My column on the "Internet of Money" was mostly about real money being represented on the Net, because, well, the Internet is eating everything. (See: Will the Internet Devour Your Job?)
One side item I mentioned was Bitcoins, a virtual currency that went from a high of $31.91 US per Bitcoin in February to $100 on April 1 -- and that's no joke. At press time, the exchange rate is $139.89 to one.
I would like to talk about why that might be and what it might mean for us.
Paper money -- be it dollars, Euros, Kroners, pounds, take your pick -- has certain problems. To transfer the money or store large amounts of it, you probably have to go through a third party, like a bank or credit card company. These third parties tend to charge fees, either at the ATM, through a monthly statement, or via wire transfer. In the case of credit cards, the retail store you purchase from pays the fees.
The economic term for this is friction. This friction is, in a small way, a bit like playing poker in Las Vegas, where the house takes 10 percent of each pot.
In addition to friction, putting your money in a traditional third party means that third party can refuse to give you the money back. We say it can't happen, but it is happening in two ways -- first the seizure of bank assets in Cyprus, and also the inflation created by the Federal Reserve when the US Government spends more money than it takes in.
When the people of Cyprus woke up and found their money was gone, it makes sense that every other European rushed the bank, creating a market for third-party resistant stores of money.
Suddenly a lot of people were interested in Internet currency.
Bitcoin is a peer-to-peer network standard that, like the Napster of old, does not need any centralized server to operate. Any programmer with reasonable skill can use Bitcoin's code libraries to create software to trade the coins, and non-technical folks can use existing free open-source software like Bitcoin Armory.
Because the software is peer-to-peer, you can store it on your own computer. To take the coins, the government would have to break into your house and compel you, by force of arms, to give up your password. Bitcoins also have no weight and take up no space (unlike precious metals), and the number of Bitcoins in supply is limited; they can't lose value through printing more.
If only that were the whole story.
Most people don't store Bitcoins on a personal computer; it's too much of a security threat. Those that do often physically disconnect the computer from the Internet as soon as a transfer goes through, using it for "offline mode" and only connecting for planned transfers, and then, only from a wallet with enough money in it to pay the bill.
That's a lot of work, so exchanges sprang up, to trade other currency for Bitcoins, and to act as banks.
You guessed it. Putting your coins in an exchange puts you right back where you started. Instawallet was a Bitcoin bank that was hacked; I say was, because the company is now out of business. Mt Gox, which claims to manage 70 percent of Bitcoin transactions, suffered a denial-of-service attack
on April 3, meaning its users were unable to perform any transactions. The price of Bitcoins dropped from $130 to $30 overnight.
In 24 hours, they returned to their high, and are now $139. That's an incredibly fast recovery, but it also suggests a financial system that is not mature. Can you imagine the Euro or the US dollar going down because of a single bank software failure? It seems unlikely. (Not to mention the legal and tax implications with an alternative currency: The last guy to try with "Liberty Dollars," made of silver, is currently behind bars.)
What should we do?
Bitcoins represent a huge opportunity and risk, both personally (investing) and professionally (writing, contributing, or using Bitcoin software at work). The only thing I can say for certain is that pundits predicting the future should not be certain.
To balance the risk and reward, I suggest a strategy I learned from my father about the stock market. I call it "playing."
In other words, decide an amount of time (three nights a week for three months) or money (a few thousand dollars) that you are willing to risk. Invest that time or money, make sure you do it in something you find fun, and make sure you learn something. If your idea failed, well, hey, you never gambled more than you could afford to lose, right?
Come to think of it, that's not a bad way to manage your entire career, is it?
I do wonder what will happen with Bitcoins -- and what I should be experimenting on next.
What do you think?
— Matt Heusser is principal consultant of Excelon Development.