News has been filtering in about the problems that are besetting a virtual currently called Bitcoin. The day to day rumblings of its story are fascinating enough but it is the evolution of the underlying idea that I think is important. This is one of those events that we often miss at the time and look back on as ushering in a new epoch in its long-term implications for the world, as for example the printing press did it its day.
So what is Bitcoin? It’s a virtual currency that can be used to buy and sell with much as you can with a normal currency. The difference is that while virtually all other currencies on the planet are backed by a central bank and so a nation state, Bitcoin is backed only by its users. It is a peer-to-peer currency developed for the networked age.
Before I get much deeper into what Bicoin is, its also important to consider what it is not. Most of the other innovations around money we see have been in the form of transactional means; the ease of transferring money between people (such as PayPal) or the ease of making a payment, such as using a mobile phone to pay. There have also been innovations we seel less of, such as credit default swaps that play around at repackaging value and risk. But underlying all these is still a national currency. None of these are a new currencies but a means to assist in the flow of old money but in a new world. Bicoin is, to a degree, some of these things, it is a digital native after all. But is is also not dependent on an underlying currency, because it is a currency.
To better understand we do need to spend a little time looking at what a currency is. Now I’m in no way an economist, so any reading this who want to correct my definitions, please let me know! As I understand it, a currency is basically a means of representing wealth for ease of transaction. So the various means we humans developed for representing wealth have tended towards portable yet rare items; gold being one common example. Gold as a metal was not that useful (it is now in electronics but that is another story) except that it was uncommon and easy to craft into jewellery so as to allow the owner to show off their wealth. Thus materials like gold became a proxy for wealth where so long as everybody agreed that it was valuable; it was. Paper money is also in itself not valuable and unlike gold it is not a rare material (which is why it gets forged). But what paper money does have is each note has the promise of a national state to pay the owner goods to the value of that note. Its an I.O.U issued by a state and because states tend to be powerful enterprises next to us people, its a promise that carries the weight of gold.
Now value does not have to reside in currency alone, indeed many of our problems come from an obsession with falling for the lust for proxy value. Value comes from, as with gold, the belief that an object is valuable. For example diamonds are not particularly rare, but because there is a near monopoly on their supply combined with the perception of rarity and hence value can be created. This is the first fundamental problem any new currency needs to solve; either something big a powerful (like a nation state) needs to back its value or it needs to be perceived of as rare so holding its value. The digital, by contrast, is the opposite of both of these. Digital is ethereal and far from rare because it is in its nature to be copied. To resolve this, a Bitcoin is, like a bank note, not just any collection of data but is ‘watermarked’ to ensure its authenticity. In the case of Bitcoins, they are watermarked by a hugely complex algorithmic slew of data that is uniquely generated. So copying it is not an option. The coins can be generated, or mined, by using the Bitcoin software – this starts running the algorithmic process and will, in time generate you a new coin. Your computers processing power is being distilled into a discrete package of value: a Bitcoin.
Hang on, you may think, how can a currency be created out of thin air? The answer is central banks do this all the time. Remember most money in existence is not in a physical form. Central banks create ‘base money‘ to keep their currencies flowing. Its a bit of an esoteric process as if they create too much then deflation follows yet too little and the liquidity of the economy suffers. Bitcoin uses the ‘mining’ of its peers to create the ‘base money’, so the balance of getting its level of generation right is created not by top-down be-suited men in offices, but by the natural ebb and flow dictated by the number of peers in the system.
So far there is little to recommend Bitcoins to the population at large because its central feature; being outside the control of governments was until recently only really pursued by a minority of cyper-rights, libertarians and geeks. Then the Unique-Selling-Point of the Bitcoin currency came into play; that it is outside of government regulation. A website of sorts appeared caslled The Silk Road, which offered anonymous trading but only via Bitcoins. The Silk Road is like a backstreet eBay and was soon filled with people buying and selling illegal items; cracked xboxes, guns and in the main, drugs. Lots of drugs. Suddenly there is a value to Bitcoins; you can by illegal stuff with them. The value of the currency rockets as people rush to get them to get high (I was told to $30 per Bitcoin). Then the Silk Road is interrupted and people can no longer use their Bitcoins for naughty things and so the value drops to a fraction of its high (to around 50 cents per Bitcoin). At the time of writing the Silk Road was back up and the value of Bitcoins purchased on eBay was £12.50 for 1 Bitcoin. Bitcoins are also subject to predation and gaming that afflicts normal currencies; theft, hacking and the like. Bizarrely these influences severe to show the value of this fledging currency, after all you don’t bother to steal something that is worthless.
So where is the printing-press epoch here? Before the printing press was developed, written knowledge was expensive. Books had to be copied by hand and as the skills to do this were also rare. As such there were limits on the knowledge and its transmission via the written word. It was predominately the realm of the rich and powerful. When the printing press came along all that changed. Copies could be easily made and so the control of the written word moved out of the hands of the rich and powerful and started its long journey of democratisation that is still ongoing today. Money is subject to the same facets. It is created and controlled by the rich and powerful and even in a democracy we have almost zero control over its form, value or function. With Bitcoin that changes as the ebb and flow of form is generated non-hierarchically by its peers. It can be assigned values (for good or ill) outside the nation state.
This is the start of the transfer of power for the mechanisms of wealth from the few to the many. Like the invention of the printing press it also means more than just the process of pressing ink; the opening up of the skills to read and write, of who can put ideas up for consideration and how how we can transmit those ideas to one another for learning beyond our immediate circle. What will be equivalent collateral changes with Bitcoins? One of the things I think really important is around the idea of currency regulation. Currently financial regulation rests with the nation state and its member organisations like the IMF. Whatever regulations that lawmakers may develop to control risk within such systems will always be gamed by clever speculators. The ability for the nation state to react to such predation is poor. However in a peer currency the response for such regualtion may also rest with the users. While this wont stop gaming and predation, it may be that afluid peer system is better able to react to such attacks to evolve a means to defend itself.
One thing is clear to me, however drawn from the parallel example of the printing press, which is that Bitcoins are will not be the final form of this journey, but they are only the start of the story. A story that has a long way to run, but like the printing press will echo into all sectors of humanity. Facing serious environmental challenges such as climate change and peak oil means the systems of wealth also need to change and I’m willing to bet, with Bitcoins 😉 that what is happening here will be a part of that much needed transformation…
(Also posted on my blog.)