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What if everything you know about money is about to change?

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    13 March 2014

    What if everything you know about money is about to change? The birth of Bitcoin

    13 March 2014
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    Bitcoin and the broader virtual currency movement aim to replace entities with a trusted process.

    Mt. Gox, the oldest exchange in Bitcoin’s short history, shut its doors on February 24. The exchange lost 750,000 Bitcoins, worth roughly $350 million at the time, angering the Bitcoin community and highlighting issues around the viability of a monetary system built on untested trading platforms. Despite an initial panic, Bitcoin didn’t die as a result of the closure. Instead, the price dipped slightly before rebounding, and the Mt. Gox debacle is yet another stress test that Bitcoin has survived. The shutdown and loss nevertheless raised important questions about Bitcoin’s prospects, such as who should run and regulate Bitcoin exchanges.

    Bitcoin began on Halloween 2008, when an anonymous computer scientist or group of individuals under the name Satoshi Nakamoto published a paper on a new electronic cash system, e-mailing it to like-minded computer nerds and hackers. Nakamoto argued that a purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution—and thus, Bitcoin was born.1

    Today, people exchange value through trusted third parties (e.g., credit cards, bank transfers) using currencies backed by nation-states. Bitcoin and the broader virtual currency movement aim to replace these trusted third parties with a trusted process. A Bitcoin is essentially a string of numbers, known as a private key, that, when matched to another string of numbers, known as a public key, is considered a unit of value. An open network of peers validates that the private key and the public key match, allowing the transaction to proceed. These validators—or miners—are rewarded for their work with new Bitcoins. In Bitcoin’s case, every single private key is tracked and validated in a public ledger, so every Bitcoin transaction is publicly viewable.

    Nearly four years after the first Bitcoin transaction occurred on January 12, 2009, I found myself at the Future of Money and Technology Conference in San Francisco with two GovLab Fellows, Tiffany Wan and Vetan Kapoor. My most rewarding responsibility at Deloitte is to help mentor emerging leaders of Deloitte’s Federal Practice. Each year, a few get the chance to explore new concepts and ideas that could soon become important to the public sector. Tiffany and Vetan had quickly developed world-class expertise on virtual currencies, and that’s why we had all travelled to the West Coast to meet with economists, venture capitalists, bankers, and self-professed geeks about how virtual or “alt” currencies would reconceptualize finance and transform business.

    Tiffany, Vetan, and I thought we were already well-informed about the principles and mechanisms behind Bitcoin. We left with a new sense of energy and excitement about the potential of virtual currencies to transform the financial landscape and even how we share information across the Internet. And, of course, more questions.

    Just as the Internet changed many nation-state structures and societal organizations, virtual currencies could make obsolete some economic and financial tenets considered unquestionable today. What would it mean if one day every unit of currency spent in the world were part of a public ledger that anyone, anywhere could see? How would an independent method of storing and exchanging value challenge the economic policies of nation-states? Will national governments someday want to evolve their own financial instruments by copying the Bitcoin model to combat fraud and control monetary supplies?

    Our presentations at the San Francisco conference and at the subsequent Inside Bitcoins meeting in Las Vegas covered what Bitcoin would need to do to stand at par with currencies guaranteed by nation-states. Tiffany and Vetan explored whether virtual currencies could meet key standards of reserve currencies, such as global recognition, a money supply and financial system that supports high transaction volumes, survival of stress tests, and governance by trusted institutions such as central banks. Although virtual currencies cannot yet handle high transaction volumes and it is arguable whether algorithmic governance would be better than governance by central banks, Bitcoin to date has survived every test thrown at it, establishing worldwide name recognition in the process. Conference participants, of course, were enthusiastic that virtual currencies would someday handle significant amounts of economic activity, including all digital transactions. Given that many had a stake in Bitcoin’s success, it’s particularly hard to tell whether they were clear-headed prognosticators or naïve enthusiasts.

    In any case, the revolution in currency and finance will not begin until individuals and businesses start to use Bitcoin to exchange actual goods and services, as opposed to holding Bitcoin as a speculative investment. In San Francisco, panelists predicted that once Bitcoin acquired a foothold in commerce, its overwhelming advantages over traditional currency models would lead to widespread adoption. What will that foothold look like? That’s hard to predict, but in its first two weeks of use on Overstock.com, Bitcoin accounted for $500,000 worth of purchases.

    We’ve also come to appreciate that the protocols behind Bitcoin may prove much more significant than the currency itself. Bitcoin and other virtual currencies are creating a new architecture for exchanging peer-to-peer information without an intermediary that is paradoxically open, yet secure. Imagine how other systems that rely on intermediaries could be disrupted by a similarly open peer-to-peer system.

    The media has been quick to highlight Bitcoin’s triumphs and failures, often glossing over the implications and downstream impacts. The GovLab team and I believe many of these views are incomplete at best and could lead businesses and governments to underestimate the potential impact of the virtual currency movement. Focusing only on Bitcoin itself can be limiting. It is only one attempt to use information technology to develop a more effective way to exchange and store value. In the same way that early Internet developers learned important lessons from the failures of startups around them, dozens of virtual currency entrepreneurs are studying Bitcoin today, hoping to improve it. Is it the final product, or an early iteration that one day we will remember as an answer to a trivia question? Is Bitcoin the Friendster, Myspace, or Facebook of virtual currencies?

    Endnotes
      1. Satoshi Nakamoto, “Bitcoin: A peer-to-peer electronic cash system,” Abstract, October 31, 2008, http://article.gmane.org/gmane.comp.encryption.general/12588/ View in article
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