Why bitcoin isn't dead yet

Digital hotshot bitcoin has had a bad run of late, but its boosters say there are still reasons not to abandon all hope in the upstart cryptocurrency.

Digital cryptocurrency has been hit by scandal, but people still spend real money on them

Bitcoin prices have fluctuated wildly in the past year, but true believers say their real worth is as a way of making online transactions easier. (Simon Dawson/Bloomberg)

It's been a rough month for bitcoin.

The digital cryptocurrency — which may or may not have been founded in 2009 by a 64-year-old Japanese recluse — was hit by the biggest challenge it's faced so far when Mt. Gox, the world's largest bitcoin exchange, suddenly announced that hundreds of millions of dollars worth of bitcoins were stolen last month. Unable to handle the loss of that much money, the site has begun formal bankruptcy proceedings.

Then last week, a much smaller site based in Alberta known as FlexCoin had something similar happen. The site closed up shop overnight after thieves managed to steal $600,000 worth of bitcoin from their servers.

The list of woes took an even bleaker turn this week with the death of a 28-year-old woman in Singapore. Autumn Radtke was the CEO of another upstart bitcoin exchange called First Meta until she was found dead this week. She's believed to have jumped from her high-rise apartment.

Bitcoins are units of digital currency that true believers use to complete online transactions securely. Bitcoin backers say they're the future of commerce because the value of a bitcoin isn't tied to any central bank or government policy. But detractors say bitcoin's existence in the shadow of regulation makes it rife for fraud and abuse, and an excellent way for criminals to launder their money.

The losses at Mt. Gox, Flexcoin and elsewhere didn't rattle prices as much as one might expect (after crashing through the $1,000 US level last year, they've steadied in a range between $500 and $700 since then) but bitcoin critics say the whole system is just a speculative bubble destined to pop.

Others aren't so sure. "The reality is that in any system, bad people are going to do bad things," says Rodolfo Novak, the CEO of Coinkite. "But nobody jumps to saying how the dollar is dead any time a drug dealer is caught using them."

Novak says considering abuses in the conventional banking system that people seem to shrug off every week, bitcoin comes off looking comparatively clean.

The market for them is certainly growing. Market monitor shows the total value of all bitcoins on earth is currently above $10 billion, stashed in various bitcoin wallets (a unique series of letters and numbers that function like an email address or bank account). That's a drop in the bucket compared to the trillions of dollars moving in foreign exchange markets. But it's not small enough to dismiss entirely.

And it's not just digital nerds and speculators on both ends of those transactions. Real businesses with real products report positive experiences. Entrepreneur Will Coates is the CEO of Digital Tunes, a website that sells digital music to customers around the world over the internet. The site began accepting bitcoins last year, and Coates says the early returns are positive.

"Bitcoiners aren’t just a bunch of nerds wanting to buy drugs online," Coates said recently. "Out there is a vibrant international community of consumers who have realized the advantages of this new kind of money, and it’s growing day by day."

Coates lauds the currency for its ability to keep costs low. Other services such as PayPal charge a 35-cent fee per transaction — an exorbitant sum for an online seller who might be selling a single song for about $1. By theoretically allowing fees to be zero, Coates says that helps keeps his costs low and his prices down.

Bitcoins also helped him because the transactions are irreversible; there's no meddling around with halted payments from credit cards. "Once you get paid, you get paid," he said. "This is baked into the code at the heart of the digital currency [and] this is wonderful, as it means the responsibility for combating fraud is not shouldered by the merchant, but instead lies with the bitcoin wallets – the ‘banks’, if you will, of digital currencies."

Businesses in the real world are signing up. In addition to letting users trade bitcoins, one of Coinkite's businesses is manufacturing, selling and installing bitcoin debit machines, that will let users make purchases in a way that's familiar to them. "It's so people like my mother can use and understand it," Novak quips.

Coinkite outsources the manufacturing of the machines to a factory in China, and when it came time to pay for the job, both parties were more than happy to deal in bitcoin. Novak says his company keeps most of its operating capital in bitcoin.

Wild price swings

With prices being so volatile, however, one of the problems bitcoin is facing is consumers reluctance to part with them in real transactions. If the value of the dollar went from enough to buy a cup of coffee to enough to buy a computer within a year, you might be reluctant to part with them for fear of getting burned.

Most of the focus on the price of bitcoin is centred on the notion that it's an asset class to invest in — not a currency that makes commerce happen. But most people involved in the space say the focus on bitcoin's "price" takes away from its real potential to make selling easier.

"We watch the price closely because we're big advocates of bitcoin," says Stephanie Wargo, the vice-president of Florida-based BitPay, a payment processing firm. "But from a business standpoint, not much has changed."

The tipping point for bitcoin will be when consumers stop thinking of it as a thing they can buy, and more as a currency that can be used to buy things. That will only come when it's quick, easy and liquid, Wargo says. "It's my dad being able to obtain bitcoins easily," she says. "The biggest problem is still liquidity."

Novak says right now, bitcoin is acting like a currency and a commodity at the same time. Long term, he's confident it will fall into the first category. But speculators looking to profit from the rise in the latter are certainly having an impact on prices.

Liquidity is definitely an issue. The best guess is that there are at most a few million people who own bitcoins around the world, and the vast majority of those holdings are very concentrated. Recent data suggest that fewer than 50 people currently own almost a third of the bitcoins on earth, and even if you extend the cutoff to half the world's bitcoins, you're still talking about about fewer than 1,000 people.

It's written into bitcoin's basic infrastructure that there can never be more than 21 million bitcoins, a limit that conventional banking systems can't claim. "In the fiat system, they have no problem printing a little extra money if they need it," Novak says. "The bank system is an IOU system, but we are a full reserve — we can't play with your money."

A niche fad controlled by very few people will have a hard time growing to mainstream adoption, and the underlying numbers are supporting that so far. The 80,000 transactions processed in bitcoins every day sound like a lot, until you realize they are a drop in the bucket compared to other payment methods — Visa handles about 2,000 transactions every second, and PayPal does 4 million a day, for example.

Speculators buy bitcoins the same reason they buy any fad — because the price has gone up. It's what happens after that stops that's likely to set the real value of bitcoins over the long term. That's the moment they'll become a currency, not a commodity. And there's enough evidence to think that might be happening now.

Ultimately, "bitcoiniacs" aren't fazed by the recent headlines and are confident their cryptocurrency is here to stay. "Like anything else you need to be careful where you're storing your money, but to me it's the equivalent to having gold bars in your basement," Novak says.