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Making Heads or Tails of Bitcoin

NEW YORK (Real Money) --The digital currency revolution is here -- maybe. The seemingly overnight rise of bitcoin has spread across the Internet faster than the Harlem Shake or videos of cats playing the piano. Unlike these fleeting Internet memes, bitcoin may herald a new era in currency exchange, though some may wonder if it is just a scam.

Nobody knows for sure who created bitcoin. It consists of a digital string of numbers and letters earned by bitcoin "miners" in cyberspace on peer-to-peer servers. Its circulation is limited to 21 million units by way of open-source code; if circulation increases beyond 21 million, everyone will know. It isn't regulated and it isn't associated with any country. Some would say that is a problem, while others would argue that that is the point.

So, is bitcoin a scam? Possibly, but there is no unequivocal proof. And even if proof of a scam should emerge, it will already be too late for holders to get out. Does bitcoin have value? That's for the market to decide. Bitcoin is accepted as payment at some locations, therefore, it has value -- at least for now. Its future value, if any, is unknown.

Legit or not, bitcoin has several serious drawbacks to consider:

  • That 21-million-unit hard limit on circulation may sound fine, but bitcoin can be hacked and its parameters changed. You'd know about it, but that knowledge wouldn't prevent a loss. Even if bitcoin circulation remains within its current parameters, the potential supply of virtual currency is unlimited.
  • Its creator or creators may decide they no longer wish to adhere to previously stated policies. They are bound by no law or regulation. Either way, you'd be out of luck.
  • Bitcoin's biggest problem could be competition: If the concept proves successful, an unlimited number of knockoffs could appear. There is already a competing virtual currency called Ripple.

Though bitcoin is considered a joke by some, what it represents is not. It's a radical attempt at control in what is increasingly an out-of-control economic world. We accept the idea of central banks dumping billions into world economies on a daily basis; is that not a radical concept as well? For centuries, a virtual currency has been a response to economic policies that rendered real currencies valueless. This is just a partial list of currencies that abruptly lost their value:

  • Bolivian peso, 1985
  • Nicaraguan cordoba, 1987
  • Yugoslavian dinar, 1992
  • Russian ruble, 1992
  • Bosnian dinar, 1993
  • Brazilian cruzeiro, 1994
  • Zimbabwe dollar, 2008

It's doubtful that any of these countries intentionally wrecked their own currencies; just as liquidity can be added, it can also be withdrawn. Obviously, this is not as easy as it sounds, as has been proven by so many currency failures.

Can bitcoin even be considered a currency? That's debatable, but many of the reasons given why bitcoin is not a currency are actually invalid. First, let's blow up a few currency myths.

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