Bitcoin has been called everything from a Ponzi scheme to the beginning of the third wave of currency. The creation of an anonymous coder operating under the pseudonym Satoshi Nakamoto, bitcoin is a private, decentralized digital currency best known for its fluctuating, bubble-like price. It is “mined” by a network of computers that calculate complex equations and consists of a single string of text.
When it launched in 2009, each bitcoin traded under one cent. Within the last two years, the price has skyrocketed exponentially, hitting a high of $260 earlier this month. It crashed immediately afterwards and, as of Apr. 23, settled at an average price of $132.
Increased media coverage plays a strong part in upping the value of bitcoin, but the economic insecurity caused by the Cyprus bailout caused the price to shoot up in March. When the island nation considered levying a one-time tax on all bank accounts, both secured and unsecured, the promise of a currency independent of any government became very popular.
Bitcoin is difficult to trace and, like gold, independent from governments. Because there are a set number of bitcoins in existence (21 million), bitcoin will never be subject to hyperinflation, which happens when national banks increase the money supply.
While part of bitcoin’s appeal is that the people control its value, this digital currency is far from being universally accepted.
Bitcoin as a lending currency
As bitcoin gains popularity, the number of stores that accept it has grown as well. WordPress takes bitcoins, as do Reddit, 4Chan, Etsy, a cupcake shop in San Francisco and a creperie in Brooklyn. Jeff Berwick, entrepreneur and owner of Dollar Vigilante, plans to open bitcoin ATMS in Cyprus and Los Angeles.
Buying with bitcoins is one thing, but lending is another thing all together. Say, for instance, you took out an auto loan of 50 bitcoins with 5 percent interest on the morning of April 10, when a bitcoin was valued at approximately $250. That afternoon the value of bitcoins dropped to $150 per bitcoin. Instead of owing $13,125, the borrower is only on the hook for $7,875, a $5,000 loss for the lender.
“Bitcoin is heading in an upward direction, and for that reason any kind of long term commitment denominated in bitcoin is a dangerous thing to do,” said Vitalik Buterin of Bitcoin Magazine.
Buterin told loans.org that the reason bitcoins are worth what they are now, instead of ten times more or ten times less, is that people think the value of bitcoins will increase in the future.
This mentality, however, also increases the risk of currency hoarding. Economists warn against rigid currency supplies because it leads to hoarding. People hold on to their money thinking it will be worth more later on, which keeps funds out of the market.
P2P lending community
That’s not to say that online exchanges haven’t been able to create business models out of bitcoin lending. BTCJAM, based in Brazil, has served as a peer-to-peer bitcoin lending community since last November.
“When Bitcoin first came to our attention its great potential and world transforming capabilities became obvious to us very quickly,” Celso Cardoso told loans.org in an email. Cardoso, the founder of BTCJAM, previously worked in Brazil’s banking sector and has a background in computer engineering and cryptography. He was drawn to the independent nature of the currency (free from government and banking regulations).
“Decentralized? Near instant payments? Almost no transaction fees? It’s marvelous and it’s surely the next big thing in mobile payments.”
In the five months that BTC has been live, their business has expanded to five continents, with customers from countries such as the US, Canada, the United Kingdom, Russia, China, and India. Cardoso didn’t offer exact traffic numbers, but says that the number of loans being made has increased by 170 percent. The company, however, is not yet profitable.
To avoid the main concern of bitcoin lending — watching your loan become unprofitable or exorbitant as the market price fluctuates — BTCJAM regulates the repayment terms of the loans.
“High volatility is bad for bitcoin, but we strongly believe this bubble mentality will go away as adoption increase,” Cardoso said. “Today we handle it by making loans that have their payout calculated taking into account the price variations, so the payments are more predictable thus protecting the borrower and the lender.”
Alternatives to bitcoin and the future of e-currency
The biggest roadblock bitcoin faces in becoming a global currency is its inaccessibility. Most people don’t understand what they are or how “mine” them. It’s difficult to covert them into cash, especially into uncommon currencies.
There are, as it turns out, alternative digital currencies available. Ripple, created by Jed McCaleb, the founder of Mt. Gox, the largest bitcoin exchange site, meets the needs that bitcoin ignores. Users can register on a website and monitor their funds, as well as exchange it for other currencies, including bitcoins. Unlike bitcoins, which are mined in extensive computer processes, ripples can be purchased directly through OpenCoin, the company that owns Ripple.
There are two problems with this scenario according to bitcoin evangelists. First, the fact that OpenCoin owns the entire supply of 100 billion Ripples means that they, not Ripple owners, has the power to determine how many Ripples are in circulation. Second, the currency lacks the privacy of bitcoin.
Still, the future of digital currency may depend on Ripple and similar competitors. Buterin says that there are a number of different scenarios in bitcoin’s future.
“It could disappear entirely and be replaced by something like it or even better,” he said. “People might start using it more as an investment.”
Whether it will ever be truly mainstream is anyone’s guess.
“Eventually I think bitcoin will become more stable,” Buterin said, “but probably not fully.”