The mysteries of cryptocurrencies

You can buy this mermaid print using Bitcoin

Is the electronic currency Bitcoin the borderless currency of the future?

From time to time I may share with you my understanding, such as it is, of Bitcoin and alternative digital currencies, sometimes called cryptocurrencies. You can take this as a starting point for your own enquiries if you wish, and whether you agree or not with what I write, if you have something to add to the discussion you are very welcome to comment.

Bitcoin is a digital currency on what is called a distributed ledger. This means that the record of who owns what and all transactions are held electronically on computers all over the world. There is no central banker. The system is designed for peer-to-peer transactions, that is, ordinary folk buying from and selling to each other without banking interference and across borders. Also if, for example, you lose your virtual wallet (for example, you own Bitcoin in your smartphone and your smartphone is lost), as long as you have your code words you can get your money back.

Currently the UK, USA and most if not all countries of the world use fiat currencies, that is, money not backed by precious metals. The USA left the gold standard in 1971 (Mervyn King, The End of Alchemy, Abacus 2017 p.73) as did Britain temporarily in 1797 when at war with France and permanently in 1931 (ibid. pp.75-6). Fiat currencies allow governments to print money whenever it seems useful to do so, whether to fund a war or to get the country out of economic difficulty.

One problem with fiat currencies is that if they get out of control, hyperinflation can occur, rendering money virtually worthless, as happened during the Weimar republic and more recently in Zimbabwe. In such times people who hold gold can do well, because gold holds its value as the supply is limited. Limited supply is also a feature of the digital currency Bitcoin.

Holding gold is difficult, partly because it has to be stored somewhere and at some cost and partly because it has somehow to be converted into fiat currency in order to spend it. Bitcoin can be held securely in a number of ways including on a smartphone and can also be held off-line and so secure from hackers. It can be converted into many fiat currencies on-line, and a very small number of businesses world-wide will accept it. Its value in terms of most (but not all) fiat currencies suffers from extreme volatility, but on average its value as measured against fiat currencies has trended very much upwards up until now. (Where it will go next is not something I'd like to predict, because I wouldn't want to get the blame if it all goes wrong.) Interestingly Bitcoin is much less volatile when measured against currencies in crisis, such as the Venzuelan bolívar.

What effect the large-scale adoption of Bitcoin would have on the world economy is difficult to imagine. It would allow borderless transactions between ordinary people without going through a bank and without having to pay currency conversion and transmission charges.

One thing that is holding it back now is that a little bit of research is needed for an ordinary person to understand exactly what Bitcoin is, and storing it requires a little bit of technical know-how. Another thing holding it back is lack of sufficient speed in the system to support the number of transactions that major card companies do every day (a complex topic which is covered elsewhere) and a third problem is the lack of charge cards or debit cards that can be used to pay with Bitcoin.

If it were possible to have a charge card that would convert the Bitcoin held on it into the local fiat currency on the fly (that is, without the intermediary of a bank) to pay for goods at a contactless or chip-and-pin checkout then I believe Bitcoin would take off.

There are a large number of debit or charge cards available that claim to be able to let you pay with Bitcoin, but as I understand it for the most part these cards require you to convert Bitcoin into fiat currency in order to load them up, and they cost money to use. Therefore this leads to the same old bank charges for cash withdrawal and currency conversion. I cannot see the point of them.

A true Bitcoin card would do currency conversion via an on-line Bitcoin exchange. The only contactless Bitcoin payment system I've found that comes close to a true peer-to-peer system doesn't actually exist yet: it will be an app that you have on your smartphone. In this case you send as much in Bitcoin as you want to spend that day to the address on the app. The Bitcoin is converted to your local currency using a peer-to-peer trading network and is then available to spend using your smartphone for contactless payments. It remains to be seen whether you will be able to change your preferred fiat currency easily within the app (for example when travelling). This is not a product recommendation but it certainly looks interesting. If I were to use it I'd only put as much on it as I was likely to use in a day or so, since funds held on-line are at least in theory vulnerable to hacking or the system organisers closing down and running off with the money, not that I have any reason to suspect that particular organisation.

Anyway, as an experiment I have created a page on OpenBazaar (a peer-to-peer alternative to eBay - perhaps one day) to sell some artist's prints in exchange for payment in Bitcoin (see illustration at the top of this post). So far I have not become rich (or actually sold anything) but it's early days. My next hurdle is to set up an old computer to be a server so that I can have my page on-line all the time.

All comments and questions welcome.

[Disclaimer: I am merely passing on my own understanding and hoping to start a debate. I do not claim to have expert knowledge and no-one should base any financial decisions on what I have written, nor do the links provided necessarily imply a recommendation (except that Mervyn King's book, which is not about Bitcoin, is very good).]