If you’re a tech-savvy grid owner, there’s a good chance you’ve heard of Bitcoin, a new virtual currency that’s completely private, untraceable, and isn’t backed by any company or government.
For some, Bitcoin is the future of online payments, an alternative to our current, outmoded, failing financial system.
But before you bet your company’s future on Bitcoin, here are some thoughts to consider.
1. There are no Bitcoin police
If your company keeps its money in a traditional bank account and someone steals the money from the bank. First, under U.S. law, your account is covered by federally mandated deposit insurance. In the U.S., you’re covered for up to $250,000 per bank — if you have more than a quarter million, and you’re worried about your bank going under, you can distribute your money between multiple banks for full coverage. According to FDIC, the agency responsible for this,  no depositor has ever lost a single penny of FDIC-insured funds since the system was first set up in 1933. Other industrialized countries have similar systems in place.
But that’s only some of the protections you get when you’re dealing with the existing financial system. You also get the full weight of the FBI, Interpol, and various other local and global agencies who are busy chasing financial criminals. In the short term, a crook might get away with it for a while. In the long run, however, there’s a pretty good chance the crooks will get caught, and the more they steal, the faster they’ll go down.
Then, all the financial players have their own enforcement systems in play, partly due to national and international money laundering laws, and partly to reduce their own fraud-related losses. Many financial firms will even cover your losses for you — credit card customers, for example, aren’t liable for fraudulent charges made to their accounts.
No, it’s not a perfect enforcement system. But an enforcement system exists, it’s massive, it’s international, and it’s steadily improving.
There is nothing similar for Bitcoin. If your employees steal your company’s Bitcoin, if your online Bitcoin bank or exchange loses them, if a hacker gets into your computer and steals your Bitcoinwallet — well, there is pretty much nothing you can do.
That’s not to say that there won’t be some enforcement — some day. But until then, don’t keep any more money in a Bitcoin wallet than you can afford to lose.
2. Bitcoin have no backers
With all other currencies, there is always a place you can go to spend your money. Sometimes, this is due to a government mandate. Other times, it’s a company promising to redeem its chips, coupons, frequent flyer miles or whatever its virtual currency might be. For example, if you have a bunch of Linden Dollars lying around, even if nobody else wants them, you know you can always use them to pay rent on virtual land in Second Life.
Sure, this guarantee only lasts as long as the company — or country — exists and is willing to honor its commitment. But if Linden Lab — or the US government — suddenly stopped backing its currency, it would be a very major issue and could lead to the company going out of business and the government collapsing.
Now, companies go out of business all the time. I wouldn’t recommend keeping more money in Linden Dollars than you can afford to lose, either. And governments do occasionally default on their currencies, or suffer severe deflation or inflation.
But switching to Bitcoin to avoid this risk is like buying a car with no brakes because brakes sometimes fail. And no, the network effect won’t help, because there are no switching costs.
Say Bitcoin becomes wildly popular. A million businesses take it. Then something sexier comes along — Justin Bieber, say, releases ByteCoin and gives away a free kiss to all users. What is to keep users from selling off their Bitcoins and switching to ByteCoins? What is to keep companies from dropping Bitcoin and only accepting ByteCoins? Companies don’t have to accept Bitcoins if they don’t want to. Users don’t have to have Bitcoins if they don’t want to.
Bitcoin are like Beanie Babies — as long as people want them, their price will go up. When people stop wanting them, their perceived value will drop through the floor. And, unlike with Beanie Babies, there’s no hope that if you wait long enough they’ll come back into fashion or become historic collectibles.
3. Bitcoin are volatile
A common justification for using Bitcoins is that they’re immune to the currency fluctuations seen with traditional, government-backed currencies.
Unfortunately, they’re not immune to the much bigger fluctuations caused by hype and fad cycles.
Traditional currencies have large institutions hedging against fluctuations, and governments themselves will also buy and sell their own currency to keep it level. Fluctuations are bad for business. The systems aren’t perfect, and currency traders can sometimes exacerbate problems but, overall, currencies typically rise and fall by a few cents.
With company-backed virtual currencies, the value is typically set by the company itself, which keeps it steady. If the currency is also traded on secondary exchanges, the issuing company has incentive to keep values relatively level by stepping in and buying excess currency if it threatens to flood the market.
Nobody has a vested stake in keeping Bitcoin values steady. And, so far, Bitcoin value has soared up to around $30 and down to around $5. This is a much, much wider trading range than most established currencies. For example, the Euro has ranged from $1.22 to $1.45 dollars over the past year. The Russian ruble has ranged from $38 to $44. Even Tunisia, which has suffered a great deal of political instability recently, had had less fluctuation, with its currency dropping from $0.73 to $0.62 over the past year.
4. Bitcoins may attract regulatory attention
Accepting Bitcoin is quite a bit like accepting cash. They’re anonymous and untraceable, and you can’t prove how much you’re taking in and how much you’re sending out.
At first glance, this might seem like a great deal — the tax inspectors won’t be able to tell how much money you’re making. But, as many cash-based companies have found out, that’s not necessarily a good thing, because it just makes them look harder.
But it’s not just tax collectors who want to see nice, clean, auditable financial records. So do banks, if you want to borrow money. So do investors, if you want to sell stock in your company. Big customers sometimes want to see financial records as well, before signing major business deals.
Finally, given that the major advantage of Bitcoin over other payment methods is its untraceability, other investigators may show up as well, to check that the Bitcoins aren’t being used to hide illegal gambling, child pornography, or money laundering, and that can create public relations issues for your grid.
5. Bitcoins are unfair
Many people believe that governments create money by printing new bills whenever they need more spending cash. But that’s not actually true.
Money is created when banks lend it out. If you have, say, $100 in your bank account, and the bank lends $90 of it to someone else to start a business, the total amount of money effectively in circulation has almost doubled.
People borrow money to finance college educations, to buy cars and houses, to start new businesses. Governments borrow money to pay for infrastructure projects. The loans help grow the economy. If the economy grows at the same pace as the money supply, inflation is minimal. To increase the amount of money in circulation regulators can allow banks to lend out more of their depositors money, or they can lower interest rates.
Our modern financial system is a pretty darn amazing invention. Money is never wasted. Even when it looks like its just sitting in a bank or brokerage account, it’s actually out there, doing work. Not like the old days, when wealth was in the form of gold or silver coins, and stored away in castle vaults.
Now, we do have quite a bit of economic inequality right now, especially here in the United States, but that is less a factor of the financial system than the political system, and plenty of countries with similar financial systems to ours have more equitable distributions of wealth.
Bitcoins, however, are created in a fundamentally unfair way. Folks who got on the Bitcoin train early were able to create a lot of Bitcoins relatively cheaply — all it takes is a dedicated computer and enough time to crank through the Bitcoin creation algorithms. As time goes on, the algorithms get more and more difficult to crank, and Bitcoins get harder and harder to produce.
As a result, Bitcoins create wealth for folks who were lucky enough to get in early, and then were able to convince other people to buy the Bitcoins they produced. And Bitcoins also create wealth for hackers who control big botnets and are able to hijack the computing power of thousands of computers and force them to mine coins.
These folks have a lot to gain by maintaining the illusion that Bitcoins have value. And, without any regulatory oversight, they can easily carry on fake trading on Bitcoin currency exchanges, passing money back and forth between their own accounts.
That’s not to say that everyone who’s involved in Bitcoin is a crook. Bitcoin does have technical appeal. But without any mechanism to keep crooks out, and that’s not a good situation.
When you buy a currency you are, indirectly, putting money into the hands of the folks to create the currency. When you buy US dollars, you are helping support the US economy. When you buy Second Life’s L$, InWorldz’s I’z or Avination’s C$, you are rewarding those companies for creating enjoyable virtual worlds. When you buy OMC, you are rewarding Virwox for running a stable, reliable virtual currency exchange and for dealing with all the legal and security issues that this entails.
When you buy Bitcoins, you’re rewarding folks for running a program on their computer that does a bunch of calculations. And not useful calculations, either, like searching for signs of extraterrestrial life, or folding proteins to help cure diseases.
Bitcoin alternatives
There are plenty of alternatives to Bitcoin.
You can use regular money on your grid by way of PayPal and PayPal Micropayments. These modules are widely available for OpenSim and many hosting companies will set you up for little or no extra cost.
You can use the OMC currency from Virwox — which also supports Bitcoin trading, if you want your customers to have the option to use Bitcoin in some capacity.
And you can issue your own currency. That has some legal implications as well (see yesterday’s article Virtual Currency 101), and you have to be careful about how your set up your currency, but if you do it right you get to keep all the money you make from selling your currency in addition to providing a fun, low-cost way for your users to spend money in-world.
Hosting companies Dreamland Metaverse and TalentRaspel specialize in setting up custom virtual currencies for private grids — and the Website infrastructure needed to manage them. And the currency modules are also available, if you have the technical skills to set it up on your own.
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