Legitimacy is earned by widespread use, but also comes from the support of traditional institutions, such as banks, Furlonger says.
Bitcoin has been most widely used by tech-savvy hobbyists, in part because the process of “mining” them, or acquiring them as they are created, requires fast and powerful computers. People without supercomputers or advanced programming skills can acquire Bitcoins and participate in the Bitcoin economy through one of dozens of exchanges that have cropped up to let people swap traditional currency for the digital coins.
The exchange rate for Bitcoin has been volatile. Bitcoins were first traded for fractions of pennies each. Last year, the price per Bitcoin reached $30, though today it trades for about $7. Over the past summer, the price dropped to 30 cents after a hacking incident at a prominent Bitcoin exchange.
As Bitcoin acceptance grows, it could run afoul of federal laws prohibiting the creation of currency that competes with the U.S. dollar. Bitcoin users may also run into trouble with the Internal Revenue Service.
“As long as Bitcoin is a couple thousand mathematicians playing with each other no one cares, but when real transactions start to go on, that raises the question of how we tax this,” says Bruce Abramson, the intellectual-property advisory partner for Rimon Law Group Inc. of San Francisco.
Since one of Bitcoin’s chief selling points is its purported anonymity, there is also concern that it could be used for illicit purposes.
“The anonymous transfer of significant wealth is obviously a money-laundering risk, and at some level we are aware of Bitcoin and other similar operations, and we are studying the mechanism behind Bitcoin,” says Steve Hudak, a spokesman for the Financial Crimes Enforcement Network.
Andreson and others say such concerns are overblown. While the most tech-savvy users can make their transactions anonymous, that won’t be the case for the majority of Bitcoin users.
For one thing, Internet Protocol addresses are traceable, and anyone participating in the Bitcoin economy must get online to participate, says Brian Riley, senior research director and analyst with TowerGroup in Needham, Mass.
Each Bitcoin transaction also has a unique numerical sequence that allows activity to be tracked every time a Bitcoin is transferred or spent, Andreson says.
“The best way to think about Bitcoin anonymity is to imagine a world where the serial number of every bit of paper currency was tracked,” Andreson wrote in an email. “Banks would broadcast to the world, ‘Somebody just got five $20 bills, with these serial numbers.’ “
There are currently about 8 million Bitcoins in existence today, worth more than $50 million. About 200,000 of them, worth more than $1 million, change hands each day, Andreson says.
While the hard limit on the eventual number of Bitcoins embedded in the code makes the currency an appealing concept for libertarian economists and others wary of government money-printing, others see this as a serious drawback.
Bitcoin is premised on “a very narrow, monetarist sort of view about the role of currency and it looks more like a gold standard with limited supply,” says Steve Ledford, partner at the consulting firm Novantas LLC.
An important role for the banks is also to create money, Ledford says. When a bank in a fractional reserve system takes a deposit of a single dollar, it can also loan out that dollar — in effect creating two dollars. Bitcoins by design cannot be duplicated.
“The idea that Bitcoin is seen as a hard currency that can’t be expanded limits the role of credit, which is one of the essential roles of banking,” Ledford says. “An expansive notion of the Bitcoin defeats the whole purpose.”
Matonis, who oversaw foreign exchange and credit card interchange for Visa in the early 1990s, argues that Bitcoin is not so restrictive. “All banks have the ability to perform lending functions, even with [the] 100% deposit ratios of Bitcoin,” he wrote in an email. Depositors could place one-year or two-year certificates of deposit at a 2% interest rate, and banks could lend those Bitcoins out at 4%, assuming the risk of repayment on behalf of the borrower, he suggested. The number of Bitcoins in circulation would not increase, but banks would still be performing an age-old role: facilitating the provision of credit by acting as intermediaries.
A number of start-ups already offer services in the fledgling Bitcoin economy. They range from the more than a dozen exchanges that allow consumers to turn standard currency into Bitcoins and back for a fee to companies like BitInstant, which provides float services to such exchanges, and BitPay, which helps online merchants integrate Bitcoin into their checkout systems.
Two of the biggest and best-known exchanges are Tradehill and Mt.Gox, which is a unit of Tibanne Co.
Both rely on alternative payment providers such as Dwolla Corp. of Des Moines, or competing person-to-person payment facilities such as Liberty Reserve and Paxum.
Since banks and credit card companies won’t let consumers link a bank or credit card account to Bitcoin exchanges, these companies provide the key service of letting users transfer cash from their accounts to the exchanges.
A potential customer service issue is another quality Bitcoin shares with cash – once they’re spent, they’re gone. Users cannot initiate chargebacks as they can when spending from a credit card. Disputes thus become an issue for the exchanges and providers like Dwolla to handle.
For some weeks last summer, Dwolla disabled its funding of Tradehill because of chargeback requests it could not fulfill, according to Tradehill’s blog.
“Bitcoin traders are like merchants receiving payment for something they are selling. Any time you have a group of people in one marketplace, fraud will be attempted,” says Ben Milne, founder and chief executive of Dwolla. Dwolla did not have significant chargeback problems with the exchanges, he says.
BitInstant, of New York, hopes to speed the exchange process, which can take days, leaving customers hanging. For a fee, it provides a float to customers who want to transfer dollars to Bitcoins. BitInstant also plans to address the chargeback issue; for a fee, it would cover losses.
“Most people in power at banks either say, ‘We don’t see the value or the potential of Bitcoin yet,’ or they do but it is negative and they don’t want anything to do with it,” says Charlie Shrem, CEO of BitInstant.
As the concepts of currency and payments become more fluid and global, banks are likely to start allowing customers to manage alternative currencies through their bank accounts, experts say.
Some banks, such as Fidor Bank AG, of Munich, are already experimenting with bank accounts that will let customers store multiple currencies, even including gold and platinum. Fidor does not accept Bitcoin.
“You have what looks like a bank account, but it recognizes that customers have multiple value currencies, including real currency, loyalty points … alternative currencies and Facebook credits, all of which customers want to manage and trade,” says Zil Bareisis, senior analyst for research firm Celent.
Andreson, the software developer, says he expects Bitcoin will survive, and he says he hopes that banks will become partners.
“This is an opportunity for any bank willing to work through the issues,” Andreson says.