This has been a big year for Bitcoin. At the start of the year, interest in the virtual currency was largely limited to technology buffs. Then the price rose more than 10-fold, prompting regulators, investors and the general public to take a closer look.
To help policymakers get up to speed, the Mercatus Center, a libertarian think tank, has published a new primer on the technical, economic and legal issues raised by the currency. Here are five of the most interesting observations that the authors, Jerry Brito and Andrea Castillo, make about Bitcoin:
Bitcoin isn't exactly anonymous
It's common to describe Bitcoin as anonymous currency, but Brito and Castillo argue that this is a misunderstanding of how Bitcoin works. True, you don't have to provide identifying information to participate in the Bitcoin network. But records of every Bitcoin transaction are stored permanently on the network's shared public transaction register.
As a result, the researchers write, "it is very difficult to stay anonymous in the Bitcoin network." Sophisticated analysis of past Bitcoin transactions could reveal patterns that unmask the identity of users. And, they say, "once Bitcoin intermediaries are fully compliant with the bank secrecy regulations required of traditional financial intermediaries, anonymity will be even less guaranteed, because Bitcoin intermediaries will be required to collect personal data on their customers."
Bitcoin regulations are as clear as mud
Bitcoin is sometimes portrayed as a bit of an outlaw currency. But there's a good reason that members of the Bitcoin community sometimes seem to be operating outside the law: Legislators never anticipated the possibility of a fully decentralized payment network like Bitcoin. The legal categories that govern conventional markets simply don't make much sense for Bitcoin, making it difficult for Bitcoin users to figure out how the law applies to them.
For example, the anti-money-laundering agency FinCEN has issued guidelines for Bitcoin "users," which it defines as those who acquire Bitcoins to purchase goods and services. But what if you acquire Bitcoins for some other purpose, like investment or to transfer cash overseas? None of FinCEN's categories seems to fit these individuals. Similarly, Bitcoin miners, the people who process Bitcoin transactions and are rewarded with new bitcoins, do not fit into any of FinCEN's regulatory categories. Without clear legal guidance, the Bitcoin community has been forced to wing it.
Bitcoin is big in Argentina
Argentina is currently suffering from double-digit inflation and strict capital controls. That has caused Argentine citizens to look for alternative ways to protect the purchasing power of their cash. And a growing number of them are turning to Bitcoin as a way to move their wealth without restrictions from the Argentine government. One Bitcoin exchange is even planning to open an Argentine office to capitalize on growing interest in the currency there.
Volatility isn't necessarily a big deal for Bitcoin
Bitcoin has been known to lose as much as 80 percent of its value in a matter of days. A number of commentators have argued that this volatility makes it a poor currency. But Brito and Castillo argue that this conventional wisdom is wrong.
It's true that if a country adopted Bitcoin as its official currency, that could produce economic turmoil as the fluctuating value produced inflation and recessions. But the authors say that for individuals using the currency to make short-term financial transactions, volatility isn't a big deal. "Merchants can price their wares in terms of a traditional currency and accept the equivalent number of bitcoins," the authors write. "Customers who purchase bitcoins to make a one-time purchase don’t care about what the exchange rate will look like tomorrow; they simply care that Bitcoin can lower transaction costs in the present."
International Bitcoin transfers could be a big business
Immigrants send more than $400 billion to families at home each year. "In the first quarter of 2013, the global average fee for sending remittances was 9.05 percent," the researchers note. In contrast, the transaction fees on the Bitcoin network are negligible, raising the possibility that Bitcoin could disrupt incumbent money-transfer services like Western Union.
But a significant amount of work will need to be done before that vision can become a reality. Right now, converting between conventional currencies and Bitcoins is still a slow process, and exchanges charge around 1 percent for each transaction. And users dealing in Bitcoins abroad face additional risks, including security breaches and fluctuations in the Bitcoin exchange rate. The Bitcoin economy will have to overcome those challenges before Bitcoins can become a serious competitor to conventional money-transfer services.