Bitcoins: Q&A

Recently I read this awesome book by Nathaniel Popper on the digital cryptocurrency, Bitcoin, titled Digital Gold. Boy, is it informative and superbly written!

Why the need for a new currency?

1)      Ideology: Many people in the US in particular dislike and distrust the power of governments to print money because, if done for the wrong reasons, that dilutes the worth of existing money. Now, it is one think to be wrong due to unforeseeable reasons; but let’s face it: governments mostly do wrong things because they are doing them for vested interest groups and for votes.

2)     Privacy: In the West, as most transactions are via credit cards, credit card companies and banks know what you spend on. Plus, of course, the government can force both of them to share that information.

3)     Experiment: For many, this was a chance to try something new, to test their software skills. For others, to understand how money evolves.

(Other reasons came up later, but they weren’t why the currency arose).

Ok, so we have a currency. But why would anyone accept it?

1)      Based on the reasons mentioned above, Bitcoins were designed to be anonymous, i.e., they get assigned to whatever ID you choose (like your mail ID). They were also decentralized, i.e., no one central authority controls it and therefore, no one figure or entity knows who uses them.

2)     You must have guessed by now: these characteristics of Bitcoin were what made them attractive to people wanting to trade illegal stuff online, like drugs. Sites like Silk Road got Bitcoins in use.

But wouldn’t users need to convert Bitcoins into “real” money eventually to be able to use it?

Yes, absolutely. That is why Bitcoin exchanges arose on the Internet. They are the equivalent of forex agents who buy and sell currencies. And yes, therefore, the “exchange rate” of the Bitcoin against the dollar does fluctuate, based on good old demand and supply.

This sounds like a currency for illegal operations only. Should the rest of us care about it?

1)      Actually yes. Because ideology + experimentation is what got the currency started; illegal operations is what found a use for it first. But others too began to find use for it later.

2)     Soon enough though, retailers began to think: Hey, credit card companies charge a surcharge for every transaction. With Bitcoin, we could avoid that. Not a huge set currently, but not zero either.

3)     Others began to think of Bitcoin more like gold than like a currency, i.e., use “regular” money to buy Bitcoins like an investment. Convert the Bitcoins back to “regular” money if the exchange rate is favourable!

4)     If you live in countries like Argentina, where inflation is rampant, Bitcoins serve as a way to preserve the value of money against inflation, i.e., you hold your money as Bitcoins rather than Argentinian pesos! Wouldn’t dollars and Euros have served the same purpose? Ah, but Argentina doesn’t allow for free currency conversions for exactly that reason…

5)     If you live in countries with strict controls over how much forex you own, you were stuck with investing only in your country. Bitcoins provided a way around such government controls. In fact, that’s exactly why Bitcoins began to catch on in China!

So is Bitcoin the currency of the future?

Possible. Or it may be the first version which gets updated and redone to come up with a new one eventually. Because it has many hurdles to clear:

1)      Since it is not issued by a government, it has no legal backing.

2)     Since it is decentralized, all institutions related to it like those Bitcoin exchanges aren’t regulated. What if they took your money and ran?

3)     How secure is a digital currency? What if hackers broke in?

4)     And finally, is an anonymous currency a good thing, no matter how much you mistrust governments? Would we be handing the world to crime lords and terrorists by making such a switch?

The book is an awesome read from multiple perspectives: for tech geeks, for ideological folks, for economists who want to see how currencies evolve, and for regular folks who just want to know what the hype is all about.