced tax revenues, which will reduce the impact of monetary policy unless tax is recouped in other areas.  The IRS have recognised this as a potential issue, and so are in the process of agreeing a taxation system specifically designed at taxing Bitcoins. If successful, this will create a solution for Governments to roll out, but may create a layer of inefficiency for the Bitcoin network.

Lastly, let us not forget the unavoidable computer viruses, destroyed hard-drives and corrupted data which could wipe the digital wallet without discrimination.

Although new to many people, Bitcoin has been on the scene for 5 years, which, some would argue, makes it more than a fad. In 2013 the Bitcoin hit an all-time high of $1,242 per coin, which makes it a serious competitor for commodities such as gold which attracted $1,240 per ounce on the same day. The widespread popularity in China and amongst the middle-class in countries such as Cyprus is giving the Bitcoin global presence which shouldn’t be ignored.

Therefore despite the volatility, the Bitcoin offers a niche in the global financial systems and so serious consideration must be given in this digital age.