Column: Bitcoin’s challenge

Dec 19 2013, 01:40 IST
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SummaryThe challenge lies not in containing Bitcoin’s criminality but in finding ways to regulate it and create a trading and banking system for it

Reactions to and explanations for the sudden rally of Bitcoin in November are still trickling in. Last month, the world’s first completely virtual, anonymous and decentralised currency raised both hopes and fears at it soared through the $1,000 barrier in a vertical climb. Immediately, Germany promised to embrace it and Ben Bernanke cautiously said that it would bear watching—at least, its innovations in payment processing were interesting. However, the European Union now warns that it is an unreal currency based on nothing at all—in short, invest or trade at your own risk. But Gaurav Burman is doing just that, buying into itBit, a Bitcoin exchange in Singapore. Even though recently, Chinese banks were banned from trading in the cryptocurrency.

Is Bitcoin leading the world down the primrose path? A general perception is developing that the cheap money that banks unloaded to fight the crisis of 2008 has been creating several asset bubbles, the latest being a Bitcoin bubble. China believes that the spike in Bitcoin prices was triggered locally, when Chinese speculators realised that Bitcoin was a dandy way to stash liquid assets overseas, out of reach of regulators and the taxman. Meanwhile, the EU is raising the bogey of chaos. Bitcoin does not have a central bank. Rather, it facilitates transactions that completely bypass regulation, controls and the formal banking and financial systems. Besides, there is the threat of sudden devaluation for purely technical reasons which have nothing to do with markets.

Bitcoins can be mined by anyone who owns a computer and devotes machine time to running an algorithm which computes data blocks representing value. Like conventional currencies, it is built on the notion of scarcity. In this case, the difficulty of computation and the physical limitations of computer hardware create scarcity. A standard desktop computer would take months or years to create enough Bitcoin for its owner to buy anything worth having. Risk is limited by Moore’s law, which observes a doubling of computing efficiency at the level of hardware every two years. It offers stability because, as chip components become smaller and smaller, as economies of small scale become harder and harder to achieve, the span of time for doubling is believed to be increasing.

However, a degree of unfairness is built into the system. Someone with a supercomputer—a government, an institution or an institute—has a huge edge over a miner with a regular computer. Hardware arms wars are

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