Bitcoin’s Big Problem

There’s been a lot of discussion in the past couple of weeks about Bitcoin, the online virtual currency whose value has been extraordinarily volatile of late. A currency that’s electronic but as untraceable as cash surely has its uses for some people, but there’s one aspect of it that hasn’t been fully considered yet: its uniqueness may not last.

National currencies have one great advantage over currencies like Bitcoin: they usually don’t face much competition. It’s true that countries with weak currencies sometimes use dollars, euros, or even cigarettes as alternative or parallel mediums of exchange. Broadly speaking, however, a national currency is a useful focal point; the government requires that everyone accept it in transactions, and so everyone can agree to use it. That’s what makes it valuable.

Bitcoin is not so well-defined as a currency in comparison to a dollar or yuan, and thus its uniqueness is much less clear. The currency based on a mysterious algorithm whose originator is anonymous. No one really knows whether the algorithm can be trusted to generate Bitcoins as promised, or who would be accountable for errors or frauds; there is no definitive monetary authority.

Were any problems to occur, a new electronic currency, perhaps one vouchsafed in a more transparent way, might arise. If the people who found Bitcoin useful for its anonymity, virtuality, and globality were to switch to this new currency, the value of Bitcoins would tumble. The reason is simple: Bitcoin’s exchange rates with other currencies depend on supply and demand; if no one wants Bitcoins, they’re worthless. And Bitcoin need not run into trouble for a new currency to appear. The new currency’s originators just need to invent an architecture that people prefer.

Of course, people won’t switch away from a popular currency for the sake of small improvements. But Bitcoin is just the first virtual currency to make it big – and you can bet it won’t be the last.