Bitcoin: the unregulated currency (International General Counsel, January 2015)

Somewhere buried in a landfill rubbish site in Newport, Wales, is a computer hard drive that was worth more than £4 million in December last year.

James Howells was cleaning out his desk last summer and discarded the unused drive, originally from a broken laptop. Held in the device’s storage was a digital wallet containing 7,500 bitcoins.

Howells had tasked his computer with ‘mining’ the digital currency in 2009 – back then the coins were worthless, but by the time he threw them out they were valued at £500,000 – he only realised his mistake months later in November when news reports revealed that a single bitcoin had surpassed the US$1,000 mark. Just three days later, it hit a peak of US$1,209.

More attentive traders have already made millions from the virtual currency in the last few months when its value multiplied nearly six-fold in just over a month, despite fluctuating around the $50-100 region for the vast majority of 2013.

Bitcoin is an electronic peer-to-peer currency which is created and held digitally, with no regulation and no centralisation. Each takes the form of a unique registry number, which is created by a computer set to run software which solves mathematical problems, known as mining. They are widely-regarded as the first of a form of crypto-currency, and they have the banks running scared.

The concept of Bitcoin as a digitally-minted currency was proposed in a 2008 paper by a software developer whose only pseudonym is Satoshi Nakamoto. Many argue the currency’s conception was a group effort, seeing as it takes an understanding of cryptology, economics and computer programming to implement. Nevertheless, one year later the Bitcoin open source code and software was released. It’s rumoured that Nakamoto is in possession of around one million bitcoins – in December last year they were valued at US$1.1 billion.

Like tokens, they work by the idea of perceived value, as long as people keep using them, and that there are a finite number of them in circulation. Their value is determined by their usage and demand: the more they are used, the more valuable they become. Each denomination is assigned to a user’s digital wallet, each with a specific address – when a transfer is made, the address is replaced with the new recipient’s details, much like the title or deeds to a property.

To preserve the balance of worth and popularity, the crypto-currency has algorithms which increase the complexity of the mathematical problems to solve before a bitcoin can be mined. A few years ago a home computer would have been sufficient to do the job – then it was discovered that jury-rigged graphics cards were adept in processing the computations. However current complexities now mean that many home computers would consume more in electricity rates than what one would be worth.

In any gold rush, it’s the guy selling the spades and pickaxes that turn the most reliable profits. Application Specific Integrated Circuit (ASIC) mining machines have now hit the market, selling for thousands and manufactured for the sole purpose of excavating the currency.

Then again, bitcoins are clearly not as tangible or intrinsic as gold – while early adopters and shrewd prospectors have made fortunes already, their significance and potential role in big business is just another facet of technology that many are struggling to get their heads around.

The initial incentive is the profit boost from the negligible transaction fees, as opposed to the 2-3% levied by debit and credit card companies. It could also disrupt global money transfers – for a fraction of the usual fees, users can swiftly move money anywhere in the world, unencumbered by international borders, complex verification processes, bank holidays and imposed limits. Wiring one million US dollars in Bitcoins aboard would cost approximately five US cents in fees and be verified in around 20 minutes.

Early moves by retailers to adopt them as a payment system have been perceived as more of a fashionable PR move. In November, Richard Branson announced that the currency would be accepted by Virgin Galactic for space flights, while lingerie-seller Victoria’s Secret and online game company Zynga have also recently embraced the currency.

Though merchants are continuing to come round to Bitcoin, the rate of adoption is still slow among big business in the US: stringent Financial Crimes Enforcement Network rulings, 50 state jurisdictions and a lack of federal oversight cloud the push towards making it legal tender. However, fact-finding hearings have recently taken place at New York’s Department of Financial Services, which may set the precedent for state by state regulation in the US. If the currency is given the nod of approval at Wall Street – a global economic arena – it could mark the outset of a massive wave of acceptance and usage.

And yet, it’s a currency that has been mired in controversy, not least because of its unregulated and decentralised nature – there’s no organisation to turn to if you’ve been the victim of a fraudulent transaction for example, and no guarantee on how secure the open source code is. More worryingly, the anonymity of transactions raises issues with the use of fronting for criminal activities such as money laundering. It became the default payment system used on Silk Road, the online underground black market. Most recently, the US has arrested operators of two exchanges for the virtual currency, on suspicion of violation of the US Bank Secrecy Act in connection with money laundering, weakening both its position and value.

Its volatility is also a major turn-off for businesses – what firm wants to post a profit report and have estimates slashed only days later if the price of Bitcoins drop as quickly as it can? Price differentials also exist between countries, sometimes by up to 10%. At the present, it poses simply too much risk even for the blue-chips despite its benefits.

Even so, its main driver at this point is people. As a disruptive and destabilising device, Bitcoin is a dream come true for libertarians, who view every transaction as a digital two-fingers towards the establishment. Every micro transaction circumvents a need for traditional roles filled by the centralised monetary institutions, which in turn upsets the leaders that bailed them out.

“The Bitcoin currency and system operate in such a manner that allows individuals to bypass banks and obfuscate the origin or destination of the currency via a process called mixing,” says Javier Marti, MD of Bitcoin Global Investments. “This is a problem for governments because Bitcoin comes into the picture at a time when the last thing governments want are ways for people to evade taxes...any kind of taxes. The mere concept of a currency/protocol/commodity that acts as ‘digital money’, working across borders with the potential to greatly disrupt whole industries including finance, banking, the legal profession and many others is way too complicated for individuals in power to legislate effectively on.”

Remember the outrage of the Cypriot people in 2013 when their government announced a haircut seizure of uninsured deposits, and refused transfer requests to move money off the island? Bitcoin could theoretically remove the possibility. Start-ups and entrepreneurs with limited cash flow could also stand to hugely benefit: no more making an appointment with the bank manager and asking for a loan, when instead you could arrange a peer-to-peer loan under mutually agreed terms.

As interest and awareness of Bitcoin escalates from the bottom up, regulators will have little choice but to get into the game and push for some form of transparency and compliance in regards to domestic transactions. If the approval is given, this could bring the currency into the mainstream and help keep a leash on illegal transactions and trades.

Marti says: “This will be the year when the gloves come off and governments around the world finally understand the huge potential for disruption that Bitcoin offers and come down heavy on it, either by making it illegal, taxing Bitcoin exchanges out of business, or co-opting the idea by creating a nationalised version. It does not mean they would kill it, but would simply prevent it from developing properly in their country.”

Right now however, there is no clear future for Bitcoin as a viable currency on its own right, beyond its staggeringly liquid (yet potentially highly lucrative) value. Proponents argue that it has all the core parts in the traditional model of value – divisibility, fungibility and finite stock – all that’s needed is greater usage, oversight and trust.

Arguments against state that it’s nothing more than a weapon of tax evasion and money laundering, and that without a centralised regulatory body it could suddenly become worthless against its bricks and mortar counterparts. For big businesses dealing in established currency, the risk may pose to be too significant to justify dabbling in – for the moment.

In a post-recession environment where people are weary of NSA spying, toxic investments, banker bonuses and bailouts, Bitcoin is a tool for revolution, driving change in a unique way. Peer-to-peer forever changed the landscape of both the music and the movie industries in just a few short years – now it has its sights set on disrupting traditional currency. While not intended to replace its fiat brethren, it still has the potential to whip the old-guard of monetary institutions into action and get involved in some way or the other.

It’s performing a precarious balancing act so far, while the crowds are beginning to stop, look and throw down a few coins of their own – if Bitcoin gets governmental approval and traction in international business, experts say its dollar value could soar into the thousands, if not tens of thousands. The gold rush may be over, but the party is just starting.