Blog

Will Bitcoin pay off?

Internet fad or global game changer, new digital ‘cryptocurrency’ has backers in Kentucky

By Frank Goad
Internet-generated fads and new technology seem endless – from dancing baby animations and videos of Mentos candy-and-diet soda geysers to streaming movies and mobile banking. Discerning which is passing whim and which is the next big thing, however, has major financial significance. Currently standing at the crossroads of global financial legitimacy or Internet curiosity is Bitcoin, a digital, stateless, universal “cryptocurrency.”

Bitcoin

Some Kentucky businesses accept bitcoin payments. Some Kentucky tech entrepreneurs are so sure its promise outweighs its potential to dissolve back into the Internet ethers that they are investing time and energy into creating bitcoin-based products. In fact, they believe the commonwealth could cash in by jumping in now while it’s still early.

Despite growing acceptance, bitcoin is little understood. Born in 2009, there is bitcoin the currency and Bitcoin the worldwide cryptographic software platform that secures its movement. There have been disconcerting swings in bitcoin valuation on currency exchanges. Less than $100 a year ago, individual bitcoins shot above $1,100 in late November, fell below $600 two weeks later and was back above $900 in early January. It was back below $600 as the world’s biggest exchange in Japan developed problems, reported it had “lost” hundreds of millions of dollars worth of the cybercurrency and went bankrupt at the end of February. Other exchanges promptly bid bitcoin up at 20 percent. Other exchanges promptly bid bitcoin up at 20 percent.

The Economist magazine says bitcoin interest is growing faster than technology can keep up.

Whether or not bitcoin the currency has a lasting future, Bitcoin the technological platform is making global waves in commerce. More businesses and consumers are exploring its use, which has come a long way since the first purchase ever made with bitcoin: a pair of alpaca wool socks.

In August 2013, Germany accepted bitcoin as a “unit of currency,” making it taxable. The Royal Canadian Mint launched a secure digital currency system nicknamed “Mintchip,” now in its final proof-of-concept phase and meant for retail purchases equivalent to $100 or less. “We call it a digital-cash-like product, and we like to dub it as a product that’s been architected for the 21st century,” said Marc Brule, chief emerging payments officer at the Canadian Mint.

Some financiers remain convinced this “gold for nerds” is a novelty doomed to fade away.

Nonetheless, mega-finance firm J.P. Morgan filed a patent in December 2013 for its own cryptocurrency. Seattle and Austin are soon to join Vancouver, British Columbia, as cities with ATM-like bitcoin machines; more are slated in Asia and Europe. Digital currencies appear to be “what’s next.”

Kentucky: Horses, bourbon and bitcoin?

Companies in Lexington, Louisville and Northern Kentucky are accepting bitcoin as payment for goods and services, commonwealth software application developers are creating ways for consumers to use it, and political parties and social activists are promoting it as a way to roll back government intrusion into our lives.

Beyond that, some say Kentucky could be a center for the new currencies – a sort of Wall Street west. While that’s highly optimistic, it’s possible because cryptocurrencies are a new development.

“Everyone is at the starting gate, so if we as a state work together and take advantage of this, Kentucky could be a leader,” said Lamar Wilson, of 212ths LLC in Lexington.

Wilson and his partner, Lafe Taylor, developed a “hot wallet” app that holds bitcoin and can be used to buy groceries and entertainment or pay 212ths for services rendered.

“It can scale to any size, from the purchase of an office building to buying a lemonade from a kid’s stand on the street,” said Taylor.

Digital currency is seeping into government, too. Tiny Vicco, Ky., made national news in 2013 when Sheriff Tony Vaughn asked the city commission to pay him in bitcoin, which it did. His taxes were paid in U.S. dollars. A Cincinnati firm that handles electronic payments for utilities informed customers in 2013 they can pay in bitcoin through its system.

The Northern Kentucky Tea Party posted a supportive invitation last October for a meeting of the Cincinnati Bitcoin Initiative (which has many Northern Kentucky members). The invitation asked, “Frustrated with the uncontrolled money printing by a centralized Federal Reserve system that is never audited? …  Love capitalism and individual liberty?”

In November 2013, Bitcoincharts.com counted more than 1,000 business and 35,000 online merchants accepting bitcoin, including TigerDirect.com, Overstock.com, Tesla and even the IRS through an online bill payment service.

Kentuckian’s invention to enable merchants

In Northern Kentucky, Andy Schroder is on his second prototype of a bitcoin “fluid dispenser” app, originally aimed to be a management tool for vehicle fuel purchases.

“Say a company doesn’t want to issue cash or credit cards to their employees, yet wants to allow them to purchase things as part of their job,” Schroder said. “Using this system, they can pre-set the amount of bitcoin in the employee’s wallet and know instantly when and where a purchase is made. At this point there are no, or only miniscule, fees to use it, plus no chargebacks or double-spending. The merchant has no risk because the customer must have enough bitcoin (in the wallet) to start the purchase, and they don’t have to pay several percent of each transaction as with a (credit or debit) card to banks or processing firms.”

It can be used for any fluid and be mobile for an employee or fixed for a dispensing merchant, said Schroder, who besides inventing is at the dissertation phase of a Ph.D. in aerospace engineering, farms, converts used cooking oils to biofuels, and has a solar thermal collector business.

“I get far more consumer questions (about the fuel system) than from merchants,” he said. “There is a surprising number of people interested in using bitcoin in our area.”

Another incentive, Schroder said, is that people are concerned about companies losing customer data to hacking and identity theft, which does not happen with anonymous bitcoin transactions that use only an account number and its balance.

Building confidence but legal issues remain

Bitcoin

As with any currency, bitcoin’s “value comes down to the confidence and security people believe it has, and that’s why the dollar is strong – people know the U.S. is strong,” said Jason Rastovski, assistant professor of economics at Centre College. “Anything can be used as money if enough consumers and merchants have confidence in it, even potato chips. (Bitcoin is) traded like any other currency, but it is outside of official regulation since no government controls or owns it, but its value is limited and I don’t believe it will be a big influence” in the overall economy.

The value of all bitcoin worldwide is a bit over $7 billion. By comparison, the value of all denominations of currencies traded daily in global markets is over $5.3 trillion.

“From my perspective as an economist,” Rastovski said, “it is largely a technological curiosity. All currency achieves three things: One, it’s a unit of measure; two, it’s a medium of exchange; and three, it’s a store of value. (Bitcoin) works well as the first, moderately so as the second, but figuring the third is tough because its value could disappear instantly if someone figured out how to hack the system, which is unlikely but possible.

“Banks have the FDIC, so that’s some security, but bitcoin is up to the faith of those holding it. Conventional currency has natural markets developed over time, bitcoin does not – there’s nothing stable about it. Only when the majority of consumers and businesses put their faith in it will it ever be truly solid or stable.”

Bitcoin has unique legal issues. Professor Lars Smith, the S.J. Stallings Chair in Law at the University of Louisville’s Brandeis School of Law, is taking a sabbatical to research the legal, intellectual property and patent implications of Bitcoin and the other new currency “platforms” being created.

“Since there is no single entity that is Bitcoin, what if there is a problem or someone finds a way to break into the system?” Smith muses.

“To what extent does our federal government have the authority to say it can or can’t be used in transactions?” he said. “You can use gold to buy things, but it’s tangible; how do you regulate a non-asset-based currency? How do you regulate a trading medium that exists only as 1s and 0s outside any institution?

“This represents a milestone in that it is a universal, global currency,” Smith said. “So, how do you regulate it in step with the rest of the world, even in those places that outlaw it, like China and Russia have for the moment?”

The legal problems, he said, begin with contracts.

“Anytime you buy or sell something, you’ve created a contract. If you use bitcoin in a transaction, can or will the government recognize it as legitimate since it’s not done in a legal U.S. currency? The answer is likely ‘yes,’ but that could change. Beyond that,” Smith said, “does the government even have the authority to regulate it? Going another step, since it is a software-based system, what if someone claims they have a patent on Bitcoin – since it’s global, who would arbitrate that? And whom would you sue since Bitcoin isn’t controlled or owned by any single entity?”

If large banks and financial institutions get involved, according to Smith, “it could get ugly because this would undermine their business model. It could kick off their cry for regulation and restrictions as Russia and China have done. That would fly in the face of America’s reputation as a major software producer and our belief in free enterprise.”

Meanwhile, he said, the U.S. Justice Department owns 144,000 bitcoin seized last year in a raid on Silk Road, a company that sold illegal goods and accepted only bitcoin. The U.S. government apparently must take a position regarding bitcoin. If the federal government says bitcoin has no value, the $78 million-plus (at the time this was written) in currency it seized has no worth. But exchanging those 144,000 digital units for anything else recognizes its value.

Bitcoin vs. bitcoin: What’s the difference?

Bitcoin is the first and most widely traded currency that relies on a global network of computer bookkeepers; it has “competitors” like Litecoin, but it is fast becoming the standard.

The Bitcoin system was created by Satoshi Nakamoto in 2009 and is designed to cap out at 21 million “coins” in 2040. There now are about 11 million in circulation, with new ones being “mined” at declining rate built into the system.

The global tracking and trading computer network is “big B” Bitcoin. The currency is denoted as “small b” bitcoin and is described on the bitcoin.org wiki as “a distributed, peer-to-peer, digital currency that can be transferred instantly and securely between any two people in the world.” Peer-to-peer means no central authority issues new money or tracks transactions. These are managed collectively by the network.

Each bitcoin has a unique serial number of at least 33 characters that are cryptographically encoded during a transaction (hence the name “cryptocurrency”). Every serial number is known to the global Bitcoin network of computers, a supermajority of which must verify each serial number as well as that the buyer account has “money” before a transaction can proceed. It takes only a few seconds. Fraud is considered nearly impossible because of the encryption and systemwide verification.

Bitcoin allows anyone to buy or sell globally in transactions outside any financial institution, bank or service. Transaction fees are modest or there are none – appealing to merchants who pay Visa and MasterCard “swipe fees” of 1 to 4 percent per electronic transactions.

A bitcoin can be spent fractionally – e.g., b.05 or b.25 – like a dollar or euro. There are bitcoin exchanges worldwide. Much more than established currencies, bitcoin’s value has fluctuated significantly the past year or two when news and events impact market psychology. Fluctuations are becoming fewer and smaller.

Bitcoin is likened to gold because its market value changes daily; it isn’t controlled by one government or central bank; there is a limited quantity; it has value because people believe it does. Like cash or gold, if physically lost it’s gone. There are only so many bitcoins in the world, unlike currencies that are printed as needed or desired – which can be subject to political issues.