By Al Doyle for CoinWeek .....
Many freedom-oriented people are skeptical about long-term prospects for the U.S. dollar and other fiat currencies, which means they often invest in gold and silver while seeking other monetary alternatives. Let's take a moment to define terms before proceeding.
Fiat currencies are unbacked by precious metals or other commodities and meet just two of the three qualifications for true money. While national currencies tend to be widely accepted even across borders and are issued in convenient and divisible sums, they miserably fail the third test - a store of value.
Federal Reserve notes (FRN) (which are issued by a private banking cartel rather than the U.S. Treasury) are "money" because the law declares them to be legal tender. Legitimacy is based on government fiat (declaration) and the trust of most citizens.
Going back a century to the Fed's debut in 1913, a number of different notes circulated simultaneously in America. Gold and silver certificates were essentially a warehouse receipt for precious metals. Local financial institutions were allowed to issue National Bank Notes in sums equal to the amount of government bonds they purchased. Demand Notes were redeemable in coin, while Legal Tender Notes were a forerunner to the FRN.
Some might call the early 20th century a time when various forms of currency circulated side by side. Any pretense of competition ended by 1968 when the U.S. government stopped redeeming silver certificates for metal. Various sources estimate that the value of today's dollar is equal to 20 cents or less in 1963. That means the FRN has lost 4/5ths of its purchasing power in just 50 years.
The U.S, dollar's status as the world's reserve currency combined with the even poorer performance of other fiat money such as the Mexican peso have masked the decline of the FRN, but that doesn't erase the miserable performance of the greenback. So what can the average person do to protect their wealth?
Precious metals are a logical and time-proven option, but some people seek the new and novel. Bitcoin and other virtual or cryptocurrencies fit that description.
Thanks to its rapid rise and breathtaking rollercoaster ride during and after all the Cypriot financial crisis of 2013, Bitcoin has gotten a good deal of publicity in the mainstream press. It debuted in 2009, and Bitcoin's background is murky, to say the least.
Anywhere from a lone operator to a team of people using the Japanese pseudonym "Satoshi Nakamoto" created Bitcoin. This medium of exchange isn't backed by gold, silver, copper ingots, McDonald's gift cards or any other tangible asset. Bitcoin is based on "complex algorithms" that produce more pieces as transactions are made. This "peer to peer electronic cash system" allows for buying and selling to be made between individuals or with merchants who accept Bitcoin as payment for goods and services.
Bitcoin's recent price history is way beyond erratic. It closed 2011 at $4.72 and climbed to $13.36 on December 31, 2012. Who would complain about a 183 percent gain in just a year? This was Steady Eddie stuff compared to what has taken place in 2013.
The price rose to $20.41 a month later and passed $25 on February 12. If this sounds like a mania, it was ho-hum stuff by comparison to what took place in March and April of this year. Financial meltdown in Cyprus combined with legitimate concerns of the same thing happening in other debt-ridden nations.
A combination of fear on the part of some along with trendiness propelled Bitcoin to $190 on April 9. What may have been the most volatile session for a financial instrument took place the following day when Bitcoin surged to $266, plunged to $76 and closed at $160. Such record volatility is too much for many potential Bitcoin holders.
Do Bitcoin and its competitors such as Freicoin and Ripple qualify as currency? TV financial show host Jim Kramer would say no, as he insists that a true monetary unit is issued by a central bank, but the federal government's Financial Crimes Enforcement Network (FINCEN) would disagree. That's because Bitcoin accounts on Mt. Gox (a popular Bitcoin exchange) were seized by FINCEN on May 15 because the site "was not registered as a money transmitter."
Amazon.com has come up with its own virtual money that tends to be used for purchases on the all-encompassing web site. Each Amazon Coin is worth one cent, and those who buy them by the thousand get a slight discount at $9.50 per block. So what could the future hold for Bitcoin and various wannabes in the cryptocurrency game?
What backs these monetary units? Algorhythms might appeal to geeks and techies, but it's essentially the same hot air that "supports" national currencies. Virtual currency could be an answer to a question that was never asked or an excessively complex solution to a simple problem. Bitcoin has promised to cap creation at 21 million units, but what would prevent them from reneging on their word? Central bankers and politicians do so every day. A currency is only as good as the integrity of the people behind it, and no one knows the identity of the Bitcoin originators.
Those who buy Bitcoins hoping they appreciate in value should understand that it's a speculation and gamble. Making profits is possible, but these are totally uncharted waters.