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Bitcoin believers: Why digital currency backers are keeping the faith

Vitalik Buterin is the brains behind what some say is the next generation of bitcoin, called Ethereum.

MATTHEW SHERWOOD/The Globe and Mail

On Wednesday nights, a disproportionately male, thirtysomething crowd jams into a spartan room in a small downtown Toronto building to plot the future of money.

The weekly "meet-up" is for people interested in bitcoin, the controversial Internet currency that supporters believe can displace much of the current financial system. Entrepreneurs, early adopters and the merely curious gather at Bitcoin Decentral, a Spadina Avenue building rented by Anthony Di Iorio, executive director of the Bitcoin Alliance of Canada. Similar centres have popped up in other cities in Canada and around the world.

"It's like a cult," consultant William Mougayar says over the din at the meet-up. "You say you are coming from this other [bitcoin centre], and they welcome you and give you a tour."

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Those who attend the meet-ups say that right now is a special moment for digital currencies – a moment akin to the early days of the personal computer or Internet, when an interesting bit of technology finally achieves the power to burst beyond a small group of enthusiasts and create new companies and new fortunes. Many of the regulars at the meeting are bitcoin evangelists, who are working flat out on new businesses, ranging from bitcoin exchanges to a new generation of digital currency technology, a kind of bitcoin 2.0.

But as bitcoin pushes for mainstream recognition, it is facing, for the first time, mainstream scrutiny – and many people don't like what they see. The world's largest bitcoin exchange, Mt Gox, collapsed in February after an attack by hackers, resulting in an estimated loss of about $500-million (U.S.).

Tax authorities, regulators and banks have begun to take a harder look at the digital currency, probing its potential for tax evasion and money laundering.

The bitcoin community has largely dismissed the recent problems as growing pains, but not everyone is convinced. The digital currency has thrived on its ability to provide anonymous, free transfers of wealth, outside of any government intervention. If authorities force regulation on the currency, bitcoin's appeal may fade.

It could also founder on simpler issues. One big problem: the wildly fluctuating value of the currency. Trading for $5 or less just a couple of years ago, it soared to $1,200 a few months ago, before plunging to around $444 today. The abrupt shifts in value make it difficult to use bitcoins as a dependable store of value.

Bitcoin boosters are confident they can provide answers to these problems, but it's clear that the currency is facing harsh tests as it moves from backrooms crowded with enthusiasts to the wider world.

Unless it can meet the challenges, bitcoin's special moment may also prove to be the beginning of its decline.

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'The year of regulations'

No matter what its potential as a day-to-day currency, bitcoin is an impressive feat of engineering. Reportedly invented by an unknown programmer that calls himself Satoshi Nakamoto, it allows transactions to be verified, but without revealing the identities of the people doing the deal.

Bitcoins exist only in computer code. Transactions in the currency are authenticated by a network of computers that can do extremely difficult math problems. Once verified, the transactions are entered into bitcoin's "blockchain," a kind of ledger – but at no point do the people involved have to identify themselves by name.

Those with computers on the network are known as "miners," and their specialized computers are "mining equipment." As payment for handing over computing power to maintain the network, miners are rewarded with new bitcoins.

Proponents say bitcoins allow for instant transactions anywhere in the world, with either nothing, or very little, in the way of fees. They believe that bitcoins could eventually provide a far less expensive alternative to credit cards as well as many conventional banking functions.

In the wake of the Mt Gox debacle, however, governments are busily considering new rules on virtual currencies. That could mean added costs, potentially eroding one of bitcoin's key edges. Government-imposed rules might also alienate bitcoin's more libertarian supporters, who hail the currency as way to exchange money anywhere in the world without the state, the banks or big corporations getting in the way.

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Bitcoin enthusiasts shrug off the danger. Some see more government involvement as a necessary next step in the rise of bitcoin – a way to legitimize the currency. "The way it is going to happen is this year will be the year of regulations. It's already starting to happen," said Sunny Ray, the Toronto-based business development director of Buttercoin, a startup bitcoin exchange in Palo Alto, Calif., that is launching shortly and is backed by Google Ventures, the search engine's venture capital arm, and Reddit co-founder Alexis Ohanian.

Mr. Ray, who spoke to the Toronto meet-up, says his new exchange, which will launch in Canada and the U.S. in the next few months, will be faster and safer than existing exchanges such as Mt. Gox. He believes that it can offer customers a far better deal on remittances – small payments, usually sent from workers in developed countries to relatives in developing ones – than current operators such as Western Union. His exchange will charge below 1 per cent in transaction fees, he said, far lower than the 10 per cent it can cost now to wire cash.

It's unclear, however, whether every country will allow bitcoin transactions. In China, the country's central bank recently ordered commercial banks and payment companies to shutter their bitcoin trading accounts, trying to clamp down on the use of bitcoin as a way to get around China's strict currency controls.

Tax authorities in Canada and the U.S. have recently said bitcoins are not money, but taxpayers who make money selling them need to report those gains for tax purposes. In the February federal budget, Ottawa warned it would bring in unspecified rules to curb the use of bitcoin and other virtual currencies by money launderers and terrorists.

For their part, Canadian banks are watching bitcoin closely, as it, or something like it, could one day be a major competitor for their payment processing services.

Bill Downe, chief executive officer of Bank of Montreal, said recently in an interview with the Financial Post that if bitcoin was properly regulated, he could see the bank dealing in it, just as it deals with foreign currencies.

But Gordon Nixon, CEO of Royal Bank of Canada, was more dismissive at his bank's general meeting in February: "I have a very difficult time understanding the sustainability of a currency that doesn't have a government or central bank behind it."

Some economists are also skeptical of bitcoin's future. Jean-Paul Lam, a University of Waterloo professor and former economist at the Bank of Canada, says he believes bitcoin is a bubble.

He warns that it suffers from inherent limitations. As part of bitcoin's basic design, the total potential number of bitcoins is fixed, and will max out at 21 million, a trait its boosters say makes it inflation-proof, unlike the traditional "fiat currency" that can be printed by central banks.

But if, as many speculators and investors hope, bitcoins continue to increase in value, this would actually make them unattractive as a medium of exchange, Prof. Lam says. Consumers will want to hang on to them instead of use them.

Bitcoin's extreme swings in value over recent months demonstrate the practical challenge. "If I have bitcoins right now, and you ask me to buy my coffee in bitcoins, I will think twice," Prof. Lam said. "I will look at the value right now and if I wait five more seconds, you don't know if the thing is going to fluctuate. ... If I am paying in dollars, I know their value won't fluctuate so much."

The next phase for bitcoin

Bitcoin's challenges haven't dampened the high spirits of the people who attend the Toronto meet-up.

At the gathering, Ryan Scott shares his vision with the crowd for his startup, which he calls Knights of the Satoshi. (Bitcoins are each divided into 100 million Satoshis, in honour of the currency's purported founder.)

The self-taught Mr. Scott, who worked as a sales supervisor at Future Shop until last year, says his business will allow customers to contract out the mining of bitcoins to him. This will spare them the need to purchase expensive computers and pay for electricity and air conditioning to keep servers from overheating. He is currently looking for data centres to store his computers. "It was a passion or a hobby that turned into something more," he said of his interest in bitcoin. "I never expected bitcoin to go where it is, the huge upward potential."

Some in the bitcoin world are already talking about what they see as the next level of innovation, that goes beyond bitcoin but builds on the technology.

Vitalik Buterin, a 20-year old Torontonian who dropped out of the computer science program at the University of Waterloo, is the brains behind what some say is the next generation of bitcoin, called Ethereum – but to outsiders, the concept may seem more than a bit vague.

He describes it as a platform that will allow software developers and bitcoin users to make contracts with each other, allowing them to hedge bitcoins, or create their own virtual currencies, or even buy virtual shares in virtual companies. Bitcoins must first be exchanged into Ethereum's own virtual currency, called ethers, which will initially be sold to finance the venture.

At the meet-up, Michael Perklin, who recently quit his job as a digital forensic investigator with a telecom company to start a bitcoin security business, shows the crowd a brief video promoting next week's Bitcoin Expo in Toronto, apologizing for using tiny speakers for the audio.

While he admits that securing bitcoins against hackers is a "cat and mouse game," he is confident that bitcoin is here to stay: "You cannot put this technology back in the box. ... You can't unmake bitcoin technology. So it is not something that can just disappear tomorrow."

The virtual currency known as Bitcoin took a step away from the margins of the financial system Monday, as the U.S. Senate homeland security and governmental affairs committee set aside a good chunk of the afternoon for testimony on whether the private – and largely anonymous – payment system requires special regulatory scrutiny. It was the first time a congressional committee had conducted hearings on digital currencies. Read the full story.

So what is Bitcoin, how is it "farmed" and how do you buy it? Read the full explanation below.

What is Bitcoin?

Bitcoin is a completely decentralized form of virtual currency that enables direct payment over the internet by skipping the middleman, which is usually a bank or credit card company. Transactions are safe due to cryptography used to prevent double spending, counterfeiting, or theft. Users can use bitcoins for a variety of real transactions.

How does Bitcoin work?

Before a Bitcoin can be purchased, a user must install a virtual 'wallet' onto a personal computer or mobile device. The wallet is similar to personal finance software and keeps track of Bitcoin balance and transactions.

The user then pays for bitcoins, either through a credit card, bank account or anonymously with cash. Bitcoins are transferred directly into a Bitcoin account, and the user can send and receive payments directly to a buyer or seller.

Similar to trading stocks, a buyer can place an order for a Bitcoin through an exchange program once the funds are available. Bitcoins can also be purchased from third parties.

Users pay far fewer associated fees by skipping the middle man in each transaction, and they can also maintain a much higher level of anonymity.

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About the Author
Toronto City Hall Reporter

Jeff Gray is The Globe and Mail’s Toronto City Hall reporter. He has worked at The Globe since 1998. From 2010 to 2016, he was the law reporter in Report on Business, covering Bay Street law firms and white-collar crime. He won an honourable mention at the National Magazine Awards for investigative journalism in 2010. More

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