Conspiracy theorists and science fiction fans unite-your world of non-tangible, virtual currencies are here. They are called bitcoins and they’ve been increasingly covered in the news over the last few years. Still, most people really don’t follow or care to understand them.
When talking about digital currencies, Bitcoin is the name that always comes up, like ‘Tabasco’ in the ‘hot sauce’ space. But there are other virtual currency competitors out there including Litecoin, Peercoin and Ripple. They are all gaining in popularity and acceptance. They’re also gaining some powerful backers. For example, Google, through its VC arm, Google ‘Ventures’, has invested in Ripple.1 Even the Federal Reserve Bank has commented that bitcoin could improve what is a “disco era” payment system in the U.S.2
What is Bitcoin?
Bitcoin is digital currency created by Satoshi Nakamoto, presumably a pseudonym, in 2009. It is a completely online, decentralized currency. Bitcoin’s supply, and therefore its value, can’t be manipulated any central bank or government, although it could become regulated at some level. The Federal Reserve can increase the money supply by purchasing U.S. Treasury bonds form the government. But digital currencies don’t work that way. Through a complicated algorithm, bitcoin supply is kept in check through a complex system of transaction reconciliation, called ‘mining’. It can’t be manipulated like the fiat currencies of today can.
First, bitcoin was considered a threat. Senate hearings immediately started expressing valid concerns with this new technology. Bitcoin has a checkered past and has allegedly been used in the shadowy ‘Dark Web’ for all kinds of seedy ventures. Illegal sites appeared where customers could buy anything from hardcore drugs and machine guns to contracting murders-for-hire, proliferated with the rise of anonymous digital currencies. Virtual currencies make it harder for authorities to catch online criminals, but not impossible. Law enforcement shut down the largest Dark Web drug site, Silk Road, in 2013.3
But is Bitcoin Safe?
What if you get hacked and your digital ‘wallet’ gets drained of its bitcoins? Bitcoins have certainly been stolen before. Given the extent that some hackers will go, is there any kind of actual insurance against the theft of your bitcoins? There is no actual government sponsored insurance like a bank account enjoys through FDIC. But there are some indications that a private sector safety might not be too far away. One digital wallet company, Elliptic, recently began offering insurance on their bitcoin holdings through a policy from the venerable British insurer, Lloyd’s of London who has been in business since 1668.4 That says something about the possibility of wider acceptance.
Commercially, Bitcoin is starting to gain some traction as more and more retailers are accepting the digital currency. Accepting bitcoins offers a cheaper alternative for vendors compared to credit card systems which charge vendors fees of around 3%. Overstock was the first major online retailer to accept bitcoin. And there actually is crime insurance coverage available from Great American Insurance Group.5
Not only are individuals and businesses susceptible, but entire exchanges where bitcoins are bought and sold have been hacked. One of the first exchanges, Mt. Gox, was hacked and 75,000 bitcoins allegedly stolen. Some question whether there was a hack at all in the exchange or there was just the mis-management of funds. People couldn’t withdraw dollars from the exchange, like they are supposed to be able to do, for about a year so there was warning signs something was amiss.6 But if the 75,000 bitcoins were stolen, that would amount to roughly a $187 million dollar heist. The entire value of all bitcoins is around $3.5 billion so that would have wiped out about 5% of total bitcoin value in the world.
The blockchain technology underlying bitcoin is being developed for a myriad of applications. It is a digital, permanent record of all bitcoin transactions. It also verifies the ownership of any asset. This technology has the ability to improve many industries. Finance and health care seem to be the two most obvious.
Another industry that could be optimized by the use of blockchain technology is healthcare. With an enormous volume of sensitive patient information online, the consequences of a data breach, including theft and fraud, could be devastating for many. The fallout from the massive 2015 data breach of Anthem is still being assessed. Personal account information, including social security numbers and birthdates, of 80 million employees and patients were stolen from Anthem’s system by a “very sophisticated external cyber-attack”, according to Anthem CEO Joseph Swedish, who had his own information stolen.7
Using this new technology, patient information could be encrypted onto the Bitcoin blockchain with a timestamp. Also, the data could not be accessed without two or three different people’s permission. This would involve two separate entities (such as a doctor and the patient) entering key codes to access from the blockchain (like movies where two people need to turn separate keys at the same to activate a nuclear device). Further, the technology may improve the efficiency of processing claims for an industry fraught with red tape. This isn’t just a pipe dream. Philips, the healthcare giant, is currently exploring blockchain technology for use.8
The coming decade could see a quantum shift in the way bankers do business. In finance, operations department’s efficiency can be massively improved. Clearing trades and settlements could be done much quicker, compared to the current T+3 models. Wire departments could move money so much easier than the archaic systems currently in place. Traders could better maximize profits if the trades settled nearly instantaneously like an email. Real estate transactions could be streamlined with transfers of title. Overstock was so impressed by the technology, they issued a small $25 million bond offering on the bitcoin blockchain.9 The newest crop of B-School recruits may need to list coding as a skill as prominently on their resume as their Masters in Finance degree.
Maybe the biggest potential with bitcoins is as a payment system. It is a true peer-to-peer payment system so intermediaries are basically eliminated. Google and online payment system Square announced that they are working on new payment systems that would accept bitcoins which could directly challenge the burgeoning ApplePay.10
With the vast potential of bitcoin, some ambitious capitalists want a piece of the action. The Winklevoss twins, of Facebook infamy, have gotten involved. They have set up an exchange for bitcoin trading, called Gemini. There are other bitcoin exchanges including Coinbase, bitstamp and a Chinese exchange, OKCoin.
There is even a private equity fund specializing in the new technology, Cayman Islands-based Bitcoin Capital. Part of the capital was raised through equity crowdfunding. According to Bitcoin Magazine, the fund aims to invest in blockchain startups, bitcoin miners and long-term coin value speculation.11
But speculating on bitcoins is not for the faint of heart, with volatility that would make dotcom stocks seem like utilities. The price for a bitcoin was literally pennies when it started transacting around 2010. In fact, according to a chart from CoinDesk, bitcoin traded at .09 cents in July of 2010. In December of 2013, bitcoins traded hands at a record price of $1,147.25. As of today, the price to buy one bitcoin is currently $431.47.12
What the future has in store for bitcoin is impossible to know. It could be perceived as a savior or a threat to our current monetary system. Maybe the whole technology will be a non-event. Regardless, we’ll continue to watch for developments in bitcoin and blockchain technology as this is clearly one of the trends in finance to watch over the next decade.