Column: Bitcoins challenge

Written by Pratik Kanjilal | Updated: Dec 19 2013, 07:10am hrs
Reactions to and explanations for the sudden rally of Bitcoin in November are still trickling in. Last month, the worlds first completely virtual, anonymous and decentralised currency raised both hopes and fears at it soared through the $1,000 barrier in a vertical climb. Immediately, Germany promised to embrace it and Ben Bernanke cautiously said that it would bear watchingat least, its innovations in payment processing were interesting. However, the European Union now warns that it is an unreal currency based on nothing at allin short, invest or trade at your own risk. But Gaurav Burman is doing just that, buying into itBit, a Bitcoin exchange in Singapore. Even though recently, Chinese banks were banned from trading in the cryptocurrency.

Is Bitcoin leading the world down the primrose path A general perception is developing that the cheap money that banks unloaded to fight the crisis of 2008 has been creating several asset bubbles, the latest being a Bitcoin bubble. China believes that the spike in Bitcoin prices was triggered locally, when Chinese speculators realised that Bitcoin was a dandy way to stash liquid assets overseas, out of reach of regulators and the taxman. Meanwhile, the EU is raising the bogey of chaos. Bitcoin does not have a central bank. Rather, it facilitates transactions that completely bypass regulation, controls and the formal banking and financial systems. Besides, there is the threat of sudden devaluation for purely technical reasons which have nothing to do with markets.

Bitcoins can be mined by anyone who owns a computer and devotes machine time to running an algorithm which computes data blocks representing value. Like conventional currencies, it is built on the notion of scarcity. In this case, the difficulty of computation and the physical limitations of computer hardware create scarcity. A standard desktop computer would take months or years to create enough Bitcoin for its owner to buy anything worth having. Risk is limited by Moores law, which observes a doubling of computing efficiency at the level of hardware every two years. It offers stability because, as chip components become smaller and smaller, as economies of small scale become harder and harder to achieve, the span of time for doubling is believed to be increasing.

However, a degree of unfairness is built into the system. Someone with a supercomputera government, an institution or an institutehas a huge edge over a miner with a regular computer. Hardware arms wars are known to have broken out among miners already. And risk will suddenly tend to infinity if Moores law is superseded. Mass supercomputing enabled by superconductivity at room temperature or the development of alternative logic architectures like the quantum computer would rip the bottom out of the Bitcoin market.

But the greatest source of perceived risk is the very structure of the Bitcoin system. It is decentralised, can effect digital-only payments that leave no trail in formal banking and markets and wholly dematerialised entities can use it to transact. In short, it is a godsend for the ungodly.

New technologies are released for legitimate aims but unanticipated applications develop almost immediately. For instance, the internet ramped up pornography to unprecedented levels, turning a furtive local trade into a mainstream business with a global footprint. Bitcoins dematerialised, untraceable payment system has now brought on a whole new business model, connecting the dots between freelance producers and clients, and is suspected to have expanded volumes all over again. In fact, with the benefit of 20-20 hindsight and some imagination, Novembers Bitcoin spike is now attributed to the growth of home-to-home delivery of smut over social networks like Reddit.

Criminals on the dark net, which is invisible to search engines and can be navigated only within the Tor anonymous network, were early adopters of Bitcoin. Even before it was clear what Bitcoin could buy in offline markets, the currency was being eagerly accepted by truly questionable shopkeepers on the dark web, in exchange for assassination services, hard drugs in bulk, skimmed credit cards and so on, traded over sight-unseen escrow networks. But curiously, the Bitcoin spike appeared just weeks after these markets were torn down by law enforcement agencies, apparently with the help of the intelligence community and hackers.

Perhaps the Bitcoin spike owes something to crime and illegal speculation but its very survivaldespite being based on nothingreveals that the currency is answering a need that is yet scarcely felt, but which would intensify as more and more immaterial goods and services are traded with dematerialised coin. Indeed, the challenge lies not in containing Bitcoin criminalityfor rupees or euros, too, are used in criminal commercebut in finding ways to regulate it and create a trading and banking system for it, which connects tightly with formal banking.