What do you think about Bitcoin?

The crypto-currency has been in the news a lot, lately. What started as a way for math-geeks to keep score with one another has developed into a significant item for payments and money transfer. Bitcoins are pieces of computer code that can be stored offline and are—to this point—impossible to replicate. They can be “mined” by solving very difficult math problems, and once created can’t be destroyed.

There is no central repository of who owns which bitcoin, although each bitcoin comes with a serial record of who mined it and who has owned it over time. Users can establish anonymous identities to preserve their privacy. The algorithm at the heart of each bitcoin’s creation and transfer is elegant, and thus far, has not been replicated. To date, about $6 billion in bitcoins have been mined.

Two days ago the largest bitcoin exchange, Tokyo-based Mt. Gox, shut itself down amid rumors of massive theft. Mt. Gox handled about a third of all bitcoin/currency exchanges. It’s the equivalent of a bank closing its doors—and folks with funds there can’t get at their bitcoins—reported to be worth almost $400 million. But because it’s not officially a currency, there’s no clear path to restoring its operations.

Bitcoin has popularized the idea of a virtual currency; it has many cash-like properties. Because it preserves the anonymity of its users, it is the exchange-medium of choice among drug-dealers, identity-thieves, and other criminals. It’s also popular among libertarians looking for a currency that doesn’t involve a central bank. But its distributed nature is also its risk: as the Mt. Gox episode shows, bitcoin users have limited options if their funds go missing.

Because of the potential for abuse, authorities are watching bitcoin carefully. In Russia and China, it’s illegal to exchange bitcoin for anything. If the cryto-currency becomes so popular that it materially threatens tax revenues, I’d expect the Fed to co-opt it—maybe by issuing “Fed-coin.”

Douglas R. Tengdin, CFA

Chief Investment Officer

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