Bitcoins: Currency catch-up

Written by Anand J | Updated: Dec 22 2013, 16:34pm hrs
BitcoinsBut how far can the world go to cash in on a virtual money built on algorithm, hope and hype?
An ounce of gold today costs roughly $1,200. That is only a little more than what a bitcoin trades for. But unlike the yellow metal that has to be dug out from the earth and purified, bitcoins are born out of algorithms, the mathematical calculations that run our virtual world. The only tricky part is that cracking the software puzzle gets tougher as more and more people work on it.

If the Internet and money had a child together, it would be the bitcoin, say users. Since the bitcoin was invented in 2009, it has caught on globally as a virtual currency and has had many such currencies following in its wake. But unlike money, there are only 21 million bitcoins that can ever be generated. And, like gold, its users love to hoard them.

As of today, 12 million bitcoins have been created and, every year, only a fixed number of bitcoins can be generated or mined. One person can create and download more than one bitcoin. Bitcoins are, however, divisible and one does not need to have $1,000 to own one. One can just buy a fraction of it.

In case one cannot mine bitcoins, one can buy them from one of the many bitcoin exchanges that have sprung up recently, by paying in rupees or dollars. The exchanges serve as a platform to connect buyers and sellers. The users hope hordes of people will eventually accept bitcoins as payments for goods and services.

With around 12 million bitcoins in circulation, the total market capitalisation comes to around $12 billion. Only 40% of the bitcoins are exchanged, as people see them as investment and they are hoarded. They are stored in digital wallets, which could be a pen drive or a hard disk, and have a key or a password. One can store more than one bitcoin in a wallet. Every fraction of a bitcoin has a digital address to identify itself.

Bitcoins got a leg-up last month, when lawmakers in the US called it a legitimate financial service. In India, however, the Reserve Bank of India (RBI) has not yet formulated regulations to govern the trading or for the profits generated from bitcoins. There is no concrete information as to how many bitcoins are held or traded by Indians.

To increase awareness among people of the country, home to the worlds third-largest lot of Internet users, a global bitcoin conferencethe first in India and the second in Asiawas held in Bangalore recently. It saw participation from investors, speakers, entrepreneurs, bitcoin exchange builders and payment processors, among others. What it did was to demystify the rising popularity of virtual currencies, or cryptocurrencies, as they are known.

Who has got bitcoins

According to Wired magazine, the Federal Bureau of Investigation (FBI) of the US is the owner of the single-largest bitcoin wallet in the world. In September, the US government clamped down on Silk Road, an online marketplace that sold drugs for payments made in bitcoins. The FBI started seizing bitcoins belonging to the operator of Silk Road, who is said to be an American citizen, named Ross Ulbricht. The FBI now controls more than 1,74,000 bitcoins over two wallets.

But bitcoin inventor Satoshi Nakamoto is estimated to have mined one million bitcoins in the currencys early days. In those days, even the conventional computers could solve the algorithm, while it requires supercomputers today, as the number of people trying to solve the algorithm has gone up tremendously. Nakamotos stash is presumed to be spread across many wallets, most of them holding just about 50 bitcoins, to spread the risk of losing the key to the wallet.

The total number of bitcoin holders are estimated to be around 2.5 lakh, with many holding more than one. Last year, the number was estimated to be around 1.5 lakh. China is also supposed to have an outsized number of bitcoins today. In November, the China-based bitcoin exchange, BTC China, surpassed the Japan-based Mt Gox and the Europe-based Bitstamp to become the largest bitcoin exchange by trade volume.

India calling

The global bitcoin conference sought for government intervention in the form of recognition and the RBIs framework for greater adoption of the virtual currency in the country, home to one of the worlds largest software talent pools. The conference highlighted that the government and consumers will immensely benefit with the uncertainty being taken out of the bitcoin system.

What we want is a dialogue with the central bank for greater understanding of the system, as well as what can possibly be regulated and what cannot be, says Sathvik V, managing director of CoinMonk Ventures, one of the organisers of the event and a bitcoin exchange that sells and buys bitcoins. A lawyer from RBI also attended the conference after a request from the organisers, but refused to comment or identify himself.

According to the bitcoin community, without the necessary RBI regulations, the system currently bypasses the banking system and hence drives it to the black market, which results in illegal transactions. They say unlike other illegal activities, every bitcoin transaction can be traced and stored in millions of computers across the world. If RBI forms a framework, this will be one of the easiest systems out there that can be monitored by government agencies, says Sathvik of CoinMonk.

The biggest threat for investing in bitcoins is the threat of a regulator coming up with any law that affects the system retrospectively. What is more important here is not what bitcoins actually are, but how they are perceived by lawmakers. Finally, if consumers lose a lot of money in a democracy, they will come back and ask the government as to why it does not protect them, says Na Vijayashankar, director of Cyber Law College, Bangalore.

The bitcoin community believes recognition will create more awareness and reduce the speculation and volatility of the system. Users see a huge opportunity in getting a share of the $70-billion remittances to India.

They feel the current system takes a 10% commission on transfers, whereas consumers can do the same in virtual currency without any cost.

Buttercoin, a white label bitcoin exchange backed by funds, including Google Ventures, the investment arm of Internet giant Google, will be setting up a bitcoin exchange in the next couple of months in Mumbai, in association with other parties. Its director of business development, Sunny Ray, insists on getting a non-banking financial company (NBFC) licence for running the exchange even though it is not currently necessary. He says bitcoins, being limited in supply, are useful in fighting inflation and currency depreciation, calling the currency digital gold.

The recognition itself is not driving people away from doing business in bitcoins. MadOverCoins helps people to buy physical goods from them in bitcoins. Its CEO, Vikram Nikkam, has been doing this for six months with partners and buying the physical goods by paying in rupees, taxes duly paid. The idea is to bring more users to the system. If I think about regulation that is going to come in future, I will not be able to do business today. That is a risk I am taking, he says.

Jeet Singh, a commodity trader from Switzerland, is trying to set up an exchange in New Delhi that will change bitcoins into rupees and vice-versa. No one wants to sell bitcoins and liquidity is a huge problem. This ability to exchange will make them more acceptable and liquid, he says. Singh also feels some regulation is better rather than the system collapsing a few months down the line after regulatory norms are laid retrospectively.

Vested interests

The push to make bitcoins ubiquitous is coming from the likes of people who will benefit the most from the system being more popular. For all that is democratic about the cryptocurrencies, more than the pull factor of users, the global conference in Bangalore was crowded by people with vested interests.

Even as the bitcoin operators are minting money, one needs to have bigger and better supercomputers to successfully generate new coins as more people are trying to solve the algorithm. Butterflylabs, a company that manufactures such machines, is selling a 600-gigahertz (GHz) machine for $4,800. The privately-held company, valued at $140 million, was also the main sponsor of the Bangalore conference.

This will go the way of e-mail adoption but, as with any technology adoption, this will reach more people in half the time taken by an earlier technology, says Josh Zerlan, COO, Butterflylabs. He says while India is not currently among the top 10 countries in terms of shipment, the country is a sleeping giant. The company ships almost 5,000 units a month. Another bitcoin mining machine manufacturer, High Bitcoin, was also represented at the conference by its CEO, Gangesh Ganesan.

The way Internet has become an important part of our lives, the future will hold the same for cryptocurrencies, says Yudhajit Nag, co-founder of start-up LivQuick, a mobile payments company, which has a few coffee shops as clients. Nag, who has a few bitcoins as investment, is also considering bitcoins for the mobile payments made on LivQuick and his company will in turn pay the clients in rupees. There are several companies that accept payments with bitcoins, including Internet companies like OkCupid, Reddit, WordPress and Virgin Galactic., a bitcoin exchange based in Ahmedabad, claims to be already doing transactions worth over R1 crore in a month. Techies still dominate the bitcoin community in India as traders will come only after seeing traction, says Mahin Gupta, CEO of the company.

There is also a bitcoin robotic trading company based in Russia called that helps users to install a software online and trade the currency. If the value goes down below a certain level, the software sells the bitcoins and buys when the value goes up. Sales executives from the company, whose back-office support is done from its Bangalore office, were seen roaming at the conference selling the software to bitcoin enthusiasts.

Concerns and confusion

However, globally, the opinions are divided or people are simply confused, while many others have adopted a wait-and-watch policy. There are concerns of bitcoins being used as a money-laundering channel, apart from being used by drug racketeers and terrorists.

Last week, bitcoins received a setback when the Norwegian government refused to recognise them as a valid currency. But Norway will still treat it as an asset and charge a capital gains tax. Germany has also been doing the same since August this year.

The European Central Bank also sent out warning signals last week, as there was no protection for people who own the digital wallets. Korea had also recently rejected bitcoin as a legal currency. The US Homeland Security and Governmental Affairs Committee is currently involved in evaluating the promises and risks associated with the cryptocurrency.

In China, although individuals are permitted to freely trade and exchange bitcoins as a commodity, it recently prohibited banks to operate bitcoins as legal tender currency. It also said entities dealing with bitcoins must track and report suspicious activity to prevent money laundering using the virtual currency. In Switzerland, it is treated as a foreign currency and Canada already taxes gains on trade in bitcoins. The lawmakers and the central bank of the European Union have adopted a wait-and-watch policy, so has the RBI.

Libertas, Aequitas, Veritas

Bitcoin goes by the tagline, Libertas, Aequitas and Veritas. In Roman mythology, these words stand for the goddesses of liberty, justice or fairness and truth, respectively. Naoko Yatani, a sociologist from Japan, thinks bitcoin is democratic and such cryptocurrencies will be the currencies of the future. Yatani, who works as a consultant for Japanese companies in India, is holding on to the bitcoins and has no plans to sell them. Countries like the US and Japan are printing currency notes at will and devaluing the money people have. This is mismanagement. Bitcoins give power to the people to decide on the value. This will also have a peg-less future, she says.