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Posted at 03:53 PM ET, 04/03/2013

Why Bitcoin may be bad for you now, but great for innovation


Stacks of U.S. $100 bills are arranged for a photograph in New York, on Feb. 7, 2013. (Scott Eells - BLOOMBERG)

Before you rush out and convert every dollar in your possession into Bitcoins, stop. Seriously, don’t do it.

The virtual, decentralized currency has seen a surge of interest as of late, and reached a billion dollars in total value this week. The rise has been credited by some to Cypriots desperately looking for a way to shelter their money from their country’s banking maelstrom. But cold water has been poured on that theory, with experts finding increased media attention in the wake of Cyprus’s economic woes to be more likely the cause for the meteoric rise in Bitcoin’s value.

The rising value, however it is coming about, is leading people who once dismissed the digital currency as a risky, passing fad to start taking a closer look and even convert some of their cash. That also means regulators are stirring. The Financial Crimes Enforcement Network (FinCEN) released new guidelines on virtual currencies in March with no mention of Bitcoin. But, as Ars Technica’s Timothy Lee writes, the new regulations left no doubt as to where FinCEN was pointing its regulatory finger. (Lee’s post outlining four reasons not to buy Bitcoins also is well worth a read as is this explainer by Wonkblog’s Brad Plumer).

“We’re in the middle of a [Bitcoin] bubble right now,” writes Reuters finance blogger Felix Salmon in an extensive piece exploring Bitcoin’s past and future, “and it’s only a matter of time before the bubble bursts.”

Salmon’s piece also walks through the potential threat of hyperdeflation posed by the currency. The more people adopt Bitcoin, and the higher the value of the currency goes, the less commodities stand to be worth. That in turn, writes Salmon, leads to currency hoarding and a spectacular, Depression-style crash. Salmon concludes that Bitcoin “isn’t the future. But it has helped to light the way ahead.”


(weusecoins.com)
So, have no doubt, Bitcoin is an in­cred­ibly risky place to put your hard-earned cash. Just Wednesday the largest Bitcoin trading market, Mt. Gox, crashed. And the “crypto-currency,” the legality of which is still murky, is accepted by a very limited pool of vendors. That means, if you have Bitcoins, there are very few places to spend them. And, yes, the Bitcoin market is still susceptible to disruption by a smarter-than-the-average-bear hacker and attractive to those looking for a way to launder money.

“I would guard against the gold rush mentality too much,”said CoinBase co-founder and former Goldman Sachs trader Fred Ehrsam, “Don’t put in more than you can reasonably expect to lose.”

Ehrsam spoke with the Post on Tuesday — not long after news broke that the bitcoin exchange rate had soared past $100 to 1 Bitcoin. It was at $108, said Ehrsam, at the time of the call. It has since blown past $120 per Bitcoin. CoinBase is a service that allows users to plug in their bank account, convert their real-world dollars into Bitcoins and monitor their Bitcoin “wallet” as they would an online bank account.

The company handles security by taking the private keys each Bitcoin wallet holder is given offline. They are stored as paper backups and on USB flashdrives. A version of the private keys, said Ehrsam, are also stored in brick-and-mortar banks, locked away in safety deposit boxes. Other Bitcoin wallet platforms require users to store the private key on their computer, meaning that if that machine is destoryed or the key is somehow lost, all of a user’s Bitcoins disappear — gone forever. Ehrsam says the goal at CoinBase is to “[abstract] that problem away from the consumer.”


Stacks of U.S. quarters arranged for a photograph in New York, on Feb. 4, 2013. (Scott Eells - BLOOMBERG)

CoinBase makes its money by charging 1 percent each time a user converts dollars to Bitcoins, and another 1 percent on the vendor side when they convert Bitcoins into dollars. Transactions in Bitcoins, however, are free. As Ehrsam points out, this is markedly cheaper than the fees vendors are charged for credit card transactions, making the currency appealing to small start-ups.

CoinBase only converts U.S. dollars to Bitcoins. Even with that limitation, CoinBase has received such a spike in user activity recently as to significantly slow transaction times.

“We definitely are seeing massive influxes,” said Ehrsam who has been with the company for four months and is its first hire, “It’s been relatively insane.”

So, warts and all, Bitcoin is growing, and Lee has noted that the currency could represent “a new platform for financial innovation.” Ehrsam backed this up when asked why he left an otherwise comfortable job at Goldman Sachs where, as he put it, “the economic incentives certainly are not bad.”

“I wanted to build something — in this case, build something that I think is really going to change the world.” In other words: an opportunity to disruptively innovate. Ehrsam says, in six months, he sees consumers finding at least one vendor they normally interact with accepting Bitcoin, and in another year and six months that number of vendors growing to at least ten. But a lot could happen in the global economy between now and then.

“It’s a very nascent asset market and one that has extreme potential. And, with that potential, will most likely come volatility,” said Ehrsam, “View it as you would any other investment. A modest percentage allocation.”

Read more news and ideas on Innovations:

A new life for Bitcoin?

Will a ‘Facebook phone’ help women ‘lean in’?

Is the BRAIN initiative the next dot-com boom?

By  |  03:53 PM ET, 04/03/2013

 
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