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Bitcoin is one of the world's most popular digital currencies, meaning that it is exclusively created and held electronically. But, what do we actually know about digital currencies and the potential of these currencies to replace conventional money?

Like conventional money, the major function of a digital currency is to serve as a means of payment, whether that is in exchange for goods or real currency, such as dollars and euros. In addition, similar to how a normal currency's exchange rate is set, the price for bitcoins - per the CoinDesk Bitcoin Price Index (XBP) - is based on market dynamics and expressed as the midpoint of the bid/ask spread. Bitcoin’s current value against the US dollar is of $453. The highest price for bitcoin since it was launched in 2009 was $1,147 in December 2013. After that spike, the price trended down to a 3-year low of $177 in January 2015. Bitcoin's price is gradually rebounding, buoyed by increased demand for the digital currency in China caused by the weakening yuan: digital currency, like gold, is a refuge for investors in the periods of uncertainty.

While the flow of a traditional currency is tracked by banks and controlled by governments, the circulation of digital currencies is decentralized, a key factor that drives expectations for the spread of bitcoin to new markets and transaction types. Even though traditional currencies now exist primarily on digital ledgers of banks like bitcoins, the ledger for bitcoins has no separate owner or regulator. Instead, bitcoin is maintained and updated by bitcoin users on the basis of the bitcoin protocol. Since the bitcoin network is not controlled by a single institution, it has several advantages over government-controlled currencies. These advantages include:

  • Limited circulation. The amount of bitcoins in circulation is limited by bitcoin protocol to 21 million bitcoins. In contrast, central banks have the authority to issue additional currency, which, if not accompanied by GDP growth, may lead to a surge in inflation and related economic problems. As of May 27, 2016, there are 15.6 million bitcoins in circulation with total value of $7.4 billion.
  • Low-cost, open access. Due to the absence of traditional currency regulations, a bitcoin address - analogous to a traditional private bank account - can be set up in seconds, is free of charge, and cannot be disabled by a third party.
  • Quick, simple account management. Many banks and financial companies have announced new investments in virtual currency technology based on expectations that bitcoin transaction management and digital records will reduce administrative burdens and allow for more rapid transaction processing than existing systems. The simplicity of bitcoin has also proven attractive to the Swiss city of Zag, which plans to initiate a 6-month pilot program in July under which local citizens may pay for public services in bitcoin. 

The anonymous nature of bitcoin, a byproduct of its decentralization, makes it a perfect tool for illegal activity. Examples include:

  • Illegal drug trade. One of the most well-known examples of the use of bitcoins in the illegal drug trade stems from bitcoin-based transactions on the online drug bazaar Silk Road, which was launched in February 2011 and shut down by the US Federal Government in October 2013. 
  • Terrorism. Cyber terrorists may similarly use bitcoins as the currency of choice to receive ransom payments. According to a Cyber Threat Alliance report, ransom payments made via the bitcoin network to hackers through the CryptoWall virus are estimated at $325 million total. 

The taint of bitcoin and other virtual currencies by criminals' use of the currencies in illicit transactions coupled with the anonymity inherent to virtual currency fuels skepticism that virtual currency will achieve the level of acceptance of traditional currency much less replace it. Without meeting the essential prerequisite of trust in a currency, the widespread expansion remains doubtful. 

 

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