The Rise of Virtual Currency: A Look at Bitcoin and Ripple
The stunning rise and crash of digital currency Bitcoin last month has created a vast amount of worldwide interest in what could be a disruptive new global monetary system.
The currency, which some see as a
tech stock, is already accepted by many e-commerce sites and
has passed
the first round of approval required to become a Web standard.
Yet its volatility has many skeptical of its viability; the value
of Bitcoin soared to from $13 per Bitcoin at the start of 2013 to
as high as $266 last month. It then plummeted on the same day to
$100, gaining some of its value back a few hours later to reach
$160.
There are many concerns with a currency that isn’t tied to any
government, and isn’t regulated, aside from having to comply
with
U.S. anti-money-laundering laws.
However,
venture capitalists are taking it seriously. In an
angel round of funding that closed on April 11th, 2013 US-based
Ripple (XRP),
another online currency platform, attracted major financial
players, in the form of Andreessen Horowitz, FF Angel IV,
Lightspeed Venture Partners, Vast Ventures, and Bitcoin Opportunity
Fund. OpenCoin is the company developing the Ripple protocol and
the investment will be used to expand it.
How Bitcoin and Ripple work
Ripple’s older rival Bitcoin was created in
2009. Devised by an individual or group of people under the
pseudonym Satoshi Nakamoto, Bitcoin is based on a vastly
complicated computer algorithm. Essentially, it’s a virtual
currency that can be traded online with anyone who accepts it as
payment for goods and services. At the moment, there are more than
1,000 or so sites where you can spend Bitcoins.
The currency is slowly increased by digital “mining,” a process
in which new bitcoins are added to the existing
pool of currency, determined by complex algorithms. Typically, a
government can issue new currency at a rate tied to the amount of
goods being exchanged, to create economic stability. In a Bitcoin
economy, individuals that agree to run the mining algorithm on
their computers are rewarded by receiving new Bitcoins. (For more
on mining, watch this
video and
consider the structure of controlled
currency supply).
Transactions are then administered through a decentralized peer-to-peer network. This means that there is no central bank or authority that controls Bitcoin and, crucially, it cannot be taxed by governments. Trading platforms like Open Transactions, an “easy-to-use, financial crypto, digital cash and transaction library,” can also turn Bitcoin into a completely untraceable payment method, posing a challenge to existing legal systems.
There are currently around 10.05 million Bitcoins in circulation, each divided into 100 million smaller units, determined by the mining process. There can be a maximum of 21 million Bitcoins in the market. To buy Bitcoins, you must transfer real money to Bitcoin exchange companies such Mt. Gox, the Tokyo-based and largest Bitcoin exchange company, and create a “wallet” on your mobile phone or computer to store the money. (You can also watch PandoDaily's video below for a very brief overview):
Meanwhile, Ripple was developed byOpenCoin, a Silicon Valley
startup led by financial technology pioneer Chris Larsen (founder
of E-LOAN and Prosper) and veteran developer Jed McCaleb, who
initially built the Bitcoin exchange Mt. Gox.
Ripple's main difference from Bitcoin is that it's not just a
single online currency; its allows you to send and receive money in
dollars, euros, yen or, even Bitcoin, for the fee of one "ripple."
As of this April, one ripple was wroth a thousandth of a cent. 100 billion will be put
into circulation, but after that, no more will be created; the
currency is essentially a token given for the service of exchanging
money.
Some think that Ripple's diversfication away from a single currency
may hedge the risk of having a centralized trading
market like Mt. Gox, that is prone to attack by hackers. Another
important advantage of Ripple has over Bitcoin is that transactions
take as little as 10 seconds, whereas with Bitcoin they take much
longer because of the intensive computer process that is involved.
For now, Ripple may serve as a good market for Bitcoin, but if its
own currency becomes more expedient, some say, it could also
destroy Bitcoin.
(Watch the clip below or read Kevin Roose’s
article in New York magazine for more details on virtual
money.)
Trust in a software based currency
While the new e-currencies hint at the possibility of a revolution
in the global money system, serious questions persist. For
instance, when a currency exists only on software and computers,
what happens if there is technical problem? After a software glitch
in March, the exchange rate of Bitcoin
dropped 23% in an hour. The value of the virtual money
currently exceeds more than $1.55 billion, but it could crash at
any moment.
Trust, control and market volatility are key issues surrounding
virtual money. Some people have called it a joke, including
Bloomberg’s Paul Ford. Famous economist Paul
Krugman criticized Bitcoin for making a few rich – as with the
conventional system– rather than the entire economy better off. He
also points out that the real value of Bitcoin transactions has
decreased as a result of hoarding.
Bitcoin and Ripple are not the first wave of
alternative currencies. Previously, there was the Brixton Pound
launched in London in 2009, Bavaria’s Chiemgauer begun in 2003, and
the Credito used on a commune in Italy called Damanhur.
What is next?
P2P lending, Bitcoin, or Ripple may not be the
robust solutions of the new economy, and economists are
especially wary. But they also prove that Wall Street supports
alternatives at the very least by clamoring to grab a slice of the
speculative pie.
Whether e-currencies or tech-stocks, virtual currencies show how
technology entrepreneurs can open the minds of more traditional
economic players, who may go on to build stable solutions with the
initial innovation. One thing is for sure, says security researcher
Dan Kaminsky: Governments can’t kill Bitcoin.
It’s here to stay.
As the virtual currency market continues to evolve, markets where
e-commerce is very strong, or a rising sector, as it is in the Arab
world and Turkey, entrepreneurs will have to pay particular
attention to these new money systems in order to understand the
future of money and dare to support alternative financial
systems.
In this region, it will undoubtedly encounter more resistance from
existing structures than it has in the U.S. Yet the beauty of it is
that Bitcoin needs the approval of the web
community, but not of established institutions. A new
revolution is coming, whether or not Bitcoin is just a ripple in a
pond.