Bitcoin: Why the new electronic currency is a favorite of libertarian hipsters and criminals.

Commentary about business and finance.
May 18 2011 6:07 PM

My Money Is Cooler Than Yours

Why the new electronic currency Bitcoin is a favorite of libertarian hipsters and criminals.

Different currencies. Click image to expand.
Could Bitcoin ever replace traditional currency?

On March 18, 1990, most of Boston's police officers were busy keeping the St. Patrick's Day crowds safe. So they did not notice when thieves slipped into the Isabella Stewart Gardner Museum and grabbed about $500 million worth of art, including five works by Degas, a Manet, several Rembrandts, and a Vermeer. But why? One theory is that they were working for drug or arms dealers, not aesthetes. Much to museums' chagrin, stolen art can serve as collateral or currency on the black market—a store of value and a medium of trade, a compact way to hold $500 million.

But today criminals might not need to resort to stealing old masters to facilitate their deals. They might use bitcoin, one of the world's newest currencies and one rapidly gaining the attention of felons, nerds, and monetary economists alike.

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Bitcoin is a peer-to-peer currency, meaning it is not issued by a central authority, like the dollar or yen. The money supply grows as the network grows and will max out at about 21 million bitcoins. But right now, you can purchase them online on the Mt. Gox currency exchange or an over-the counter market. They do not exist in physical form—only electronically, owned and traded by members of a special, anonymous peer-to-peer network. No third-party intermediary, such as a payment processor or a bank, needs to keep tabs on or process the electronic transactions. The network itself does, with each participating computer running a special, secure program that ensures no user can spend a coin twice or create new money out of thin air.

The currency has a few advantages. For criminals, libertarians, and privacy freaks, the Bitcoin system allows for complete anonymity and privacy. Once a transaction is completed, there is no central server with information for the government to subpoena. (If you buy Bitcoins on an exchange, of course, that transaction would have a record.) And there is no PayPal or Visa or Bank of America to follow the money, or tell people what they can and cannot do with it. Indeed, the system, constructed in 2009 by a programmer named Satoshi Nakamoto, became popular when some financial firms refused to let users send money in support of Wikileaks. Now, it is has some users looking to finance illegal activity—nerdy aficionados of online poker mostly, rather than international heroin dealers.

Bitcoins also offer a fascinating case study for economists and anti-Fed zealots. Right now, a coin is worth about $7. In April, it was worth $2, and in October, about 89 cents, as traded on the Mt. Gox online exchange. But meddling central bankers had nothing to do with the price changes. Right now, there are about 6.2 million Bitcoins, worth about $49 million. The decentralized system will create a total of 21 million coins total. This money supply is fixed and public. Thus, people trading in Bitcoins are the only ones determining their value.

There is no doubt that one reason for all the interest in Bitcoin is that it is just kind of cool—the first such non-third-party-intermediated, totally electronic currency to come into even somewhat common use. It has attracted plenty of attention from the blogosphere, the press, and even eminent economists. A host of webby companies, like site-design and hosting firms, now accept payment in Bitcoins. You can also buy alpaca socks, coffee, herbal extracts, books, and novelty dice with the currency, or browse Bitcoin classifieds.

More and more users and retailers are hopping on the bandwagon, and the value of each Bitcoin continues to rise. Some commentators even theorize that the currency might someday rival the dollar, fostering an alternative, grass-roots trade system free of corporate, regulatory, and central-bank interference. But this seems vanishingly unlikely. Currency is a store of value and means of trade, meaning stability and ubiquity are key characteristics, and ones Bitcoin can hardly guarantee.

We all use the dollar, rather than North Dakota bucks and New Mexicoins, etc., because exchanging money is a pain. If you earn your salary, pay your taxes, buy your groceries, and manage your business in dollars, you are probably not going to switch to Bitcoins for most transactions. In economist-speak, currencies are subject to strong so-called "network effects."

Moreover, Bitcoins pose risks, being the entirely electronic, unregulated, uninsured entity they are. The system does not rely on single servers, but a network of them, so even if the Bitcoin site went down, the currency would still work just fine. But a government crackdown might destabilize the market. Plus, if Bitcoin is not truly anonymous and secure, a hacker might be able to wreak havoc—either by devaluing Bitcoins by minting more or by spooking participants into pulling their money out.

In the event of such a Bitcoin panic, there would be no FDIC to insure each account and no Fed to stabilize the value of the currency. (That's another reason to recommend the dollar.) Thus, some have even worried that Bitcoin, if it came into broad use, could "topple governments [and] destabilize economies."

The most immediate risk, though, seems to be that Bitcoins will facilitate transactions for criminals, online poker players, tax-evaders, pornographers, drug dealers, and other unsavory types tired of carrying around a Vermeer. In that case, here is to hoping Bitcoin remains the currency that it is: cool, webby, free, and niche.

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