With China shutting down bitcoin exchanges and the CEO of JP Morgan calling it a ‘fraud,’ Rosamund Urwin investigates the cryptocurrency.
The world seems divided over bitcoin. Some herald it as a ‘monetary revolution’; others decry it as a boom about to go bust. Earlier this month, Jamie Dimon, chief executive of JP Morgan in London, declared the currency a ‘fraud,’ arguing that it should only appeal ‘if you were in North Korea… a drug dealer or a murderer’. At the Barclays’ financial conference in New York, he said, ‘If we had a trader who traded bitcoin, I’d fire him in a second,’ sending bitcoin’s price down six percent. He proclaimed it ‘worse than tulip bulbs,’ a reference to the tulip mania in the Dutch golden age. Meanwhile, Chinese regulators have ordered all-digital currency exchanges to close and banned fundraising through initial coin offerings (ICOs). The central bank warned that cryptocurrencies are being used ‘as a tool in criminal activities such as money-laundering and drug-trafficking’.
Could the most famous cryptocurrency be headed for a crash? The likes of Dimon arguably have a vested interest in bitcoin failing. ‘As the boss of one of the biggest banks in the world, why would he like anything that reduced his control over the money supply?’ says one hedge fund manager and bitcoin fan. A further concern is how in vogue bitcoin is. In the late Nineties, before the dotcom crash, celebrities piled into internet start-ups that mostly ended up going bust. Now, Paris Hilton is taking part in a fundraising for digital token LydianCoin, while bra baroness Michelle Mone has said she would accept bitcoin as payment for lavish Dubai flats.
Outside the financial world, bitcoin remains little understood. Notably, Google’s auto-complete suggestions for ‘is bitcoin...?’ are ‘safe’ and ‘legal.’ What makes people pay attention, though, are headlines like this: ‘If you bought $100 of bitcoin seven years ago, you’d be sitting on $72.9 million now’. So what exactly is this magical money tree?
Bitcoin is the grandaddy of thousands of other cryptocurrencies. It was released in 2009 by an individual under the pseudonym Satoshi Nakamoto. Speculation abounds about who he is — the late computer developer Hal Finney and computer scientist Nick Szabo were touted as possibilities, though both denied it. It’s a virtual payment network, not unlike Paypal, except with no owner. Instead, computers across the globe process transactions and keep a shared ledger (a ‘blockchain’) that enables different contracts to occur. It has its own currency, bitcoin, the unit in which the network carries out transactions. Getting your hands on bitcoin is relatively straightforward: you can buy them on an exchange, as you would any other currency (one is worth around AUD$9024 at the time we went to press), or you could accept them for goods and services. But you can also ‘mine’ new ones — like mining gold, except instead of digging it out of the ground, you are rewarded with bitcoins by using your computer to verify other bitcoin transactions.
With bitcoin, the money supply is controlled by the computers. That means it doesn’t require a central bank, so there’s no money being printed (hence the Twitter meme with the Queen looking irked: ‘Tried Bitcoin. Didn’t have my face on it’). That prize keeps shrinking, meaning there’s a finite supply. Circulation is limited to 21 million by 2140, although each one can be subdivided into millions of pieces. Every bitcoin is accounted for in a ledger, so you cannot get a counterfeit.
You spend them in the same way you would spend other currencies. Contrary to perception, bitcoins are traceable — you can see which internet addresses every bitcoin has been at — but the owners’ names are encrypted. As of 2015, 100,000 vendors accepted bitcoin as payment.
The irony of the debate over a bubble is that bitcoin was born just six weeks after Lehman Brothers went bust, as people searched for an alternative to the existing monetary system. It had its roots in the Julian Assange-backed ‘cypherpunks’ movement of the Nineties, in which activists argued the internet would create a new world outside the nation-state. The conversation had died down until the financial crisis resurrected it. The first transaction came in 2010 when computer programmer Laszlo Hanyecz persuaded someone to accept 10,000 bitcoins he’d ‘mined’ in exchange for two pizzas. It came to be embraced by libertarians as a way, like gold, to store wealth. Silicon Valley then joined the bitcoin crypto-rush, interested both in the technology and its potential as a way to raise cash.
Bitcoin has, however, been hit by crisis and scandal. It first entered mainstream consciousness as the currency of the Silk Road, the online black market where drugs were sold. Two major bitcoin names have also ended up in court. Charlie Shrem, who set up Bitinstant (in which the Winklevoss twins invested), went to prison after being convicted of aiding and abetting an unlicensed money transmitting business, a charge related to the Silk Road. Meanwhile, Mark Karpelès, former head of what was once the world’s biggest bitcoin exchange, Mt Gox, was charged in Tokyo with embezzlement and data manipulation after Mt Gox collapsed in 2014.
‘I reject the idea that [cryptocurrencies] are only used by criminals and terrorists,’ says Arthur Hayes, the co-founder of BitMEX, a bitcoin derivatives exchange based in Hong Kong. ‘The real currencies that finance terrorism and crime are the dollar and the euro. The cryptocurrency movement will only expand. It is a digital currency version of “I don’t trust the government”; the analog version being gold.’
It has emerged that even JP Morgan has routed customer orders for bitcoin-related instruments, although the bank does not take positions on this with its own cash.
The main worry about bitcoin is initial coin offerings (or ICOs) becoming the latest financial fad. ICOs are where ‘tokens’ in a new digital currency that promise future goods and services are sold as a way for a company to raise cash. This is where it starts to look like a bubble. Ethereum is a cryptocurrency, but also a platform for apps, allowing developers to sell a stake in the app by issuing tokens with ICOs. In June, one raised USD$30,000 in half an hour; purchasers were buying a token called ‘F***’ (described as ‘a social cryptocurrency that aims to help everyone around the world ‘give a F***’).
Scammers can use blockchain technology to create ICOs that perhaps look promising but are essentially flimflam. More than AUD$2.2 billion has been raised in ICOs this year. Where is the money coming from? Analysts say it is often from those who bought bitcoin on the cheap some years ago and are now millionaires. A UK watchdog, the Financial Conduct Authority, warned that anyone thinking of buying coins in an ICO should only do so if they are prepared to lose everything. One banker likened it to the South Sea Bubble of the 1700s, where a company bought up the rights to trade in the South Seas, then sold shares in its company which eventually become worthless.
So what’s the problem with bitcoin? ‘The main issue is that established currencies have a legal footing in each country whereas bitcoin doesn’t,’ says an Australian banker who asked not to be named. ‘Governments can clamp down on trading in it, like in China, saying it is circumventing capital controls.’
Governments have reason to fear bitcoin. It removes the role of government as the central issuer of money — and guarantor that money is real. The banker continued: ‘There’s a huge amount of power in controlling the money supply, such as using quantitative easing to pump cash into the economy. All the Western economies are based on an ever-increasing money supply. Bitcoin has a fixed supply of currency. If a government can’t print more money, it can’t run a budget deficit.’
This is why China — where most of the biggest bitcoin miners are — has cracked down heavily on cryptocurrencies. ‘China is afraid of anything it can’t control,’ Hayes explains. ‘But it can’t stop people using bitcoin — you can’t shut off the internet.’
Bitcoin’s fans argue it will have the most profound uses in countries where the money system is broken, such as in Zimbabwe and Venezuela. It could also benefit the 2.5 billion adults who don’t have bank accounts and enable immigrants to send remittances home more cheaply than the traditional banks do. As such, fans believe bitcoin could help create an equal world. ‘In the region we work in — emerging economies — banks don’t provide services for the majority,’ says Hayes. ‘Bitcoin allows people to invest, to participate in a global phenomenon.’
When the central bank of Cyprus seized savings, citizens downloaded bitcoin apps on their phones. Others believe Brexit could make bitcoin take off in Britain. Still, the technology is likely to become more sophisticated, ironing out flaws and making a future cryptocurrency viable — a bitcoin 2.0. If there is a crash, something sustainable could emerge from the wreckage.