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Bitcoin is far more than a currency for speculators
By John Gapper
People could gain ownership rights to digital goods similar to physical ones
Bitcoin is being forced to grow up fast. The arrest last week on money laundering charges of Charlie Shrem, a leading Bitcoin champion, coincided with a regulatory hearing in New York to consider what on earth it is – a virtual currency, speculative asset or a means of exchange?
The best answer is the last, although most excitement has been generated by its wild swings in value and the libertarian promise of a cryptographic currency replacing fiat currencies such as the dollar or the euro. In the end, the old laws affect everyone, including Mr Shrem, who has resigned as vice-chairman of the Bitcoin Foundation.
Payment sounds like the most mundane use for Bitcoin, or other tokens of value, yet it has the biggest potential. It is a challenge to the banking system and may allow the quick and cheap exchange – and transfer of ownership – not only of currencies but also of other assets, goods and services. It fixes a fundamental gap in the internet.
This potential is becoming clear, through the confusion and alarm created by Bitcoin speculation, and criminal uses such as trading drugs on Silk Road, the former online marketplace. Benjamin Lawsky, New York state’s superintendent of financial services, who called the hearing, wants to issue “bitlicences” for virtual currency businesses.
Bitcoin allows one person to hand a token of value to another securely, with no intermediary
Mr Lawsky is right to create a legal order for virtual transactions, rather than trying to stamp on Bitcoin, as some governments are starting to do. It would be feasible to push Bitcoin and similar initiatives underground but it would also be a wasted opportunity.
The temptation is to dismiss Bitcoin as being weird and easily abused. The fact that its inventor used the pseudonym Satoshi Nakamoto, and that deals are authenticated by a peer-to-peer network of software “miners”, makes it hard for ordinary people, or regulators, to take seriously.
The other disincentive is that Bitcoin’s most-publicised use, apart from Silk Road trading, is as a speculative asset (the price has risen from less than a dollar in 2009 to about $920 this week). A virtual currency with no central bank backing and no yield is worse than a casino chip.
Look beyond this, however, and Mr Nakamoto’s invention is very useful. He called it “an electronic payment system” and the innovation is that Bitcoin allows one person to hand a token of value to another securely, with no intermediary such as a bank. The deal is authenticated and recorded by the network.
The best way to think of Bitcoin, or other such tokens, is like the data packets that carry information on the internet. They are valued because of what they allow, not for their inherent qualities. Most people do not want Bitcoin but they do want a fast, cheap way to make payments in their own currencies.
People can already use Bitcoin for foreign currency payments in this way, swapping dollars into Bitcoin and out again into euros. Ripple, another peer-to-peer currency network, emphasises such real-world uses rather than the value of its own XRP currency. “The world is not going to adopt a new math-based currency,” says Chris Larsen, Ripple Labs’ chief executive.
Swapping in and out of Bitcoin sounds complex but is less so than a typical foreign exchange transaction via a bank, which passes through correspondent banks, exchanges and clearing houses, all of which are regulated. This adds layers of extra costs compared with a peer-to-peer network.
Payments are also a profitable activity for banks, compared with the risky, capital-intensive business of lending. The average cash flow margin on global transactions was 38 per cent in 2010, according to the International Payments Framework Association, a bank group. It is, in other words, ripe for some peer-to-peer competition.
There are already signs of payments across borders being disrupted. M-Pesa, a mobile payment system developed by Safaricom, the Kenyan operator, was partly inspired by Africans using airtime minutes as a virtual currency. TransferWise, a London start-up, uses an exchange-like mechanism to make low-value currency swaps.
Old-fashioned financial services are thus an obvious target for Bitcoin-like networks. But there could be wider applications in the future, as the technology evolves. Nakamoto’s use of cryptography to assign and transfer ownership of online tokens creates possibilities that reach beyond payments.
One is the idea of “smart contracts”, suggested by Nick Szabo, a computer scientist and former law professor (Mr Szabo is among those suspected of being Mr Nakamoto, which he denies). They would be completed with cryptography – for example, by giving a person who buys a car digital keys.
Another is that people could gain ownership rights to digital goods similar to physical ones – lending or trading them as they want. At the moment companies tend to restrict digital rights to online goods because they are so simple to replicate – one item can be copied millions of times from the original source.
Bitcoin solves this for currencies – it provides a method for the effective transfer of ownership. Once a Bitcoin is handed to someone else, the first holder cannot spend it again. If the same kind of transfer were achieved for other digital items, ownership would be meaningful.
For now, these are possibilities. Fred Wilson, a partner in Union Square Ventures, said last week that virtual currencies reminded him of the internet of the early 1990s and had similar innovative potential. The wild days of Bitcoin should not blind us to what it could become.
john.gapper@ft.comTwitter: @johngapper
