The Rise of Bitcoin
Back in March 2013, Bitcoin reached an all-time trading high of more than £21. At that time, this was seen as a major development for the alternative currency which was launched in 2009, largely unnoticed outside the crypto-currency world.
Since then, the situation has changed dramatically. What was seen as hype in March has now developed into a frenzy. By the beginning of April, one Bitcoin was already worth £150. And since a US Senate committee hearing in November backed Bitcoin as a legitimate financial service, its value really took off: following a peak of £755 on 5 December, it is currently trading at around £550.
Why has Bitcoin some attractive so quickly? How exactly does Bitcoin work? And how do regulators see the currency? Here are some facts which describe what Bitcoin is - and what it’s not.
Fact 1: Bitcoin is easy to use.
Bitcoin was created in 2009 as a safe and decentralised alternative means to facilitate the exchange of goods between a seller and a buyer. Bitcoin is not backed by a government or economy, and there are no physical coins or notes.
Using bitcoins is very easy by using a wallet, an online account enabling users to buy and sell bitcoins against another currency. These wallets require a simple registration only. Bitcoins can also be exchanged through websites, physical banknotes and cash. Bitcoin payments take longer than a payment via credit card, but the verification process means it is secure, as payments cannot be intercepted.
Fact 2: Bitcoin is not 100% safe.
When making a transaction, the Bitcoin network checks the transaction history of that particular bitcoin against the records of a number of different nodes in the network. Only when these agree that the bitcoin is genuine, the actual transfer occurs. This P2P system can neither be hacked (because too many participants are involved) nor reveal the real identify of the bitcoin holder (because no bitcoin wallet account names are used in the verification process, just numbers and strings).
However, there is no 100% safety, as Bitcoin balances are not insured. If your digital wallet is hacked or your hard drive crashes, your Bitcoins will be gone.
Fact 3: Bitcoin is not mainly used illegal activity
A widespread belief is that due to its anonymity, Bitcoin is the perfect means to pay for illegal products and services. The shut-down of Silkroad in October 2013, the largest known marketplace for illegal goods, therefore raised expectations that this could be a death blow for Bitcoin. The effect on the value was small however, in fact the media coverage around Silk Road contributed to even more mainstream awareness of Bitcoin’s existence.
In addition, there is a large range of online retailers selling electronics, fashion, books, music and many other products, and accepting Bitcoin as payments. Bitcoin payment processor BitPay for example reports that more than 14,000 fully legal merchants are connected to their Bitcoin system. Whilst some transaction will always happen in the “dark web”, the majority of transactions are 100% legit.
Fact 4: It becomes more and more difficult to create new bitcoins
Whilst the first bitcoins were relatively easy to create to help spread the currency, the algorithm makes creating bitcoins increasingly difficult however. Creating (or “mining”) your own bitcoins is possible, but this requires money for processor power - and patience. If you would like to make any profit you can calculate here how long this would take; even with modest expectations it will take a long time. For making money you are better off investing in Bitcoin and speculating that its value will increase over time.
Fact 5: Bitcoin is a sensible alternative investment
Investors and speculators have increasing appetite in Bitcoin. Volatility is high: Bitcoin was trading between £638 and £547 within the last 12 hours. But so far potential returns are huge: Exante’s Bitcoin fund is the best performing hedge fund so far in 2013 with a return of a staggering 4,847%.
Bitcoin fluctuations are higher than with any other traditional currency. As the currency is not linked to any economy or economic behaviour, future values are more or less impossible to predict. This makes Bitcoin a very risky investment – but one which pays off. At the moment.
Fact 6: Bitcoin might become be a real threat to “real” currencies
Bitcoin’s current “market capitalisation” (the number of available bitcoins multiplied with their current trading value) is around £7 billion, and there are nearly 50 transactions with roughly 750 Bitcoins exchanged every minute. This can in no way compare to any major currency, which are traded in the hundreds of thousands by the second.
The Bitcoin algorithm limits the amount of available Bitcoin elements to 2.1 quadrillion (a number with 16 digits) which can ever be around. The value of each bitcoin unit is freely defined only by its users, without any central interference. So even if Bitcoin will never fully replace a traditional major currency, this maximum amount is high enough to create an attractive alternative.
Fact 7: Regulators have stopped to dislike Bitcoin
Media coverage and mainstream interest have prompted regulators to take a closer look at Bitcoin in recent months. The response was surprisingly friendly: The FBI recognises that virtual currencies offer legitimate financial services. The German ministry of finance has officially recognised bitcoin as a financial instrument and private money. In the UK, slightly lagging behind, the Financial Conduct Authority (FCA) is actively looking into virtual currencies, and companies have started negotiating with regulators and meeting with banks to protect, promote and standardise bitcoin.
Many points are open for debate – further regulation or taxation of the currency, as examples. Every further Bitcoin milestone ensures that the discussion continues.