Why governments are keeping an open attitude toward Bitcoin

For centuries, government-issued fiat money has upheld two functions fairly well: being a store of value and serving as a medium of exchange. But developments over the past year suggest that technology might someday do these jobs better. 

Since its launch in 2009, the virtual currency Bitcoin—which is not issued by a central bank but instead maintained on a peer-to-peer computer network much the way that file-sharing service BitTorrent exists on its users’ computers—has seen its circulation rise from less than two million four years ago to 12 million today. The number of daily Bitcoin transactions has surged from fewer than 5,000 to more than 60,000 in the past two years, and other crytocurrencies or related services, such as Ripple, Litecoin, Peercoin, Anoncoin and Zerocoin, have emerged. (Another reason Bitcoin has been a hot topic: its mysterious origins. It was created by a coder or group of coders named Satoshi Nakamoto who, then, mysteriously disappeared in 2011, declaring he, she or they had moved on to other things, which set off a quest to find the creator(s) that reached a fever pitch Thursday when Newsweek claimed to have found the man.)

But digital currencies have attracted not only entrepreneurs, but also thieves. In October, China's GBL exchange vanished, taking $4.1 million in users’ deposits along with it. In January, hackers broke into BIPS, which processes Bitcoin payments for merchants in Europe, and stole $1 million. Recently, a $400 million heist—one of the biggest in history—brought down Mt. Gox, the largest Bitcoin currency exchange, forcing it to file for bankruptcy. And the week after, $600,000 in Bitcoin was stolen from Flexcoin, which also closed its doors.

And yet, all these problems have only prompted people to defend Bitcoin and its kin. After all, Mt. Gox’s problems have not spread to any other virtual currency exchanges, and Bitcoin itself has remained fairly resilient. “I think it’s a significant event, but I think there’s a decent chance that it is part of what we would call this sort of shaking out of the industry as it matures and slowly becomes a little more regulated,” Benjamin M. Lawsky, New York state’s top financial regulator, told The New York Times.

His remarks suggest that governments in developed countries will likely continue to keep an open attitude toward digital currencies, mainly for two reasons. First, as Lawksy noted, shakeouts are inevitable in any emerging industry. "With new technologies, unpredictable things can happen, and not all startup firms are responsible players, either due to inexperience or because they prioritize growth over caution," says Susan Athey, professor of economics at the Stanford Graduate School of Business and an advisor to Ripple. 

But the other reason is that cryptocurrencies solve a huge problem with fiat money: They allow for the transfer of money nearly instantaneously without a middleman. The alternative is much more cumbersome and risky, Athey says. “If I want to pay with a credit card, I have to give you all my credit card info, my address and [security] code, and at that point, I’ve given you all the information you would need to make payments I haven’t authorized,” she notes. If the transaction was handled as an ACH transfer, she would have to get your actual bank account number to wire you money—and it would take three days and cost $10. 

“I generally think that most people in the developed world are happy with their fiat currencies,” says Adam Shapiro, a financial services regulation expert at Promontory Financial Group, which is why he is less bullish on the future of virtual currency as a store of value. Instead, Shapiro says, the focus will be on, “how are you going to interact with fiat currencies so you get the benefit of payments that are nearly free, virtually instant, international and you can choose whether to intermediate it through a financial institution? How do you get all those benefits while most people will want to hold their assets in the native currency?”

Even if Bitcoin continues to experience setbacks, Athey says governments of developed countries likely wouldn't worry about it damaging their own currencies. “In any kind of large established economy, the size of the market in virtual currencies is really small compared to fiat currencies, and there are still benefits to using fiat currencies in a developed country with a stable currency,” she says. Cryptocurrencies could take greater hold in countries that already have financial instability, but there, it would help the middle class and poor better weather their country's economic storms, such as hyperinflation.

So, what’s keeping digital currencies from becoming the main conduit for money transfers? A lack of regulation and government guidance on how to integrate virtual currencies with the financial system, Athey says. “Right now the biggest concern, at least in the U.S., is uncertainty. Financial institutions have the concern that if they take a more major role in the digital currency world, they could run afoul of regulators even if they complied to the best of their knowledge and ability with current regulation.” 

But as for potential government action, Shapiro sees promising signs. This year, Canada will come out with the MintChip, a type of digital cash that can be instantly and securely transferred without intermediaries, and while the European Union has issued warnings about cryptocurrencies, it has not taken any action against them. “By and large, governments in the developed world seem to be and have taken the position that this deserves a chance to develop," Shapiro says. 

So while Athey says current regulatory uncertainty plus fiascoes like Mt. Gox are contributing to volatility, she believes a consensus about the function of digital currency will likely take hold. Then, people will consider it less of a speculative investment and focus more on its utility, and the price will stabilize.

Mt. Gox's collapse highlights the need for domestic regulation of digital currencies, she adds. "If the U.S. ends up being unfriendly to virtual currency businesses, consumers will go to overseas firms that may be risky. Consumers in the U.S. may be better protected if firms are able to operate within the U.S. and are incentivized to maintain best practices."

Photo: Zach Copley/Flickr

Sign up for our weekly newsletter featuring in-depth business innovation stories by correspondents around the globe, top domestic reporters and thought-provoking opinion columnists.

This post was originally published on Smartplanet.com