Bitcoin and the Challenges of Virtual Currency

bitcoinAlthough Bitcoin, the “world’s first decentralized digital currency”, was launched in 2009, it has only recently gained popularity as a currency. Unlike other existing currencies, Bitcoin lacks a central monetary authority, which creates problems for financial regulators. In place of a traditional central monetary authority, a computer network composed of Bitcoin users self-regulates the currency. Members of this Bitcoin network “monitor and verify” the creation of new Bitcoins and also regulate transactions between users.

Bitcoins are generated through a virtual process known as “mining.” A unique serial number is allocated to each Bitcoin after it is created. However, the total number of Bitcoins that can be produced is limited to 21 million. There are currently about 11 million Bitcoins in circulation, equivalent to approximately $1.2 billion. Popularity of the Bitcoin currency has recently surged, as Bitcoins have recently become available to “ordinary customers and businesses.” Many small businesses are therefore beginning to accept Bitcoin as a viable form of payment. Small businesses in particular benefit from Bitcoin’s swipe fees, which are on average about 2% lower than those of credit cards. Owners of small businesses also favor the simplicity of using a virtual currency as opposed to cash or other forms of payment.

Various complications have emerged as authorities attempt to regulate Bitcoin’s use as a currency. Because Bitcoin users can maintain anonymity in transactions, Bitcoins are likely to be used for illicit purchases or transactions. As a result, federal and state regulators “are taking steps to prevent people and companies from using them for illegal activities.” In a recent interview, Benjamin Lawsky, superintendent of New York’s Department of Financial Services, stated, “Virtual currency firms inhabit an evolving and sometimes murky corner of the financial world.” However, authorities must gain a deeper understanding of Bitcoin’s mechanics before instituting effective regulatory measures. As Tony Gallippi, CEO of Bitcoin-handling company BitPay, explained, “You can’t apply the rules for the horse and buggy to an automobile.”

Bitcoin has recently faced a stream of legal difficulties. Last week, two prominent officials of the Bitcoin Foundation travelled to Washington to meet with federal officials, attempting to prove their willingness work within federal laws. General council of Bitcoin, Patrick Murck, told officials, “There’s a myth about Bitcoin that it is an anonymous payment network. That is not true. [Bitcoin has] an open public ledger that shows every transaction.” Although Bitcoin’s ledger is public, there is no formal mechanism to tie Bitcoin addresses to the identities of their owners. It is also unlikely that Bitcoin will mandate user identification in the future, as this would alter the configuration that made it successful in the first place.

So far, Bitcoin has lacked stability as a currency and many argue that Bitcoin is losing steam. In January 2013, Bitcoins were worth $13, rising to $266 by April, and falling to about $100 today. Due to the general novelty of online currency, Bitcoin’s future remains uncertain. Perhaps with tighter regulations and less volatility, Bitcoin and other virtual currencies will gain prominence in the global market.

By: Marjorie Baker

Sources: Wall Street Journal, Economist, Economic Times, NBC News, Washington Post

Photo Credit: Bitcoin courtesy of flickr user Electric-Eye

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One Response to Bitcoin and the Challenges of Virtual Currency

  1. Pingback: Bitcoin and the Challenges of Virtual Currency | Bitcoin Mining Review

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