“The internet is going to be one of the major forces for reducing the role of government. The one thing that is missing …is a reliable e-cash, a method by which on the internet you can transfer funds from A to B without A knowing B or B knowing A.
There have been plenty of efforts to fulfil the economist Milton Friedman’s 1999 prediction (see below for the interview). As far back as 1982, the computer scientist David Chaum wrote a groundbreaking paper on the concept of a cryptographic digital currency. He subsequently founded “Digi-cash” and then developed “e-cash”. Others followed in the 1990s and 2000s. All failed.
Now we have a genuine contender: Bitcoin. Here’s the simple version of how it works: it’s a peer-to-peer digital currency, which uses cryptography to secure and validate it. Users can transfer bitcoins to each other – they are stored on a “digital wallet” on users’ computers – without any intermediary and a high degree of anonymity. You can trade them for real world currencies and back again at a number of exchanges. New coins are produced when a computer cracks an algorithm, which get harder the more coins are produced, until, one day, all 21 million Bitcoins are in circulation.
In its initial years – Bitcoin was introduced in 2009 – users were drawn from the niche tech and online community. Because of the anonymity it offers, Bitcoin was the currency of choice for the Silk Road, an anonymous market place where drugs were bought and sold.

When the Silk Road was shut down by the FBI earlier this year, Bitcoins lost the lingering whiff of criminality, and are steadily making the transition from the margin to the mainstream. For several months, the digital currency sector has attracted significant venture capital investment, and its exchange with offline currencies is growing more intense. In February 2011, one bitcoin was worth around 1 dollar: by July 2012 it was up to around $10. When the Department of Justice and the Securities and Exchange Commission told a US Senate Committee in November that Bitcoin represents a legitimate financial service, it went up to $1200. Following less positive comments from the Chinese government, it is now trading at between $600-800.

Many people hope Bitcoins might one day supplant existing currencies. And that’s not all bad, because there is enormous potential for business and consumers to cut transaction costs imposed by banks. Buying something using a credit card can cost 3 even 5 per cent for the buyer, and sellers stump up merchant fees, usually around 2.75 per cent: potentially all removed. Imagine the savings on international remittances, which are a crucial source of income for many developing world countries. It could potentially insulate against political macroeconomic decisions, such as intentional devaluation. In addition, it is pretty impossible to counterfeit.
But these opportunities will only bear fruit if Bitcoin becomes a living, breathing currency. At the moment, though, it looks more like a commodity: few places accept them in exchange for goods and services, but many people are speculating on them. As a result of manic currency speculation, its value against the dollar is highly erratic.
This volatility makes it difficult for Bitcoins to make the leap to genuine currency, because businesses will be wary of accepting a currency whose value is so unpredictable. Over the last 72 hours, it has lost around 30 per cent of its value – tomorrow, who knows?
More on Bitcoin
• Bitcoin has been hijacked. Are we looking at a Ponzi scheme?
• Bitcoin and the euro: the one is the future, the other the past
• Digital currencies wil sweep away our monopoly money
It works the other way too. According to figures released by the FBI, between February 2011 to July 2013 there were around 4,000 vendors who had completed around 1.2 million transactions – nearly all drugs – using Bitcoins on the Silk Road. By my very unscientific calculation, a low-level cocaine dealer, selling 2 gramme batches (which I’m reliably informed is typical) charging market rates with a 50 per cent mark up (ditto) would have accumulated around 1,500 Bitcoins profit by July this year. Because of the surge in value, this petty basement dealer is now a dollar millionaire. I’m willing to bet all my Bitcoins (0.216) that there are a hundreds of Silk Road millionaires out there, wondering how on earth this happened.
Sooner or later, I think Bitcoin will stabilise its market price and when it does online retailers will start to accept the currency. I reckon the big online retailers who would save a fortune by stripping seller and buyer fees – eBay and Amazon – will move first. Apparently there is already an entire trendy suburb in Berlin where you can more or less live on them already.
That’s when the real difficulties start. Because for all the benefits, peer-to-peer currencies like this will almost certainly reduce the ability of central banks to manipulate the money supply, have significant implications for the tracking of illegal transactions, and may erode tax-raising powers.
For at least some of those involved in the Bitcoin project, including the mysterious founder, that was the whole idea. But if a lot of people start using and benefitting from this new currency, nervous governments will have get used to it, and avoid the desire to regulate it to extinction. Written on the back of newly minted Bitcoins – which are just symbolic, because it’s the string of numbers that matters – is the currency motto: Vires in Numeris. Strength in numbers.
Tags: Amazon, Bitcoin, eBay, Milton Friedman
Bartlett-photo Author – Jamie Bartlett