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Innovations in Trading and Technology

22 March 2013

Bitcoin: Spirits in the Material World

The ongoing drama in Cyprus has very few winners, but the most unexpected one so far is bitcoin, the online currency.

Two weeks ago, one bitcoin was worth $40, which was at that point a new record high. As I write this, the price is just over $72. The reason for the move: incremental interest from holders of euros (no surprise) and Russian rubles (even less of a surprise). Bitcoin value outstanding crossed $800 million today, putting it ahead of the GDP for a dozen World Bank recognized countries.

BTC (the three letter shorthand for this currency, like EUR or USD) is clearly having a breakthrough moment here, and a deeply surprising one given its novelty and nascent infrastructure. Whether it succeeds or fails is hard to predict (although ‘Spectacular’ will likely be appended to whichever proves true), and we’re clearly in uncharted waters. But one thing is clear: bitcoin is one more lens with which to assess the ongoing European financial crisis.

Bitcoin has exploded in price and popular attention over the last few weeks, so even though I wrote about it in late February it makes sense to circle back around and see what’s new in the online currency. If you’ve never heard of bitcoin, here is a quick primer to bring you up to speed:

· Bitcoin launched in 2009 as an open source software code, which simply means anyone can download the program for free. The system was invented and program coded by person or persons unknown. Seriously – its inventor is a mystery.

[Related: "Open Up Already: Speeding Adoption of Open Source in Financial Services"]

· The network which runs bitcoin is comprised of tech-savvy individuals who both maintain transaction logs and race to solve highly complex cryptographic puzzles set up by the original software code. When a specific computer solves a puzzle, something that happens every 10 minutes or so, the system gives it a few “new” bitcoins, which then enter circulation. Unlike every other currency on the planet, the number of bitcoins in circulation grows at a predestined, and very slow, rate. Issuance will stop altogether in 2140.

· Individuals can buy bitcoins by opening up online accounts and transferring dollars/euros/yen/other currency into their “wallet” and buying them. Reverse the procedure – sell the bitcoins – and you can get local currency back. Full disclosure here: I own 0.1 bitcoins, given to me in a demonstration session 2 weeks ago. It is worth $7. If it is ever worth $10 I will contribute it to my local animal shelter.

· Once a transaction enters the bitcoin realm, it becomes essentially untraceable back to the owner. Remember those old movies where Grace Kelly shows up at a bank in Geneva or Zurich with a number scratched on a piece of paper and walks out with a briefcase full of money? It’s sort of like that. Drop $1 million into a bitcoin account, write down the (highly complex) identification code, and go anywhere you like. That money belongs to whoever has that number.

Those are the basics, but let me summarize with some stark language: bitcoin is a very new, very complex online currency, managed by a decentralized group of computer experts and beholden to (and regulated by) no one.

It is also the undisputed winner in terms of unexpected consequences of the recent financial woes in Cyprus. A few facts to back up that claim:

[Related: "The End of the Eurozone? Cyprus: The New Trojan Horse"]

· Two weeks ago BTC (the three letter code for bitcoin, like EUR or JPY) traded for $40 for the first time. As I write this note on Thursday afternoon at 6:00pm, it is trading $72-73.

· The total amount of BTC outstanding is now $813 million. If bitcoin were a country, its outstanding currency would rival a dozen World Bank-recognized nations in terms of their annual GDP.

· All this has happened even as bitcoin suffered a software glitch on March 12, 2013. Essentially there were two slightly different versions of the software running at the same time, causing a “Fork” in the continuity of the system. Past glitches/hacks have cost bitcoin dearly, but this one had no long lasting effect. Quite the contrary, in fact.

Since bitcoin is so decentralized, it is hard to pin down what has driven the online currency into the stratosphere. Still, because it lives entirely on the Internet, those interested in the currency leave their own virtual “trails.” So a few clues on who/what is generating the incremental interest in BTC:

· Using Google Trends, we can see how many users are searching for the term “bitcoin” around the world. What it shows is that the actual peak for “bitcoin” searches was in July 2011, during a spate of hacks. Searches for the term are solidly on the rise now, but still not close to that old high.

· Searches for “Bitcoin” in Spain are ramping up quickly, and about 25% away from the July 2011 highs. Interest over the last 15 months has increased fourfold.

· In Greece, Google searches for the term “Bitcoin” are back to the old July 2011 highs and 5x the level of 15 months ago.

· In terms of national interest, Russia leads the pack in terms of Google searches for ‘Bitcoin.’ Finland and Belarus place and show, with the U.S, just out of the medals. In terms of cities where the search is inordinately common, it is Moscow in first, then Berlin and Melbourne. New York comes in at #4.

· You can use sites like to examine the volume for various currency “crosses” with bitcoin. For example, something called Mt. Gox is the leading U.S. dollar/bitcoin exchange market and a reasonable proxy for the interest of U.S. dollar holders in bitcoin. Volume the last three days have been stable – about $6 million/day. There was a large set of sell orders on March 12 for $8 million, and most other days in March have averaged $1-2 million per day.

· Move over to one of the most liquid Russian ruble/bitcoin exchanges, and the data shows more explosive levels of growth. From February 21 – March 18, the average daily transactions were 500K – 1 million rubles/day. The last two days have run 3.0-3.5 million rubles/day.

· Look at euro-focused exchanges and the data looks similar – low but persistent levels of interest until March 18, and then a doubling or tripling of transactions.

The bottom line here is that incremental demand for bitcoin is coming from the geographic areas most affected by the Cypriot financial crisis – individuals in countries like Greece or Spain, worried that they will be next to feel the threat of deposit taxes. And Russians, since a good chunk of their money is tied up in the banks on Cyprus. And holders of euros generally. U.S. demand has played a role, to be sure, but price is always and everywhere set at the margin. At the epicenter of that margin is in Nicosia.

I love a technology-based success story as much as the next fellow, but the rampant success of bitcoin is a profoundly cautionary tale for global monetary systems. And we seem to be more in the introduction rather than the epilogue of the story. Here is an online currency, less than 5 years old, where the people buying the product wouldn’t likely understand 5% of what the people running the system might say about it. And yet this dynamic has created a base of capital – real, spendable, useable capital – of close to $1 billion in value. And most of that in the last three months.

I know what you are thinking – bubbles form all the time. Bitcoins are the tulip bulbs of the Web 2.0 world. And that may well be. It might work, it might not.

But what is indisputable is the following: If central banks and regulators actually ran their monetary policies to maintain public confidence in the value of their currency, bitcoin wouldn’t have a chance. Deposit taxes such as the ones being proposed for Cyprus make no sense in that context. It may not seem fair, but the deposits of oligarchs, drug dealers and tax cheats need to have the same protection as widows and orphans. The people themselves, no. But if you can’t convict them for their crimes, attacking everyone’s deposits in retribution is bad policy.

By this measure, bitcoin’s future seems to be bitter-sweetly assured. Policymakers are human; they make mistakes. Bitcoin is, ultimately, a machine; it doesn’t.

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2 Comments to "Bitcoin: Spirits in the Material World":
  • Comment_sungard

    25 March 2013

    Thanks for this useful overview & update, Nicholas. A question for you or other readers - while Bitcoin's price is shooting up, why do you think gold's is languishing below $1600/oz? (It has fallen today, despite the news from Cyprus.)

    It looks like Bitcoin is usurping gold's traditional role as refuge for those who mistrust fiat currencies, despite being itself about as solid as a  - well, as solid as an anonymously sponsored virtual network. Strange days indeed...

  • Missing

    25 March 2013

    Some things are destined to succeed if you believe in a slow progression to armageddon this makes since people will be fooled by the masses.   Their is a pervasive understanding worldwide that digital money is where currencies are evolving .

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