Some Scots investors in the cryptocurrency can barely believe their luck, writes Dani Garavelli
Around 18 months ago, Norman, a pensioner from Inverness, was contacted about an investment opportunity: bitcoin. A financial dabbler, he had once been defrauded out of quite a large sum of money, so he was reticent about getting involved. But eventually he was persuaded to take the risk. He bought just over six bitcoins at just under £500 each, through a London-based broker, as well as investing £2,000 in another cryptocurrency – Ethereum.
A few months ago, he sold one of his bitcoins for £4,000, and he is in the process of selling another for somewhere in the region of £13,000. The remaining four, plus the Ethereum (which has also more than doubled in value), he plans to keep to see if the price keeps on rising.
“I was wary, but I thought, ‘Ach, I’ll give it a whirl’ and I’ve never seen anything like it,” Norman tells me. “It didn’t do much for a while, but then it just took off. When it reached £4,000, I thought, ‘If I sell one, I’ve got my money back so I won’t lose anything’. That was my strategy.
“Most people are saying I should sell the rest of my bitcoins now, but I am quite curious to see what happens. Some experts are predicting it will go stratospheric and others are saying it will all end in tears. But either way, I will have made a profit.”
For the past few months, the world has been in the grip of a bitcoin goldrush. Though the value fluctuates wildly from day to day (or even from hour to hour), its recent growth has been breathtaking: in April 2013, one bitcoin could be bought for £20; at 10pm on Friday it was worth £13,277. Between 20 November and Tuesday, it doubled in value.
Last week, there were reports of bitcoin ATMs crashing in Singapore and Israel, while in South Korea, where trading is up to 16 per cent over prevailing international rates, Prime Minister Lee Nak-yeon is worried it could corrupt the nation’s youth.
Some new buyers are approaching the enterprise with caution. Software developer Colin Burn-Murdoch, from Edinburgh, has invested just £200 in bitcoin. He is in the process of developing software which tracks the fluctuations in the cryptocurrencies’ value, alerting him when to buy or sell.
But stories like that of Kristopher Koch who, in 2013, bought an upmarket flat in Oslo by cashing in 1,000 of the 5,000 bitcoins he bought for £14 in 2009 – and the recent rises – are fuelling rash behaviour. Some people are already running up credit card debt and remortgaging their homes to grab themselves a piece of the action.
There is an irony at the core of this phenomenon. Bitcoin was established, by a shadowy individual or consortium, operating under the pseudonym Satoshi Nakamoto, in the wake of the 2008 financial crash. Its raison d’être was to provide a decentralised alternative to the existing banking system; an alternative peer-to-peer exchange system that did not depend on an intermediary. But – though it is used to make both online and real-world purchases – its volatility is invalidating its usage. “You can’t go for a haircut and know the price of that haircut has changed by 10 per cent whilst you were having it,” says Daniel Broby, director of the centre for financial regulation and innovation at Strathclyde University.
Instead bitcoin’s success depends on it being traded as a commodity – like gold or oil (though it differs from other commodities in the sense that it has no physical form or use).
Last week’s rise in value was prompted by the start of bitcoin futures trading on Wall Street, which began with Chicago Board of Exchange Global Markets and will be rolled out by several other exchanges in the next few weeks.
“The futures contract means banks, insurance companies and hedge funds can participate in it,” says Broby. “Bitcoin is becoming institutionalised and legitimised. It is moving into the mainstream.”
To many observers, the rise of bitcoin and other cryptocurrencies feels unsustainable. But there are those who believe the global nature of the cryptocurrency means there is still plenty of scope for greater growth. Last week, several analysts including Yann Quelenn, of the European online bank Swissquote, predicted one bitcoin would be worth $100,000 by 2019/20.
But economists are already branding it the biggest bubble of all time, surpassing the South Sea Bubble of 1720, in which many people were ruined, and warning those jumping on the bandwagon that they are taking a huge risk.
“The people participating in this market are ill-informed and making quite irrational decisions,” one financial expert tells me. “The only way this can solve itself is for the bubble to burst, for people to lose their money and for more rational players to come in at lower prices.”
Cryptocurrency evangelists tend to be anti-establishment libertarians who regard banking authorities as corrupt or inept. Bitcoin appeals to them because it is anarchic and is regulated by the people who use it. But there are many who view bitcoin in a more negative light. DBS, one of Asia’s largest banks, for example, has branded the system an elaborate scam – a kind of Ponzi scheme in which new investors provide the returns for older investors. Others – who are slightly less damning – still believe a centralised regulator is necessary to provide stability.
The advantages of bitcoin include the ability to send and get money anywhere in the world at a given time, very low transaction fees, a high degree of privacy and protection against identity theft .
However there are pitfalls. The most obvious is that if your “wallet” is hacked or you lose your private bitcoin “key” (see panel), you no longer have access to the bitcoin. James Howell of Newport claims to have lost 7,500 bitcoins when he threw out a hard drive in 2013. The bitcoins, then valued at £97, would be worth £60 million today. Once a cryptokey has been stolen, it is almost impossible to retrieve it.
The fact that bitcoin is a quasi-anonymous, untraceable way of moving money has made it particularly attractive to criminals. Just a few months after it was first used to buy goods – two pizzas from Papa Johns in May, 2010 – it became the currency for the Silk Road: an online drug market operating on the dark net.
The Silk Road is no more, its founder Ross Ulbricht having been jailed for life after he was tracked down by FBI officers. Its demise in 2013 saw the price of bitcoin take a short-term tumble.
But this was far from the only scandal. A few months after Ulbricht’s conviction in early 2015, Tomáš Jiříkovský was arrested in the Czech Republic for stealing millions of dollars in bitcoin from its successor, Sheep Marketplace.
And a few months after that, Mark Karpelès, the CEO of Tokyo-based bitcoin intermediary Mt Gox, was arrested and charged with fraud and embezzlement of $390 million from the currency exchange, which had filed for bankruptcy after announcing 850,000 bitcoins had gone missing.
Earlier this year, the ransomware attack Wannacry demanded ransoms in bitcoins after targeting computers running Microsoft Windows by encrypting data.
However, it is not bitcoin’s appeal to criminals which is the greatest obstacle to it becoming an established global currency; it is the huge amount of power required for the blockchain to function. The mining network which verifies transactions now consumes 30.14TWh of electricity a year. Each individual bitcoin transaction requires almost 300KWh of electricity, enough to boil around 36,000 kettles.
“Bitcoin suffers from an inherent problem: that to create the cryptograhic keys that make it secure, you have to use the raw processing power of computers, and that’s very energy-intensive,” says Broby.
“For all the bitcoins in the world right now, the energy in use to support them is as much as the Republic of Ireland generates every year – and this isn’t even yet a global currency. We don’t have enough planets to create the energy that would support bitcoin as a currency mechanism.”
For miners to keep taking part, the “reward” they receive for successfully sealing the block must be worth more than the energy they consume in the process. Were the value of the bitcoin to fall dramatically, the balance might tip, and a lot of the miners might collapse.
“That might mean one country, such as China, where the electricity is cheap, would have all the miners in the world,” says Bill Buchanan, professor of computing at Edinburgh Napier University.
“When one country takes over the currency, they can do whatever they want with it: they can roll back, they can pay themselves money, they can say your payment isn’t acceptable.”
Another problem with cryptocurrencies is that the anonymity they afford makes it easier for those involved to avoid paying taxes. “A cybercriminal will often take bitcoins and convert them into Ethereum – they can move money around,” Buchanan says. “So long as it stays in cryptospace, the taxman and the governments will never see it. Only when it comes back out and is exchanged back into dollars will a bank see it as real money.”
Marco Baressi, 30, who comes from Dundee but is currently living in the Philippines, began investing in bitcoin and other cryptocurrencies, in early October and is already quids-in.
He says he does a lot of research, attending conferences and watching Youtube videos of investors before making a purchase. “I wouldn’t have invested in them in the first place if I didn’t believe they’ve got a good chance of ‘going to the moon’ as they say in crypto-world.
“Bitcoin is such a big deal that one day it will be globally acceptable to pay for anything in it, and eventually it may be possible to do the same with other cryptocurrencies,” he says.
Broby and Buchanan agree digital currencies will eventually replace paper money, but believe investors such as Baressi are misguided to believe bitcoin is the future.
They say other cryptocurrencies, such as Ethereum, require less energy to create the security protocols and that some kind of centralised regulation is likely to be necessary in the long-term.
In Scotland, of course, we already have our own cryptocurrency: Scotcoin, owned by Fintech investor David Low, and worth $25m.
At the moment, Scotcoin works off the same blockchain as bitcoin; this means its value has also risen sharply but that it shares bitcoin’s volatility issues.
In the future, however, Scotcoin will move on to its own “permissioned” blockchain and will be fully compliant with Anti-Money-Laundering and Know Your Customer – the regulations that apply to stocks, shares and bank accounts, says Low.
“We are basically moving Scotcoin to a professional, regulated environment where everyone who wants to trade in it has to produce a passport and a utility bill, the same as they would if they were opening a bank account.”
Broby adds: “It is people’s acceptance of the philosophy that it makes sense to have a digital currency and then jumping to the conclusion that it should be bitcoin that is driving the price up.
“But what I am saying is that the more you know about the technology behind this, the more you are driven to the conclusion that at some point, the central banks will intervene and that bitcoin won’t be the solution.
“It will be a similar solution, but with better environmental and security protocols.”
Creation of a virtual currency
The story of bitcoin’s creation, and how it works, is fascinating. Inspired by the Occupy Wall Street movement, its pioneers wanted to bypass financial institutions by establishing a decentralised system in which buying and selling could be done directly, without the need for an intermediary (though, in reality, most transactions are still carried out through a broker).
Though there are now around 1,000 cryptocurrencies across the world, bitcoin is the best known and most influential; it is to other cryptocurrencies what the dollar is to other fiat currencies (fiat currencies are those declared legal tender by a government, but not backed by a physical commodity).
First introduced in January 2009, bitcoins – like all cryptocurrencies – have no physical form (unlike the collectible coins that illustrate this article); they are pieces of computer code and exist only as numbers on a screen. New bitcoins are created by a complex computer process known as “mining” whereby participants solve maths problems to release them. The creators decided the total number of bitcoins – like gold or oil – should be finite, so there will only ever be 21 million (of which more than 16 million have already been mined).
Each bitcoin is defined by a public address and a private crypto-key – a long string of numbers and letters that act as a unique digital finger. The public address and private keys and must be kept securely in a “wallet”.
But bitcoins are also identified by their position in a public ledger of all bitcoin transactions known as the blockchain. It is the miners’ job to keep the blockchain intact. All transactions made within a set period are arranged into blocks. The miners then compete with each other to convert the information in that block into a much shorter series of numbers and letters known as a “hash”. Every time a miner seals off a block, they’re rewarded with 25 bitcoins (the incentive for taking part), the blockchain is updated and everyone in the network hears about it. Once a transaction is confirmed, it is irreversible.