Bitcoin success prompts regulation speculation

Whether a currency of criminals or a barrier-breaking tool, the digital money's popularity may leave governments with no choice but to embrace it – and then seek to control it.

The jury is still out on whether Bitcoin is the 21st century’s first truly digital cash or a criminal currency used to conduct sinister transactions online.

The Bank of England, for example, theoretically puts Bitcoin on a par with any other foreign currency, calling it “a local currency”.

A turning point in the treatment of Bitcoins might have come last week, when a US senate hearing was generally positive on the currency – perhaps signalling an emerging desire to regulate it.

At the hearing, the bitcoin was “seen in a way more positive than the market had expected because I think the market anticipated almost by definition that the authorities would be negative”, said Steve Hanke, a professor of applied economics at Johns Hopkins University in Baltimore.

In an email to the Senate homeland security and governmental affairs committee, the chairman of the US Federal Reserve, Ben Bernanke, gave a balanced view of Bitcoin dealings.

He said that “while these types of innovations may pose risks related to law enforcement and supervisory matters, there are also areas in which they may hold long-term promise, particularly if the innovations promote a faster, more secure and more efficient payment system”.

A recent Fed study said that “should bitcoin become widely accepted, it is unlikely that it will remain free of government intervention, if only because the governance of the bitcoin code and network is opaque and vulnerable”.

The author of the study, François Velde, said the Bitcoin “represents a remarkable conceptual and technical achievement, which may well be used by existing financial institutions (which could issue their own bitcoins) or even by governments themselves”.

“If bitcoin become competitive and grows it will become under the control of the authorities, who will try to regulate it,” he said.

But as seen by it wide swings in just one day, the new currency is risky and often used for short-term speculation. In April it suffered its first crash, losing three quarters of its value in two days.

“The high price will attract competitors. It could collapse easily,” Mr Hanke said.

Last Tuesday, Bitcoins reached a value of US$900 apiece for the first time on specialised currency exchange websites. But a few hours later it was down to $700, according to Mt GOX, which manages trading done in Bitcoins. Back in April the price was just $200.

There is a strict limit to the number of Bitcoins that can be created. The algorithmic and complex software used to “mint” Bitcoins limits total issuance to 21 million units.

Bitcoins can be used to send payments instantly across international borders without recourse to banks and without the usual red tape.

On Thursday, Cyprus’s biggest private university, the University of Nicosia, said it would become the world’s first university to accept tuition payments in Bitcoins. The idea was to help foreign students in countries where traditional banking transactions are either difficult or costly to pay for programmes such as online degrees. The university’s chief financial officer, Christos Vlachos, said the Cypriot government should set up a regulatory framework to attract digital currency trading companies and boost the bailed-out country’s foundering economy.

Bitcoins can also be used to store funds discreetly in much the same way as a numbered Swiss bank account once did.

Unlike traditional forms of cash, a Bitcoin has no physical presence. It is essentially a piece of code and it uniqueness is protected by powerful software designed to prevent copying or cloning. By encrypting the software, Bitcoins can be hidden anywhere on the internet in a private cache or virtual vault.

The problem facing governments across the world is that a number of citizens, for whatever reason, are deciding to circumvent national laws in favour of an online Wild West where anything goes and much is available on demand, provided the buyer has enough Bitcoins.

Bitcoin also has potential pitfalls ahead. It has already shown that, as a currency, it is far too volatile for ordinary daily use.

There are also a growing number reports of Bitcoins being stolen. There have been dozens of reports of robberies of Bitcoin banks and exchanges. But Bitcoin investors argue that thefts occur in the real world all the time and that conventional banks simply refuse to reveal the true extent of their losses to hackers breaking into their IT systems and siphoning off cash.

The origins of Bitcoin are shrouded in mystery. The virtual currency is generally believed to have first been introduced by a developer known only as Satoshi Nakamoto, although some industry sources claim the Bitcoin software is so sophisticated that it must have been developed in secret by a team of developers.