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09 December 2013

Does bitcoin make sense? 

Bitcoin is riding exhilarating ascents and harrowing declines as speculators, investors and online pioneers test the boundaries of the new, completely digital currency.

Created four years ago, bitcoin springs from computerized algorithms. Enthusiasts say it offers protection from government interference with the money supply via strict limits on how many bitcoins can be created by the “miners” who run the algorithms that create them.

The value of bitcoins has grown by a factor of several hundred in the past year as speculators have dived in to exploit the limited supply and the public’s fascination. Meanwhile, competing digital currencies are also trying to attract an audience.

What’s behind all this? For all the skeptics crying “bubble,” there’s more than a fad here. Governments that took on substantial debt to bail out troubled banks alarmed people who wondered how those debts would be repaid. They also take a dim view of financial institutions seemingly rewarded for taking irresponsible risks that nearly caused a global economic meltdown.

Bitcoin is designed to be “frictionless,” allowing secure and free transactions with no interference from governments, banks and other institutions. Some merchants already accept bitcoin to pay for goods and services, although many more will have to join the bitcoin wave for the currency to catch on.

What’s holding it back? It’s inherently deflationary: the limited supply can and does drive up bitcoin's value, thereby deflating the value of any goods or labor purchased. And because it’s purely digital, there’s no way to access it without an Internet connection.

Like all innovations, bitcoin faces a straightforward challenge – demonstrating it can outperform existing competitors. And that’s much easier said than done.