A Brief History of Electronic Currency: Bitcoins Shouldn’t Surprise You

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2013 was a year full of outrageous headlines for Bitcoin, but themes behind much of its news coverage should seem familiar. Over the past several years, electronic currencies have been connected to huge investment losses, government crackdowns, and online exchanges trafficking in black market goods.

Bitcoin’s decentralized structure is new, but some of the more dramatic stories swirling around the virtual currency have been seen before.

In May 2013, the US government announced an indictment against Liberty Reserve, an online bank that exchanged local currencies into Liberty Reserve dollars. According to the indictment, Liberty Reserve dollars were used to distribute, store, and launder the proceeds of more than US$6 billion worth of  illegal activity that included credit card fraud, identity theft, and drug trafficking. Liberty Reserve was shut down, and US authorities seized 45 bank accounts in connection with the operation.

Five months later, the US government closed the online marketplace Silk Road. The operation involved the government seizure of approximately 26,000 bitcoins and documents alleging more than one attempted assassination, but Reuters editor Matthew Goldstein noted that “the Silk Road story isn’t a totally new one.”

In 2012, a Washington Post article named three companies that employed full-time economists to manage their virtual currencies:

• In Iceland, CCP Games hired Eyjólfur Guðmundsson to manage a team of eight analysts. The notes that the complexity of Guðmundsson’s comes from the fact that there were more people playing CCP’s Eve Online game than there were living in Iceland at the time.

• Valve Corporation, which was looking to create a shared currency by linking economies in two virtual environments, enlisted Yanis Varoufakis as its economist in residence. Valve president Gabe Newell likened his company’s problems to balance-of-payments issues experienced between Germany and Greece.

• ArenaNet appointed John Smith to manage the virtual currency of its game, Guild Wars 2. ArenaNet was interested in Smith’s work because the Guild Wars 2 business model was a departure from other online games; it hoped to replace traditional subscription revenue with profits made from selling virtual items.

The announcement of a San Francisco hedge fund seeking a trader to specialize in bitcoin transactions is another entry in a long list of people making a real-world incomes from virtual currency management.

In 2011, The Guardian interviewed a former work camp inmate who claimed that work camp detainees in China were being forced to play online games to accumulate online goods that could be sold for real-world currency. The New York Times had already published a story in 2007 about companies in China engaged in “gold farming,” paying low wages for long hours spent collecting virtual assets in such games as World of Warcraft.

Bitcoin has also been connected to stories about exploitation: A recent BBC report suggests that malicious programs are now being used to create unwitting networks of computers forced to mine for bitcoins.

In 2009, China’s Ministry of Commerce announced that under Chinese law, virtual currency could not be used to pay for real goods and services. The announcement was made following earlier statements from the director of the General Office of the People’s Bank of China, who had expressed concern over the increasing popularity of “QQ coins.”

QQ coins, which were part of a virtual currency introduced by instant-messaging service provider Tencent in 2002, had started as a means to pay for Tencent services but allegedly became an alternative currency that was traded on the black market. By the time that China moved to restrict banks from using bitcoin as currency, it had already spent several years dealing with the challenge of reining in virtual currencies.

In 2006, the New York Times reported that companies including Reebok, American Apparel, and Ford had all established presences on Second Life, an online virtual world where users conducted business in Linden Dollars. The wave of Second Life publicity, and the credibility of the “real world” companies involved with it, led to an increase in speculation (or investment, depending on your perspective) conducted in Lindens.

The following year, news outlets reported that virtual investment bank Ginko Financial had collapsed, leaving Second Life users unable to retrieve approximately US$750,000 in Lindens that had been invested. By 2008, Linden Lab announced that Second Life banks were officially banned and that it was removing all objects related to in-world banking.

Bitcoin has already attracted investments that are several orders of magnitude larger than the Second Life investments, including the multi-million-dollar investment made by Cameron and Tyler Winklevoss and the US$65 million Bitcoin Investment Trust fund.

The world is still waiting to see whether bitcoin turns out to be the new gold or fool’s gold. However, at least six virtual currencies have failed since 1990, so a bitcoin collapse would not be unprecedented.

At the the 68th CFA Institute Annual Conference, Charles G. Cascarilla, CFA, discussed how financial professionals should consider the value of bitcoin.