We’ve all got at least a passing understanding of Bitcoin, that digital crypto-currency that can’t be regulated by any bank or government (at least for now).
But here’s a trickier question: what’s a bitcoin actually worth?
Like gold, Bitcoin derives its value from scarcity. It is intentionally difficult to use computers to create and add to the chain of cryptographic phrases that make each bitcoin unique—a process known as bitcoin mining. The currency is capped with a finite limit, too, so the more bitcoins exist in the world, the harder and slower it is to mine more of them.
See also Bitcoins... What Are They Again?
It’s easy to determine how Bitcoin is trading at any given moment, but that’s not the same thing as knowing what its actual value is in the real world. On Mt. Gox, the world’s largest Bitcoin exchange, bitcoins were changing hands at $103.80 as of August 8. On Bitstamp, the second largest exchange, a bitcoin traded at $94.99. On Coinbase, the popular U.S. Bitcoin wallet, it’s somewhere in between, at $96.58.
In this way, Bitcoin is just like the American dollar. What bitcoins are worth varies from market to market all over the world. For example, right now on August 8, one U.S. dollar is worth 0.75 euros, although its value will almost certainly have shifted by the time you read this.
One big way bitcoins differ from fiat currencies like the dollar is that those currencies have what you might call "safe zones" where buyers and traders can reasonably expect them to maintain a consistent value. The dollar, for instance, is backed by the U.S. Federal Reserve, which is charged with maintaining domestic price stability—that is, with minimizing fluctuations in the dollar's value as measured in goods and services.
Thanks to that backing (and a lot of monetary heavy machinery that makes it work), I can buy a toothbrush at the convenience store today and be reasonably certain that it will cost pretty much the same at the same store next week.
Not so for Bitcoin. Companies that accept payment in bitcoin can't usually pay their suppliers and employees without converting bitcoin to, say, U.S. dollars. And that introduces a big element of risk if the value of bitcoin is changing everywhere on a day-to-day—even a minute-to-minute—basis.
Knowing that Bitcoin’s worth is this volatile brings up more questions than answers. Here’s what the experts have to say.
Why Doesn't The Bitcoin Market Correct Itself?
If you know that bitcoin is trading at a much higher amount of dollars at Mt. Gox than it is at Bitstamp, why wouldn’t you buy from Bitstamp and sell to Mt. Gox? A cursory calculation assures that you'd net a quick 7% return—virtually free money.
It seems like a sound investment. And if everybody did this, the market would even out and correct itself. And perhaps that would happen, said Erik Vorhees, a Bitcoin pioneer and CEO of Coinapult, if Bitcoin conversion didn’t take so incredibly long.
“It takes forever to get USD [U.S. dollars] out of Gox,” he said. “If you sell Bitcoin there, you are going to be waiting many weeks for the money. So people prefer to sell elsewhere, though they may be happy to buy at Gox. If USD could be withdrawn from Gox in 3 to 4 days, you'd see the spread immediately disappear.”
How Liquid Is Bitcoin?
Since it takes so long to convert Bitcoin to U.S. dollars, you’d be right to assume that the Bitcoin isn’t very liquid. It takes time to buy, sell and move the cryptocurrency around.
According to Nicholas Weaver, a senior staff researcher at the International Computer Science Institute in Berkeley who studies emerging technologies, Bitcoin grows more volatile liquidity decreases the more bitcoins you want to trade. That’s because Bitcoin is still a relatively immature currency, lacking vast numbers of traders who can quickly meet buy or sell orders of any size.
“[Bitcoin is] about as liquid as a penny stock, that is, in small quantities it’s reasonably liquid but anything significant will not be liquid,” he said. “If you want to buy or sell $100K or $1M in Bitcoin, the market will go crazy.”
Is Bitcoin A Good Investment?
Here is where our two experts differ. Vorhees believes the Bitcoin is becoming a more stable investment every day.
“Bitcoin is just more volatile than most everything else because it's still new, and still a tiny market,” he said. "But, over time, the volatility will calm down, indeed it already has.”
Weaver is far tougher on Bitcoin. It’s not just that Bitcoin is volatile, but that Bitcoin transactions are completely irreversible.
If you experience credit card fraud, you can report that to the credit card company and get the transaction reversed. In order to maintain that level of fraud mitigation, you need trusted central authorities called banks, he said—institutions that go completely against Bitcoin’s core philosophy.
“Bitcoin instead, by lacking any trusted parties, is designed to be irreversible: Once a Bitcoin transaction is committed, it can NEVER be undone,” he said. “Which means you can never simply transfer your money from a bank account to buy Bitcoins. Anyone who allows such things will be undone by fraud.” As in, fraud that can't be reversed precisely because there's no entity standing behind the transaction to guarantee its integrity.
And indeed, there has been evidence of Bitcoin users who have been defrauded by irreversible transactions, mainly as part of a pyramid scheme shut down last year.
So why ever use Bitcoin? Weaver can only think of two reasons:
“You're selling to Crypto-Anarchist-Libertarian-Cave-Dwelling-Goldbugs who believe in Bitcoin—and can sock an extra charge on them for the privilege,” he said. “[Or] you're selling things that cannot be processed using credit cards, namely gambling and drugs.”
Since Bitcoin is assumed to be untraceable, illicit marketplaces like Silk Road exist to turn your bitcoins into illegal goods. But Jeff Garzik, a member of the Bitcoin core development team, maintains that Bitcoin is not as anonymous as you might think.
“Attempting major illicit transactions with bitcoin, given existing statistical analysis techniques deployed in the field by law enforcement, is pretty damned dumb," Garzik told Kotaku.
There’s no easy answer to, “what’s Bitcoin really worth?” If you truly believe in Bitcoin as a digital currency that could change the world, you’ll probably be willing to pay for the risk. If not, perhaps it’s best to keep your money in good old-fashioned dollars.
Photo by zcopley on Flickr