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Cryptocurrencies stormed into the public consciousness in November 2013 when the price of just one bitcoin broke through the $1,200 level.

The activists promoting the new breed of people-issued money claimed it would replace inflationary central-bank currency, enabling consumers to bypass the high commission charges and regulatory restrictions of traditional banks.

“It gives everyone in the world access to finance and the ability to transact with each other,” says Chris Ellis, one of the early supporters who always believed bitcoin’s potential was in democratising finance for millions of unbanked people. “The only barrier to entry is the use of a network-enabled digital device like a smartphone or a computer. “

But one year on, and despite growing popularity with retailers such as Expedia, Overstock and IBM, an FT look into digital currencies as part of the “Democratising Finance” series shows that things have not turned out as the community intended.

Bitcoin prices have collapsed in recent months. For most of January they traded below $250, incurring heavy losses for those who bought in at more frothy levels and challenging the profitability of the businesses involved.

Message boards once filled with enthusiasts now feature critical voices that question the system’s long-term viability and structure.

Bitcoin was the brainchild of the pseudonymous Satoshi Nakamoto presumed today to be the nom de plume of a group of secretive cryptologists.

It was supposed to provide a way to sidestep third parties — banks and other foreign exchange providers — and create an alternative system that could essentially be run by users themselves.

But its anonymity gained it a reputation as the currency of choice for drug dealers and money launderers, while its volatility brought it to the attention of speculators.

Series main instalments
1. Peer-to-peer lending
2. Mobile payments
3. Personal investment
4. Big data
5. Traditional banks
6. Digital currencies

Gradually companies are starting to accept bitcoin but its use is limited to a few global corporations and some local businesses keen to jump on a trend.

There are still concerns over whether mainstream adoption can ever happen in an environment where message-board commenters claim “consumer protection is non-existent” and where price volatility turns even a coffee purchase into an unpredictable expense.

The high-profile scandals of the past year have included the $620m collapse of the Tokyo-based currency exchange Mt Gox, the theft of $5m coins from Bitstamp, one of the key exchanges based in the UK, and several small-scale frauds, hacks and embezzlements that drain funds from users.

The bitcoin system processes about 100,000 transactions a day compared with Visa’s 150m. But only about 1 per cent of the bitcoin total represents actual buying and selling of goods and services, with the rest linked to spam, money laundering and double counting, according to Jeffrey Robinson, money laundering expert and author.

Most of all, the newly disillusioned bitcoin community is confused about how a system that was supposed to be decentralised and owned by no one has ended up being anything but.

Tim Swanson, a consultant to the industry, says bitcoin is too complex to achieve that goal. Rather than eliminating the need for third-party agents, he says it has spawned a whole industry of people needed to process it.

“If you introduce third parties it defies the point . . . All it does is create an extra cost,” he says. “You just end up replicating the old system, but without the features that provide functionality for customer service.”

Bitcoin fees for users are low. But they are in effect subsidised by speculative buyers. If prices fall, Mr Swanson warns that fees will rise, making it less competitive versus traditional payment methods. He estimates that the true cost of each bitcoin transaction is $15-$20.

The smart money, according to one developer of a rival system, was never invested in bitcoin directly but in the supporting infrastructure. These businesses could one day be redeployed to new and improved cryptocurrency systems or even to traditional currencies.

Meanwhile, a growing number of bitcoin intermediaries are moving to work within the established financial market.

Coinbase, the San Francisco-based start-up that lets people store, send and accept payment in bitcoins, has launched its own US dollar wallet service and broke records in January when it raised $75m from investors including the New York Stock Exchange and several banks.

The presence of traditional financial services companies and figures was interpreted as an indicator of growing investor interest in mainstream applications of the digital currency.

But some banks worry the technology could become too expensive, especially if speculative flows are removed or the cost of regulation is factored in.

Richard Brown, executive architect for banking industry innovation at IBM, says: “There are lots of claims made for this technology, many of which don’t stand up to scrutiny.”


Letter in response to this article:

Bitcoin’s price collapse is evidence of speculative excess, not failure / From Jeremy Light

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