The number of companies taking bitcoin payments is increasing from a small base, and a few payment processors such as Atlanta-based Bitpay are making real money from the currency. However, it is difficult to get accurate numbers on conventional transactions, and it still seems that the most popular uses of bitcoins are buying drugs in the shadier parts of the Internet, as people did on the Silk Road Web site, and buying the currency in the hope that in a few weeks you will be able to sell it at a profit.
This is remarkable because there is no fundamental reason why bitcoin should have any value at all. The only reason people are willing to pay money for the currency is because other people are willing to as well. Try not to think about it too hard. However, sensible economists are saying that bitcoin might become part of our future economy. That is quite a shift from October last year, when the European Central Bank said that bitcoin was “characteristic of a Ponzi [pyramid] scheme.” This month, the Chicago Federal Reserve commented that the currency was “a remarkable conceptual and technical achievement, which may well be used by existing financial institutions (which could issue their own bitcoins) or even by governments themselves.”
It might not sound thrilling, but for a central banker, that is like yelling “BITCOIIINNNN!” from the rooftops. And Bernanke, in a carefully dull letter to the US Senate committee on Homeland Security, said that when it came to virtual currencies, the US Federal Reserve had “ongoing initiatives” to “identify additional areas of ... concern that require heightened attention by the banking organizations we supervise.”
In other words, Bernanke is ready to make bitcoin part of US currency regulation — the key step towards legitimacy.
Most reporting about bitcoin until now has been of its extraordinary price ramp — from a low of US$1 in 2011 to more than US$900 earlier this month. That massive increase has sparked a classic speculative rush, with more and more people hoping to get a piece of the pie by buying and then selling bitcoins. Others are investing thousands of pounds in custom “mining rigs,” computers specially built to solve the mathematical problems necessary to confirm a bitcoin transaction.
However, bubbles can burst. In 2011 it went from US$33 to US$1. The day after hitting that US$900 high, bitcoin’s value halved on MtGox, the biggest exchange. Then it rose again.
Speculative bubbles happen everywhere, though, from stock markets to Beanie Babies. All that is needed is enough people who think that they are the smart money, and that everyone else is sufficiently stupid to buy from them. The bitcoin bubbles tell us as much about the usefulness of the currency itself as the tulip mania of 17th-century Holland did about flower-arranging.
History does provide some lessons. While the Dutch were selling single tulip bulbs for 10 times a craftsman’s annual income, the British were panicking about their own economic crisis. The silver coinage that had been the basis of the national economy for centuries was rapidly becoming unfit for the purpose: It was constrained in supply and too easy to forge. The economy was taking on the features of a modern capitalist state, and the currency simply could not catch up.