A year in a word: Bitcoin

By Tim Harford

(noun) A unit of the first and most famous cryptocurrency. After “bit”, a contraction of “binary digit”, the basic unit of digital information.  

It all sounds very mysterious. The Bitcoin is a currency based on cryptographic principles; it was created by a pseudonymous programmer, or programmers, called Satoshi Nakamoto. New Bitcoins are “mined” and the entire system is maintained by a decentralised peer-to-peer database recording every transaction in the history of the currency.

Bitcoin promises to be a new type of money. Economists like to say money has three properties: it is a medium of exchange, obviating the need for barter; a store of purchasing power; and a stable unit of account that serves as a standard of what is expensive.

As a peer-to-peer processing network, Bitcoin has the potential to become a superb medium of exchange. Our current systems for digital payment require intermediaries such as MasterCard or PayPal, and fees can be higher than consumers realise. The Bitcoin network allows Andy to send money to Belinda and have the transaction verified “in the cloud”, so to speak, at no cost. 

As a stable unit of account, however, Bitcoin is a failure. The currency’s volatility would make a dotcom director blush. That need not matter: a price can be listed in dollars, then transacted using the Bitcoin system. The dollar’s superb record as a standard of value can be married with the Bitcoin network’s ability to process payments cheaply. Alas, Bitcoin is currently used for speculation not transactions. Everyone wants to own Bitcoins but few spend them.

Bitcoin appeals to speculators for its frothy price and to libertarians for what it seems to stand against: it is not controlled by large corporations; it is not issued by a central bank; it is not really fiat money at all, even though the commodity that backs Bitcoin is a mathematical abstraction. Perhaps one day Bitcoin will gain momentum not because of the ideals it embodies, but because it turns out to be useful.

Copyright The Financial Times Limited 2013.