Bless Paul Krugman. His is the first explanation I can understand.
I have been reading about Bitcoin for a couple of years–about speculation in this “crypto-currency,” about competitors who are equally “crypto,” about people who are willing to be paid for goods and/or services in this new medium.
The problem is, I can’t get my head around it.
I know that U.S. currency was originally backed by gold, and is currently backed by the full faith and credit of the United States government. (Our stability led lots of countries to “park” their assets in the U.S.–I wonder how long it will take Trump and his band of Keystone Kops to erode their trust…) I have no idea what backs Bitcoin, so I was interested in the linked Krugman column.
If you’ve been living in a cave and haven’t heard of Bitcoin, it’s the biggest, best-known example of a “cryptocurrency”: an asset that has no physical existence, consisting of nothing but a digital record stored on computers. What makes cryptocurrencies different from ordinary bank accounts, which are also nothing but digital records, is that they don’t reside in the servers of any particular financial institution. Instead, a Bitcoin’s existence is documented by records distributed in many places.
And your ownership isn’t verified by proving (and hence revealing) your identity. Instead, ownership of a Bitcoin is verified by possession of a secret password, which — using techniques derived from cryptography, the art of writing or solving codes — lets you access that virtual coin without revealing any information you don’t choose to.
It’s a nifty trick. But what is it good for?
My question exactly! (This is one of those times–multiplying in number–when I come face-to-face with the fact that the world has passed me by. Technology has eclipsed my ability to understand it…)
In principle, you can use Bitcoin to pay for things electronically. But you can use debit cards, PayPal, Venmo, etc. to do that, too — and Bitcoin turns out to be a clunky, slow, costly means of payment. In fact, even Bitcoin conferences sometimes refuse to accept Bitcoins from attendees. There’s really no reason to use Bitcoin in transactions — unless you don’t want anyone to see either what you’re buying or what you’re selling, which is why much actual Bitcoin use seems to involve drugs, sex and other black-market goods.
So Bitcoins aren’t really digital cash. What they are, sort of, is the digital equivalent of $100 bills.
Krugman explains that equivalency: neither Bitcoins nor $100 bills are used in most ordinary transactions. But hundred dollar bills are evidently popular with thieves, drug dealers and tax evaders. Unlike hundred-dollar bills, which are backed by the U.S. government, Bitcoins have no intrinsic value. Its “value” is whatever the parties to the transaction are willing to assign to it.
Combine that lack of a tether to reality with the very limited extent to which Bitcoin is used for anything, and you have an asset whose price is almost purely speculative, and hence incredibly volatile. Bitcoins lost about 40 percent of their value over the past six weeks; if Bitcoin were an actual currency, that would be the equivalent of a roughly 8,000 percent annual inflation rate.
Oh, and Bitcoin’s untethered nature also makes it highly susceptible to market manipulation. Back in 2013 fraudulent activities by a single trader appear to have caused a sevenfold increase in Bitcoin’s price. Who’s driving the price now? Nobody knows. Some observers think North Korea may be involved.
But what about the fact that those who did buy Bitcoin early have made huge amounts of money? Well, people who invested with Bernie Madoff also made lots of money, or at least seemed to, for a long time.
Krugman quotes a currency expert who describes Bitcoin as a “naturally occurring” Ponzi scheme.
I’m still pretty hazy about what Bitcoins and their competitors are, or why it takes so much electricity to “mine” them. I’m clearly not cut out for the “brave new world” of digital money–or new and improved skullduggery.