Communications of the ACM

the Federal Reserve should not act to impede development of digital currencies. The I.R.S. will now tax bitcoins as property.f The German Finance Ministry specifically endorsed Bitcoin as “a unit of account” and allows it to be used for tax and trading purposes. 4 If bitcoins can be converted into dollars and euros, they can be converted into rubles and renminbi regardless of whether Russia’s or China’s central banks approve.

The question is not whether Bitcoin has value; it already does. The question is whether the efficiencies of a cyber-currency like Bitcoin can be merged with the certainties of an honest central bank. I believe they can and will. At some point, a country will step forward and offer its currency as the cyber-cur-rency of choice. Will bitdollars, biteuros, bityen, or bitminbi become the new global reserve currency? The first country to fully embrace what Bitcoin offers will do its own economy and the world a favor.

f Press release March 25, 2014. http://www.irs.gov/ uac/Newsroom/IRS-Virtual-Currency-Guidance.

References

1. Andreesen, M. Why Bitcoin matters. The New York Times Dealbook (Jan. 21, 2014); http://nyti.ms/1fU5Flh.

2. Benbya, H. and Van Alstyne, M. How to find answers within your company. MI T Sloan Management Review 52, 2 (2010), 65–75. http://ssrn.com/ abstract=1652432

3. Bogle, A. Is accepting bitcoins just a publicity stunt for companies? Slate (Feb. 5, 2014); http://slate. me/1fU5G90.

4. Clinch, M. Bitcoin recognized by Germany as ‘private money’. (Aug. 19, 2013); http://cnb.cx/1nN3KzR.

5. Greeley, B. The dollar will never fall to bitcoin. (Jan.

31, 2014); http://bit.ly/1c TGLMH.

6. Greenberg, A. FBI says it’s seized 28.5M in bitcoins from Ross Ulbricht, alleged owner of silk road. (Oct.

25, 2013); http://onforb.es/1oMRzll.

7. Hackers stole $45 million in ATM card breach. USA Today (May 10, 2013); http://usat.ly/1fU5RB3.

8. Jackson, E. and Grey, C. Bitcoin is the new Paypal.

TechCrunch (Feb. 20, 2014); http://tcrn.ch/1fqELe T.

9. Knight, W. Leading economist predicts bitcoin backlash. MI T Technology Review (Oct. 14, 2013); http://bit.ly/1gq8eXj.

10. Krugman, P. Bitcoin is evil. The New York Times; (Dec.

28, 2013); http://nyti.ms/1cRt6LK.

11. McMillan, R. Bitcoin exchange Mt. Gox goes offline amid allegations of $350 million hack. Wired (Feb. 24,

2014); http://wrd.cm/1esBegz.

12. Shen, D., Van Alstyne, M., Lippman, A., and Benbya, H. Barter: Mechanism design for a market incented wisdom exchange. In Proceedings of the ACM 2012

Conference on Computer Supported Cooperative Work

(February 2012), 275–284; http://dl.acm.org/citation. cfm?id=2145250

13. Simonite, T. What bitcoin is and why it matters.

MIT Technology Review (May 25, 2011); http://bit. ly/1gq8eXj.

Marshall Van Alstyne ( mva@bu.edu) is an associate professor in the department of management information systems at Boston University and a research scientist at the MIT Center for Digital Business; Twitter: InfoEcon.

Copyright held by Author.

Weimar Germany showed, politicians can manipulate their currencies during a crisis. Citizens of Zimbabwe and Ecuador use U.S. dollars as their national currencies precisely to reign in such irresponsible behavior.

The decentralized nature of Bitcoin also means that no central bank can intervene to manipulate or stabilize its value when large demand fluctuations occur. Examiners for the U.S. central bank, the Federal Reserve, object to Bitcoin because this makes it volatile and a risky store of value. Bitcoins traded for approximately $1 in April 2011 but above $1,000 in November 2013. In February 2014, they dipped below $550.d If Bitcoin had a central bank, it could have stepped in to buy or sell bitcoins as needed. An honest central broker can calm a panicked market. The failure of central banks to step in led to the great depression of 1929. The success of central banks stepping in avoided a greater recession than that of 2008.

Volatility alone is not a reason a commodity cannot function as currency, only a reason why risk averters avoid it. People use put and call options as a medium of exchange, a store of value, and a unit of account all the time. The real question is whether markets can hedge against volatility. Fluctuations also fall as a technology gains wider acceptance. The larger the user base, the less any single user can affect prices. Overstock.com limits bitcoin risk by trading in and out of bitcoins immediately.

Critics have raised two other objections. The first is that Bitcoin promotes illegal activity. Every transaction is public, but the buyers and sellers listed are simply Bitcoin addresses. The FBI recently shut down Silk Road, a popular market that accepted bitcoin, for facilitating illegal drug sales and other illicit transactions. 6 But this is guilt by association. Note that the other preferred currency of criminals is cash. Over time, law enforcement will use the public record of bitcoin transactions to track down crooks in ways they never could for dollar bills.

Critics also point to theft as a risk
for Bitcoin, highlighting Mt. Gox, a
bitcoin exchange, robbed of $350 mil-
d See bitcoincharts.com or coinbase.com/charts.
lion. 11 This problem is not new. Jesse
James has just gone digital. Wikipe-
dia lists a history of bank robberies by
country. The biggest is nearly $1 bil-
lion. In just 10 hours last year, cyber
criminals stole $45 million in real cur-
rency from real banks. 7 As a startup,
PayPal experienced fraud rates more
than five times that of established
credit cards before developing robust
systems of control. 8 The real surprise
from the Mt. Gox robbery is that any-
one thought “Magic: The Gathering
Online eXchange”—a place launched
to trade game cards—was the best
place to store large sums of money.e
As I see it, Bitcoin faces only one
serious threat: concerted opposition
by the world’s central banks. On De-
cember 5, 2013, China’s central bank
banned trading in bitcoins or convert-
ing it to renminbi. The ban greatly re-
duced demand, cutting bitcoin prices
25% just that week. Prices recovered
a bit, but then Russia’s Central Bank
banned it on February 7, 2014, drop-
ping the price 10%. If no one could
move bitcoins into any other currency,
then the only economy bitcoins could
support would be an internally limited
bitcoin exchange. Such a market could
exist, but it would be tiny.

A ban by all major central banks, however, seems highly unlikely. Recent U.S. Senate hearings concluded that e My thanks to David de la Fuente for this observation.