"I AM SATOSHI NAKAMOTO": emblazoned on an increasingly popular T-shirt, these words celebrate the enigma of a man who made his own money. In 2011, bitcoin, the digital currency he created, briefly soared in value in a way that made gold's rise look pedestrian.
It all started in 2008 when the unknown Nakamoto posted a research paper postulating a digital currency on the internet (strictly speaking, on a listserv dedicated to cryptography, the art of secure communication). In January 2009, he issued the first 50 bitcoins, as a reward to players for cracking a cryptographic puzzle. More puzzles followed an more bitcoins were earned -- or 'mined', as bitcoiners say -- with the supply of this money being restricted by the supply of puzzles.
Geeks and cyberpunks have been playing with ideas of digital currencies for some time. In online games, it is common to have a virtual currency to reward players that can be used to buy and sell items that improve their effectiveness. As gaming has become big business, some of these virtual currencies, such as Second Life's Linden dollars, have even been exchanged for real world money.
PayPal, the internet based payments and money transfer system owned by eBay, has become an integral part of the global economy, with 106 million active accounts in over 90 countries doing transactions worth more than $100 billion a year. At least one of its founders, Peter Thiel, now a billionaire libertarian philanthropist, initially hoped that PayPal would develop a private global currency uncontrolled by, and perhaps beyond the reach of, government. In the event, the money transparency laws legislated after the 9/11 attacks in 2001, and other regulatory attention, meant that this ambition was abandoned, at least within PayPal, though Thiel still believes that such a currency is both possible and necessary.
Uniquely, Nakamoto set out to embed soundness in bitcoin through an algorithm designed to tightly control the growth of the supply of this money so that it cannot be debased, unlike the Linden Dollar and other cyberspace currencies. This innovation attracted a significant number of miners and traders of bitcoin.
The first commercial transaction with this new money is believed to have taken place in 2009 when a Florida computer programmer bought two pizzas from Papa John's using 10,000 bitcoin. By 2010, exchanges had been established to trade bitcoin for dollars. Some stores even began to accept the digital currency. From a starting exchange rate of close to one cent, within a year it had reached dollar parity and, in June 2011, it hit a peak of nearly $30. Bitcoin was then hit by a torrent of security problems, as well as criticism from politicians such as Senator Chuck Schumer, who said it was being used to buy illegal drugs online. As bitcoin exchanges were corrupted and bitcoin wallets mysteriously emptied, its price plunged to close to $2 by the end of the year. Crucially, however, these problems did not appear to undermine the bitcoin money supply algorithm.
Nakamoto made no comment on these problems, or anything else. He has never publicly confirmed his identity, and disappeared entirely from public view in December 2010. His fluent written English has led to online speculation about the authenticity of his apparently Japanese identity. Rumours abound that he is in fact a they, and even that 'they' are Google, or maybe a big financial firm, or even the National Security Agency. Hence the T-shirts.
It remains to be seen if bitcoin can recover from its rollercoaster ride in 2011, but it seems possible -- especially if Fred Wilson of Union Square Ventures is right about the "hype cycle" that often accompanies promising innovation, where a bubble forms then bursts, leading to widespread predictions of the demise of what was being hyped. "The hype cycle model rings so true to me because it maps out what has happened with the commercial Internet over the past fifteen years. In 2002/2003, so many people thought the Internet was 'over' as an investment opportunity. And they were wrong," Wilson blogged in November 2011, predicting that there was plenty of life left in bitcoin. yet, he continued, "bitcoin or something else, I'm confident we'll see the emergence of currencies that are not controlled by nation states in my lifetime. Whether that is a good thing or not remains to be seen. I think it is, but there are significant ramifications that will result from the decoupling of currencies from governments. And one of them is an interesting investment opportunity that we hope to participate in."
Bitcoin is part of a new wave of information technology led thinking about the evolution of money. "It would be crazy to believe that we are going into the information age and the most important information system, our money, will not change," argues Bernard Lietaer, author of The Future of Money, who has been championing alternative currencies for more than a decade. (Indeed, money has already been changed by the technology, as the recent rise of PayPal and the growing use of mobile-phone-based money around the world makes clear.) Speaking at a TEDx conference in Berlin in 2009, this former currency trader, who designed the convergence system to turn Europe's national currencies into the euro, thinks that alternative currencies are about to take off. Traditional money created by governments, he believes, has proved too rigid. As a result, citizens are voting with their feet, and iPads, to find new, better kinds of money.
Bitcoin is one kind of an alternative currency and perhaps not the greatest advert for it. Advocates of alternative currencies argue that it is but one of a range of monetary innovations that are taking place under our noses. They point to the fact that many "air miles" are now exchanged not for plane tickets but for other commodities as a sign that these corporate-issued tokens of value are evolving into a currency -- though how sound "miles money" is remains unclear, as does its ability to survive shocks such as the collapse of an issuing airline.
This sort of alternative currency is not entirely new. The WIR was created in Switzerland during the economic crisis of the 1930s as a cooperative payment system between small and medium sized enterprises. Today, the WIR banking system has more than 60,000 members and the WIR supply of money in circulation is worth more than a billion Swiss francs. This is proof, say the alternative currency gang, that private monies can be stable, not just a flash in the pan.
Technology has the potential to innovate on an unprecedented scale that presents a genuine challenge to fiat money, and indeed to gold. True, the world of alternative or complementary currencies (like the world of gold bugs) has long attracted cranks. Many of these forms of money, particularly local community currencies such as the 'Brixton pound' that circulates in one part of London, survive simply because of the faith and goodwill of fanatical members. Alternative currencies may also endure because they offer some particular economic benefit. The Swiss WIR acts as a closed purchasing circle that supports its small business members by keeping commerce within the group. They may also offer a way to cheat the taxman, who typically focuses on income generated in legal tender. China has said that it wants to tax the virtual goods market (such as trade between players of online games), which already has an estimated value of $1.5 billion. Whether that will extend to trading done in virtual currencies remains to be seen.
Following the attacks on bitcoin exchanges in 2011, some prominent users of bitcoin expressed a desire for official recognition for the currency from regulators such as Britain's Financial Services Authority, because it would make the currency more credible -- a wish strongly opposed by other prominent bitcoiners. It seems hard to imagine, but perhaps a government, rather than regarding digital money as a threat (as it did with PayPal), will one day adopt the sound money technology of a bitcoin as a solution to the current crisis of fiat money.
Certainly, governments are already showing great interest in making fiat money entirely digital, as the end of paper money and coins would remove the cost to the taxpayer of producing them, whilst the digital records make some financial crimes harder (criminals prefer suitcases stuffed with untraceable bank hundred dollar bills). So adding a soundness algorithm might not be a huge leap, if politicians could be persuaded to give up their much used millennia old ability to debase the currency. Equally, as the public becomes increasingly comfortable with their money residing in a smart card or mobile phone, perhaps people will be more ready to use an innovative monetary technology such as bitcoin.