Bitcoin is a new type of currency. it has the form of a unique cryptographic code (key pair) that can only be derived by running an intrinsically hard algorithm. Like prime numbers there are only so much bitcoins that can be ‘discovered’ by running a discovery calculation (so called bitcoin mining). As a result the amount of bitcoin that can be created has a hard limit, and the amount that is brought into use has a cost, namely the energy and hardware invested in the necessary calculation.
A bitcoin now costs about $43
Like the wooden sticks that where split in England to create unique tokens representing value the bitcoins can be used to exchange value. You can always be sure that a coin truely one of the few around (even though there are millions) and nobody is robbing you by creating them without effort (like what banks do with cheap credit at the moment). Another nice thing about the coins is that they can be transferred as easily as a piece of software. They can be stored on an SD card, thrumbdrive, even a QR code could work. Their transfer is a matter of sending an email.
Bitcoins can be stolen by taking their digital representation
Right now there’s a number of so called ‘Bitcoin exchanges’ where you can buy the coins for other currencies and cash them in. A lot of attention is draw to the bitcoin rate of exchange. If one bought bitcoins for dollars at the beginning of this year one would have doubled ones money! The rise in interest in the coins drives demand and drives the price up. Bitcoins behave like any other commodity at the moment, which is a result of the existence of exchanges. Even real banks see the potential here, because if one can valuate a bitcoin at a value related to the exchange rate one can create new $$ based on the bitcoin asset.
Hype
We are now in a bitcoin hype, with the above symptoms. As a money and token of exchange bitcoins are usefull, but that use as pure means of exchange is what makes it tick at the moment. People that view bitcoin as a super easy and near anonymous way to transfer money around the globe are fooling themselves, they do not use bitcoin at all, in fact, their transactions could be faked without problem without use of bitcoins. This is because if you view bitcoins as "really 43 USD" and buy them to transfer $$ from the US to Hong Kong, you burden the banking system with the task of actually making sure those 43 USD are available in Hong Kong, at an administrative cost. The Bitcoin part could be replaced by any type of transmittable IOU. This easy transfer use will be embraced by banks if they can also start exchanges, because then they both drain bitcoins from circulation and they do business as usual.
The exchange of bitcoins for other currencies is the single use for which it was not intended
The moment bitcoins arrive at an exchange there are two options : 1. The Exchange needs to have sufficient dollar reserves to cash them out to the owner. This works at the moment because they get credit based on the expected value increas of the bitcoin as it is sold to the next user. If this wasn’t the case then the exchanges would have to always pay out more than they take in from the sale of the bitcoins, or there would be a dangerous inbalance. Of course new bitcoins tilt the table in favour of the exchanges, if they create them themselves. 2. The exchanges can create credit, dollars, based on bitcoin assets themselves. This would be an dollar inflationary process based on the total bitcoin money supply and the percieved value increase of the bitcoins. In both cases we are talking a ponzi scheme. If Bitcoin starts to depreciate and people cash out the currency will collapse. This bust is in the interest of the exchanges, that get to keep the $$!
Bitcoin assets are similar to real estate
The analogy with the housing bubble is clear, you have a liquid trade of houses, in which you (as bank) allow appreciation because you enable a process of increasing valuation justifying increasing credit creation (the ‘value’ of houses increased, and therefore the credit extende to buy them grew). You also make sure new houses are build based on the same valuations of expecte market value. That however is not what’s important, what’s important is that you as a bank can create credit now and profit from the cashflow and all the work that goes into running this boom.
Bitcoin cashing while the exchange rate is rising must cost someone real money. This can only be offset by credit or bitcoin mining by the exchanges
Bitcoin is a unique system of persistent tokens of exchange. They are fiat currency by your fiat. Fiat currency has a problem however, because their value is determined by some asset mandatorily traded using it. The fiat in a fiat currency is a law that dictates their use. Of course this would never work if you don’t have an asset you are strangely willing to part with for this make believe currency. For dollars it is oil and taxes and other stuff trade on the bank owned commodities markets. The desire to own dollars is stingently enforced, it is not a matter of trust, rather of force!
The one that makes the most money off bitcoin and has from the start are the energy companies. Mining coins is not green and requires kWhs. Creating 25 coins at $43 takes $47 (4%) dollars of electricity, but yields $1075 (also depends on luck!), so apart from the hardware it is profitable. (source)
For bitcoins this will turn out difficult to expect, so it seems it is destined to be a booming asset for a while, then go bust just like the housing or dot com bubble. Then people will own the coins but the fees for using them long distance will make it lose it’s advantange, and then people will wonder why they should own the coins in the first place. It is very much possible the coins will end up in regions with much manual labour or production based on renewables because it is a very usefull token of exchange, no doubt. So it may f.i. replace the dollar in Africa.