Delving into the cryptocurrency phenomenon

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Anyone who’s ever tried to send money electronically knows that it can be a huge hassle. Wire transfer fees are outrageous; currency brokers like Western Union might charge as much as 20 per cent of the total value of the transaction. PayPal horror stories abound on the Internet—reversed charges, poor customer service, and frozen accounts. Buying things over the Internet is better with credit cards, but that’s no help if you want to send some money to a friend. Our currency and our money transfer systems weren’t designed for peer-to-peer electronic distribution, at least not in the same way that cash can be transferred physically.

The rise of cryptocurrencies may have the potential to change all that.

You’ve probably heard of Bitcoin, the mother of all cryptocurrencies. Bitcoin’s foundation is the idea that if most of the people using it keep track of where most of the currency units are at any time, anyone can transfer money easily by simply sending an updated location for the amount of money. It works something like this. Say that I have 100 Bitcoins in a “wallet” on my computer. That wallet doesn’t use my real name (and I can create as many as I like); it’s simply a vehicle for storing Bitcoins. If I decide to send 10 Bitcoins to a friend, I can create a transaction (A sends 10 Bitcoins to B), sign the transaction with my private wallet key, and distribute it to the network. When a sufficient number of people in the network have received that transaction and marked in their ledgers that my friend now has those 10 Bitcoins, the transaction is “verified” and he can then go ahead and send those Bitcoins to someone else, by doing the same thing.

The distributed nature of the network cuts banks, credit card companies, and payment processors out of the loop and means that transaction costs are extremely low. Transactions can’t be reversed and aren’t easily identifiable to specific real names. All you need to send some cryptocurrency to someone is a receiving address, and they can generate one in about 30 seconds, for free. In fact, these currency transactions are so convenient that on the popular website Reddit, an entire culture of “tipping” has arisen using the cryptocurrency Dogecoin. People will send perfect strangers on the internet 50 or a hundred Dogecoins just for posting an interesting comment. (As of Feb. 25, a Dogecoin is worth about 0.10 U.S. cents, so the total transaction value is usually very small.)

If you think all this sounds too good to be true, you may be onto something. Entirely aside from potential technical weaknesses that could still lie undiscovered in the actual cryptography, governments are very leery of cryptocurrencies’ potential for money laundering and fraud. On Dec. 24, 2013, the Reserve Bank of India circulated a warning potential cryptocurrency users that they were exposing themselves to “financial, operational, legal, customer protection, and security related risks,” and that the use of such currencies could subject the users to unintentional breaches of anti-money laundering laws. That came about a week after Chinese currency regulators ordered payment processors in China to cease exchanging cryptocurrency for the Yuan. Then on Jan. 27, 2014, U.S. prosecutors in New York arrested Charles Shrem on charges of operating an unlicensed money-transmitting business and conspiracy to launder funds. Shrem, the U.S. Attorney alleges, had been operating BitInstant, a USD/Bitcoin exchange selling Bitcoins for USD, serving users hoping to buy drugs and other illegal goods on the website Silk Road.

Thus far, most regulators (except authorities in Russia) seem leery about actually declaring the use of cryptocurrencies illegal. On the other hand, they seem just as lost as anyone else when it comes to the application of traditional currency laws to this new form of decentralized currency.

From a user’s perspective, it may ultimately come down to volatility and access. According to the website, which estimates the USD value of various cryptocurrencies, Bitcoin has fluctuated in value from as little as about $500 USD per coin to as much as about $900 USD per coin and Dogecoin has gone from 0.03 U.S. cents per Dogecoin to as many as 0.18 cents per Dogecoin in the past month. Without a relatively stable valuation of the currency, especially over the short term, it seems unlikely that cryptocurrencies will become the transaction method of choice for electronic money transfer.

Moreover, using cryptocurrency can be a tricky affair. First, a user has to set up their wallet. The process is simple, but instructions on how to do so are often obscure. Then, the user needs to acquire some currency, either by “mining” it or by purchasing it on an exchange. The former, how Bitcoins enter circulation in the first place, allows a user to obtain some coins from nowhere by using their computer’s processing power. It is essentially free money, but setting it up can be very complicated and may require an investment in specific hardware to be worthwhile. On the other hand, purchasing cryptocurrency for “real” money, using an exchange service, has all the downsides of any other currency exchange, combined with the real or perceived downsides of the Internet’s inherent risks. All of this combines to repel less sophisticated users, limiting the use of cryptocurrencies to the enthusiasts.

Yet, cryptocurrencies aren’t going away, probably because of the lack of meaningful alternatives in the same niche. The Canadian Mint’s MintChip, announced in 2012, appears to have gained no traction whatsoever. Despite the disdain of some economists, like Paul Krugman (who famously called Bitcoin “evil” on his New York Times blog at the end of December 2013), transaction volume on cryptocurrency networks is very strong. As Dogecoin’s proponents say, it seems to be going to the moon.