Bitcoin has a future, but maybe not as a currency

In the course of its five-year run, bitcoin has been heralded as a beacon of hope by those who mistrust banks and an object of suspicion by those who mistrust a grassroots currency.

While the dramatic price fluctuations and high-profile breaches have not helped the cause, bitcoin's champions and critics seem to agree that the technology itself has a future.

Mark Kamstra, a finance professor at York University's Schulich School of Business, says that bitcoin has "fatal flaws" — like its fixed supply — that limit its growth. But he concedes that the underlying technology has the potential to change the online payment system.

• Why Bitcoin isn't dead yet

Francis Pouliot, director of public affairs for the Bitcoin Foundation Canada, says that the proliferation of other cryptocurrencies inspired by bitcoin is a testament to the power of the technology.

"Cryptocurrencies can't be un-invented," says Pouliot. "The cat is out of the bag, the technology has been proven to be functional, so definitely it's going to be used in one way or the other."

Created in the wake of the worldwide financial crisis of the late-2000s, bitcoin was introduced in 2009 as an alternative payment system to paper currencies, whose value can be manipulated by central banks.

Bitcoin is based on a peer-to-peer computer network akin to those that form the basis of file-sharing system BitTorrent.

Holders store their bitcoins in digital wallets and electronically send bitcoins to each other to pay for goods and services. Every transaction is encrypted and logged in a computer network known as a block chain.

The value of bitcoin has fluctuated dramatically over its short lifespan, from $0.08 US in July 2010 to over $1,200 in November 2013. More recently, it has been trading in the $600 range.

Bitcoin 'very secure'

The price volatility, as well as a number of high-profile breaches, have contributed to a feeling among many investors that bitcoin is not a stable currency.

Arguably the most serious incident was the revelation earlier this year that Mt. Gox, a Japan-based bitcoin exchange that at one point handled 70 per cent of all worldwide transactions, had lost about $450 million US worth of the cryptocurrency.

While critics have fixated on the high-profile breaches involving bitcoin, the cryptocurrency's block-chain structure makes it "very secure," says Mark Nunnikhoven, vice president of cloud and emerging technologies at online security firm Trend Micro.

He says any security breaches thus far have not been due to the underlying technology.

"With Mt. Gox and some of the other breaches, it hasn't been the currency itself that's been the problem, it's the people handling it," said Nunnikhoven. "And that's going to hold true for quite a long time, and that holds true for real money as well."

Even so, that doesn't settle the trust issue for many people, says Schulich's Kamstra. While bitcoin was created to avoid regulatory interference, he says governments and banks help legitimize currencies.

"You need trust for transactions between people," says Kamstra. "With traditional currencies, they work because countries back up the currencies with their power to tax citizens and, to some extent, stores of gold."

Another problem is the price fluctuation, says Jean-Paul Lam, a professor at the University of Waterloo and a former assistant chief economist at the Bank of Canada. With a traditional currency, a central bank manages price spikes by printing more money.

The bitcoin community has decided to cap the number of available bitcoins at 21 million. (To date, just under 13 million bitcoins have been mined worldwide.) Lam says this "inelastic money supply" is what creates the huge price volatility.

Some commentators have suggested that for bitcoin to grow, it would need to establish some sort of central authority. But that would be contrary to the currency's founding philosophy, says Pouliot.

"The point of Bitcoin is that the whole system is decentralized, and it cannot be centralized," says Pouliot.

Lam says that as long as that attitude prevails, bitcoin can never become a true currency "because it is too volatile."

'A protocol that can do a bunch of things'

While bitcoin's future is a hotly debated subject, the open-source software that underpins it has given rise to hundreds of other digital currencies.

While bitcoin currently occupies about 90 per cent of the cryptocurrency market, there are an estimated 275 digital currencies now in play, many of which cater to  specific products or services.

Namecoin, for example, focuses on helping people buy domain names outside the central domain system. Craftcoin is an internal currency for the popular videogame Minecraft, while Potcoin facilitates transactions in legal marijuana markets such as the Netherlands and U.S. states such as Washington and Colorado.

A couple of Montrealers developed PotCoin because "the legalized marijuana industry called out for its own distinct payment system," co-founder Joel Yaffe said in an email. But he acknowledges that Potcoin is a niche currency.

"The coin has been designed to attract the cannabis community exclusively, so we aren’t expecting too much further penetration outside the industry," says Yaffe.

The sheer variety of cryptocurrencies is a testament to the potential of the block-chain concept, but bitcoin's architecture has many more uses, says Jean-Philippe Vergne, an economics professor at Western University's Ivey Business School.

Due to the elaborate verification system of the block-chain concept, some bitcoin startups have been using the open-source software for all sorts of applications, from a lending network (BTC Jam) to a text-messaging service (Gliph) to a Bitcoin-only travel agency (BTC Trip).

In a report released in February, the digital currency news site Coindesk projected that venture capital invested in bitcoin startups would hit $300 million by the end of 2014.

Vergne says the block-chain structure could someday even underpin the entire internet.

"What we call cryptocurrency is really a piece of software," says Vergne. "It's a protocol that can do a bunch of things. Only one of them is mimicking money."