In December 2017, the stock price of something called Bitcoin exploded to just over $19,000 per coin.
Five years before, one bitcoin went for less than $50 in the open market.
Some people raked in a windfall by getting in on Bitcoin at the right time. And many more hope Bitcoin will be the investment vehicle that drives them to an even greater reward. And if it’s not Bitcoin, then perhaps it will be another cryptocurrency (a generic term for any digital currency that someone can hold and spend with a digital wallet).
What’s the deal with Bitcoin? LSA researcher Lynette Shaw, an assistant professor in the Center for the Study of Complex Systems and a postdoctoral scholar in the Michigan Society of Fellows, breaks it down for us.
What is Bitcoin?
Lynette Shaw: Bitcoin is money without a state. The original founding ideal of Bitcoin was to create an alternative form of money that didn't require either the state, a central bank, or any trusted third-party actors to handle transactions.
Bitcoin was designed as an electronic form of cash that allows electronic transfers without a third party. The technological problem of how to make such a currency work was an actual, outstanding issue for at least 15 years, and Bitcoin solved it. The solution became possible through new technology called the blockchain, which keeps track of Bitcoin transactions so that transactions can’t be faked.
Is Bitcoin actually worth anything?
LS: A lot of people believe the dollar is backed by gold, but that hasn’t been true for a long time. And even if people are wrong about why the dollar has value, its worth does not just go away.
Think of a Louis Vuitton bag. You pay a lot for it not just because you will get some use out of the bag, but because you know that other people will pay a lot for it. It’s a socially constructed value, which is important to how we interpret the world: I will value something highly if other people value it highly. If they don’t value it, I won’t value it.
The social valuation of dollar bills and Louis Vuitton bags rides on the correct and reliable expectation that other people will value them in the same way. So at the end of the day, the worth of Bitcoin depends on the value people ascribe to it.
I’d argue that to succeed as money, cryptocurrency has to become like a U.S. dollar or designer handbag, where people take its worth for granted—the point at which, collectively, we start to automatically treat its perceived value as reality.
How do people use Bitcoin?
LS: People are trying to use Bitcoin and blockchain technology for a huge diversity of applications, including to address gaps in the financial system. For example, many companies and groups are interested in using Bitcoin to make it easier and cheaper for foreign workers to send money back to family in their home country.
People also are trying to use cryptocurrency as a way to incentivize good stuff in society—for instance, by creating access to payment networks for people who can’t use banks or supporting things such as solar energy.
Bitcoin has been used to various extents as a form of payment. For example, people tip each other in small amounts of bitcoin and other cryptocurrencies, usually on internet discussion sites when someone has contributed a useful comment. It becomes a community-project form of exchange, and arguably, Bitcoin even started off that way: The first real-world transaction using Bitcoin was when somebody in the community said, “Hey, we need to be able to exchange Bitcoin for real-world goods. If somebody sends me a couple of pizzas, I’ll send them 10,000 bitcoins.”
Do you think that guy ever kicks himself for spending what’s now worth something like $90 million on pizzas?
LS: No, I think he probably loves it. That was the first real-world economic exchange of Bitcoin for a good. Without that pizza, those bitcoins might not be worth $90 million.
How have stores and other businesses responded to cryptocurrencies so far?
LS: Microsoft, Overstock, Expedia, and Dell—just to name some big vendors—have, at various points, accepted Bitcoin.
How are traditional banks interacting with cryptocurrencies?
LS: Many banks and other financial institutions have been exploring how they might put cryptocurrency and blockchain technology to use—which is kind of bizarre, considering that the founding of Bitcoin was explicitly anti-establishment.
How will the U.S. government regulate cryptocurrencies?
LS: Right now, the government understands that Bitcoin and cryptocurrencies are things that it’s going to have to deal with. In the European Union, Bitcoin counts as a form of money. But here in the United States, it’s not—Bitcoin is a property. When it comes to taxes, for instance, Bitcoin is taxed like property. But now, the Security and Exchange Commission has gotten involved, because some people have begun using Bitcoin and other cryptocurrencies in a way that resembles how securities are used.
The government can make decisions on how to regulate, but the government cannot control how Bitcoin is used in practice. Bitcoin is out there, and it’s open source, distributed, and anonymized, which means that no central authority can control it. But I would say that the government could unmake Bitcoin, if it said, for example, that the currency is not legitimate and the people who buy or use it will be punished.
Are cryptocurrencies a good investment, even if they’re volatile?
LS: A major question I try to answer with my research is: Can socially constructed value be stable? The more people are willing to buy into a currency, the more stable the value is likely to be, and the more valuable it is.
Back in December 2017, the run-up to more than $19,000 in valuation per bitcoin was in great part driven by perception. Bitcoin futures were officially listed on the Chicago Mercantile Exchange and the Board of Options Exchange, and with that came a huge influx of individuals who felt like Bitcoin was going to be the next big thing.
Bitcoin has crashed to less than half of its peak value since that time, but it’s still well above where it was before those decisions to list Bitcoin futures were announced. Whether you made or lost money on Bitcoin is mostly a matter of timing right now. It’s hard—maybe impossible—to predict what will happen in the short term. In the long term, though, the question is whether you think Bitcoin will stick around and become more important.
Cryptocurrency is in a phase where it can still turn out to be lots of things; the ultimate trajectory of cryptocurrency is still being settled. You can think of it like the dot-com bubble: The internet was new, and it was not clear how to evaluate the completely new industry. That ambiguity let a lot of things get off the ground initially, but that same ambiguity led to a lot of failed investments and enabled a bunch of scams. Because it wasn’t clear, investment in online businesses at the time was an innately risky space.
If somebody is really, really trying to convince you that some coin is going to be worth a lot, and you need to get in early, then ring the alarm bells. But whether we can say that one cryptocurrency will be the big success and another will not be—it’s not always clear.
- Lynette Shaw lecture: “What Is a Bitcoin Worth?”
- Learn About Supporting the Center for the Study of Complex Systems