Is bitcoin here to stay? After developments this week, I would say so

There are places today all over the world that will accept the cryptocurrency as payment for goods or services, including a church (St Martin’s in Gospel Oak, London) which will take it for charitable donations

Sean O'Grady
Tuesday 12 December 2017 16:50
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What is Bitcoin and why is its price so high?

Had you had the luck/knowledge/risk-appetite/technical skill to invest £1,000 in bitcoin in the summer of 2010 it would be worth… about £200m today, give or take. That, though, isn’t the bit that galls me. The bit that galls me is that if you’d “invested” (I use the term loosely) £1,000 in bitcoin only three weeks ago, it would now be worth £1,500 – a tidy enough return, I think you’ll agree, and quite enough for some Christmas treats.

Galling, just to be clear, because bitcoin was not last month, as it was in 2010, some obscure thing that sounded like science fiction. Last month you could buy and trade them without so much difficulty. There are places today all over the world that will accept bitcoin as payment for goods or services, including a church (St Martin’s in Gospel Oak, London) which will take it for charitable donations. There aren’t many though, and some are a bit odd, I’ll admit. The nearest to our offices is something called “Sensuous London” which offers “erotic massage”.

As if erotic massage wasn’t enough, now bitcoin takes another step forward as it is to be traded on the Chicago futures exchange. On the one hand, this is a welcome development, as it makes the cryptocurrency more liquid (ie easier and quicker to buy and sell into other currencies or commodities) and might help holders assess its prospects.

On the other, it might be simply a blunder: an even more dangerous boost to a bubble or Ponzi scheme that has already got the capacity to destabilise the financial system.

Are we giving this shadowy cryptocurrency respectability? The Bank of England has researched it, and commented on its “revolutionary” potential; true enough, but were they being too polite?

For context, the total value of bitcoins, by the way, is about $280bn. By comparison, the total value of dollars in circulation is $1,600bn, of euros some $1,300bn, and sterling around $110bn (all these being a fraction, by the way, of the much larger value of near-cash money credited in bank accounts for conventional currencies).

So bitcoin is big, by any measure, but it does need to be placed in some sort of perspective.

What’s going on? This is, after all, a cryptocurrency: a digital creation with no backing in reality. There is no company, land, precious metal, other commodity, livestock, human being or anything else “backing” this currency, promising to redeem or exchange it for anything else.

There is no national or supranational central bank supervising its creation. It is a product of some software called Blockchain, which allows transactions (and other records) to be encrypted and tracked as an alternative to a more traditional method of exchange.

Ironically, bitcoin is less anonymous than handing over a massive wad of £50 or 500 notes, but tends to be favoured by the criminal fraternity because of its physical practicality for very large money laundering jobs, and because of its inherent, virtually unhackable secrecy.

The software, and the bitcoin phenomenon, are the responsibility of a group that goes under the pseudonym Satoshi Nakamoto. Beyond that, they are the creation of everyone and anyone who uses the currency, as all money is. It simply proves the worth of the old dictum that “money is what money does”.

This has long been the case. Fish out the banknotes and coins in your wallet or pocket. Base metal and paper or polymer with ink on them and a picture of Jane Austen or Churchill. They have no intrinsic value.

Yet a bundle can be transformed into a taxi ride, a burger, a sofa or two weeks in Malaga because they are trusted. There hasn’t been anything backing the pound since we came off the Gold Standard in 1931, and the last traces of real silver disappeared from the coinage in 1948.

Once upon a time, banks issued notes, and if they went bust, the pound in your pocket was worthless.

When currencies become debased through inflation, communities turn to other currencies instead, usually the US dollar, to make commerce continue. After the Second World War, cigarettes famously became currency in Germany. In Zimbabwe, life savings were wiped out by the hyperinflation that gave them the 100,000,000,000,000 Zimbabwe dollar banknote, which would only buy a gallon of petrol (if you could find any). Money has always had its risks.

With money, and bitcoin, you have to take the long view. Money is as old as civilisation, and has taken many forms. Once they used salt, from which the word “salary” is derived. Modern “fiat” money, which is money just because a government says it is, is a few hundred years old.

Bank deposits – effectively created by commercial banks – also date from about the nineteenth century, but only became available to the working classes from the 1980s on. The US Federal Reserve was only founded in 1913, the Bank of England in 1694. PayPal came along on the back of the boom in e-commerce in 1998.

All were great novelties in their time, though some are still concerned that the high street banks lend out most of the money you have on deposit or in a current account with them. By comparison, bitcoin dates back to 2009, and its peers are even younger – Ethereum, the second largest, got going in 2015.

Whatever their value may happen to be now, they may have a long way to go. As it happens, the evolution of money is never complete.

The earliest paper money was an IOU for, say, an ounce of silver, and entirely “backed” by some lumps of silver in a bank vault. Then the banks started to realise that not everyone would cash in their silver at once, and this early paper money became a multiple of the underlying asset.

Then, the underlying asset in bank accounts on which cheques were drawn evolved into a paper national currency that was, itself, only partially covered by “reserves” of other currencies or of precious metals or anything else.

Then, before the financial crash, the rocket scientists in finance created a vast mountain of money out of the stock of mortgages which were diced, sliced and traded to create an ever more tottering mountain of “securities”, which were accepted by other financial institutions as being of monetary value.

We even had “synthetic” mortgage-backed securities, based on the insurance contracts of their owners, and based on how likely the underlying assets, usually home mortgages to "sub-prime" buyers, were to default. These too had monetary value, in theory.

Of course, though, they turned out not to be as secure as everyone thought, hence the financial crash and bank failures of 2008; and hence now the nervousness about the ballooning value and disruptive presence of bitcoin.

I think the key to understanding bitcoin is to identify its customers, who, as far as can be gathered – and that's not entirely – are those who prefer its confidentiality, like a Swiss bank account or a trusted “fence” for stolen goods.

Just as the Dong is the national currency of the Vietnamese, they use the Kwacha in Malawi, and eBay users often use PayPal, bitcoin is the favoured currency of crooks, drug dealers, terrorists and spies, and its future fortunes may prove closely linked to theirs and to vice generally.

What's more, it seems to have some cost associated with producing it, analogous to the costs of mining gold or running the Bank of England’s printing presses in Debden, Essex; apparently, the production of bitcoin on computers consumes as much electricity as Denmark.

It is also facing competition from various new entrants, and, whether a store of value and means of exchange or not, like anything else – rare tulips, classic cars or Harry Potter memorabilia – bitcoin is subject to speculative crazes and bubbles.

This is not financial advice, but they always say people should only invest in things they understand. On the basis of the above, I hope you’ll agree that there is a great deal to understand about bitcoin.

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