It’s humbling, when you come to think about it, how little we understand money. Even CFOs who deal with it every day don’t really know (and perhaps don’t much care about) the mechanics of how money is minted and controlled.
It is enough that finance correctly accounts for how much of it has already come in and may arrive in the future, and what has gone out and what may go out in the future – and that the CFO helps the rest of the business make sure more and more money comes in while the cost of acquiring it is kept as low as possible.
So the arrival of bitcoin, which is a new way of making money, tends to be seen as a non-event – or a scam. In any case, it is highly unlikely that this virtual currency will figure in any corporation’s p&l or balance sheet anytime soon.
But bitcoin can be the future of money, or at least one of its possible futures – and can change the way CFOs do their job. US Federal Reserve Governor Ben Bernanke acknowledged as much in a letter to the Home Land Security committee of the US Congress, which held a hearing on virtual currencies in November.
“While these types of innovations may pose risks related to law enforcement and supervisory matters,” he wrote, “there are also areas in which they may hold long-term promise, particularly if the innovations promote a faster, more secure and more efficient payment system.”
Senate committee chairman Tom Carper also stamped cautious approval on the idea of virtual currencies. “Rather than play ‘whack-a-mole’ with the latest website, currency, or other method criminals are using,” he said, “we need to develop thoughtful, nimble and sensible federal policies that protect the public without stifling innovation and economic growth.”
It is no coincidence that the value of a bitcoin surged to a record US$785 after the 18 November hearing (it traded at just US$13.50 at the end of 2012). On 27 November, the price of a single bitcoin zoomed past US$1,000, a 400% jump in less than a month.
What the heck is it?
You won’t find a real physical bitcoin anywhere – those pictures you see on the Internet, including the one we use in this article, are meant only as illustrations and for promotion. Bitcoin is a virtual currency, or as the boffins call it, a “cryptocurrency” – born and stored by computers across the Internet, whose numbers grow more numerous by the day.
In theory, no single entity controls bitcoins, not especially by a central bank or government-designated issuer-banks, as is the case with paper currency. There is a set amount of bitcoins that can be issued – 21 million units – as decreed by a software program created by a person or a group of persons (no one knows, really) who goes by the pseudonym Satoshi Nakamoto.
This free software was released to the wilds of the Internet five years ago. Anyone with a powerful enough computer, bandwidth and the smarts to solve a cryptopuzzle (hence the name cryptocurrency) generated by the software can “mine” for bitcoins.
A computer designed specifically for bitcoin mining costs around US$7,000, but not everyone has the know-how to solve the cryptopuzzle, which becomes much harder once the number of bitcoins created exceeds 3,600 per day.
Bitcoin miners – estimated to be in the thousands, though no one knows exactly how many there are – that succeed in solving the fiendishly complicated cryptopuzzles get to register a certain number of bitcoins that then go into circulation. They are rewarded with a few bitcoins themselves.
At the moment, the system awards 25 bitcoins about six times every hour to miners that successfully solved a cryptopuzzle within that hour.
Bitcoins and satoshis
As of 25 November, some 12 million bitcoins have been mined, meaning that there are only 9 million bitcoins left. When the 21 millionth bitcoin has been mined, which is designed to happen in the year 2140, the system will stop issuing bitcoins.
Thus, in theory, bitcoins, like gold, cannot be debased, unlike paper currencies that can become worthless because of overprinting by central banks, which is what is happening today.
But 21 million bitcoins is surely insufficient in a world with 7 billion inhabitants? Not really. Each bitcoin is equivalent to 100 million “satoshis.” At US$1,000 to a bitcoin, one satoshi is practically worthless at this time, but it can accrue real value if bitcoin use becomes widespread.
In truth, there are very few brick-and-mortar shops that accept bitcoins, though there are relatively more online gaming and shopping sites that do. These outlets say they are able to sell things more cheaply because the cost of sending and receiving bitcoins is around 1% of the transaction value, compared with 3% for credit cards and 8% for Paypal.
The soaring bitcoin-dollar exchange rate is added incentive for these merchants to sell cheap since they can make up the difference from the exchange rate, assuming bitcoin values continue to surge as they are doing now.
Can bitcoins be faked? At the moment, that seems very difficult to do. All bitcoin transactions are recorded in a global public log called the blockchain, which is available for everyone to see. Internally, the system will accept a transaction only if it can linked back to the “genesis block” – i.e., that is, when the bitcoins were first registered by a miner.
Bitcoins are stored in bitcoin addresses, each one comprised of randomly generated public and private cryptography keys. The odds of the system generating the same address twice is said to be infinitesimal.
Needless to say, any bitcoin owner should make sure to protect his or her private cryptography key, which allows the bitcoin to be sent to another address, i.e, exchanged for goods and services or for paper currency, such as the dollar.
What else you need to know
Wallets. Your bitcoins can be stored in a bitcoin wallet sitting in your personal computer, your mobile device or online.
- Personal computer: Your wallet sits in a software resident in our PC that plugs into the bitcoin network, allowing you to send and receive bitcoins, including buying goods and services online.
- Mobile device: The wallet sits in your device, which allows you to make transactions in restaurants and shops. The way it works today, you use your mobile phone to scan a QR code displayed by the few brick-and-mortar merchants that currently accept bitcoins, such as art gallery and café Artistry in Singapore’s Jalan Pinang.
- Online: Your wallet sits on the servers of a website (not your PC), which manages your bitcoin wallet for you.
Bitcoin Exchanges. These are used to trade bitcoins for paper currencies, including the US dollar, euro, yen, Hong Kong dollar and Singapore dollar. The most well-known exchange is Mt.Gox in Japan, a 24-hours/465 days market where one bitcoin traded for US$1,230 at 7:25 pm on 1 December 2013.
“Bitcoin isn’t just a currency,” says Wired. “It’s a way of making payments, like PayPal or the Visa credit card network. It lets you hold money, but it also lets you spend it and trade it and move it from place to place, almost as cheaply and easily as you’d send an email.”
It can be abused – the US recently closed down the website The Silk Road, which investigators found to be an online marketplace for illegal drugs that uses bitcoins because buyers and sellers can be anonymous.
But “bitcoin is much more than a money service for illegal operations,” argued the magazine. “It’s a re-imagining of international finance, something that breaks down barriers between countries and frees currency from the control of federal governments.”
Questions and concerns
Maybe that assertion will turn out to be true, in the fullness of time. For now, the action is in the exchanges, where people buy and sell the bitcoins that have already been mined. Some 30,000 bitcoins changed hands on Mt.Gox on 1 December at a weighted average of US$1,163 – trading that day thus topped the equivalent of US$34 million.
Bitcoin isn’t the only virtual currency that’s “re-imagining finance,” as Wired puts it. There’s also litecoin, peercoin and about 30 others, although bitcoin is by far the biggest, with its units in circulation valued at US$12 billion (No. 2 litecoin is at US$888 million). And bitcoin is the only virtual currency that has been recognized by Germany, which designated it as a “unit of account” that can be used for tax and trading purposes in that nation.
While the buzz around bitcoin continues to build, however, so are concerns about the sustainability of the system. The Economist magazine notes, for example, that “bitcoin’s success is putting it under growing strain.” Three weaknesses were highlighted: the unsustainable computational arms race among miners, the unwieldiness of the blockchain system, and questions about how secure and anonymous bitcoin really is.
Time will tell whether bitcoin is really the future of money. But the fact that it exists and is reaping some measure of acceptance and success indicates that a revolution is at hand. And when that revolution is about the very concept of money, the way financial management is done in businesses will see changes as well.
We can only hope the change is for the better – more stability in exchange rates, more security, real-time reporting of transactions (because all is done digitally) – rather than the reverse.
About the Author
Cesar Bacani is Editor-in-Chief of CFO Innovation.