BITCOIN – CURRENCY OF THE FUTURE OR A GLOBAL CRAZE

What was once seen as an illicit currency for illegal online drug trades on websites such as ‘Silk Road’, the Bitcoin has now been transformed into a global phenomenon where a single Bitcoin’s value – based purely on supply and demand- has surged from $15 in January 2008 to a current estimate of $840, leaving many nations and economists arguing whether the digital currency should be treated as a mere craze, comparable to the dot-com bubble in the late 90’s or whether the Bitcoin which offers free transactions around the world, “may hold long term promise” as the current chairman of the Federal Reserve Ben Bernake claimed in 2013.

Having once been a favoured currency of drug dealers and gold bugs, the Bitcoin has attracted many fans with its anonymous currency transactions where no one will come to know about the payment or about all other information related to the payment, including who sent it and who received it, pacifying a society nervous of privacy breaches. There’s no central bank. It’s stateless. And the supply of Bitcoin is determined by an algorithm that allows computers around the world to “mine” the currency at a set rate per day. There’s a limit – about 21 million – to how many can ever be mined and no way to issue a flood of new Bitcoins and devalue those already in circulation, leaving the Bitcoin economy to be self stabilizing which would be pleasing to the Friedmanist in all of us!

The extreme price associated with the Bitcoin has led to many uttering ‘bubble’ under their breath. Currently, the Bitcoin is booming. Investors all over the world are racing to invest in a controlled supply of Bitcoins. In recent weeks the Bitcoin’s value – for the second time- crossed the $1000 barrier mark when video game firm Zynga announced their intentions to allow the Bitcoin to be accepted as a payment option. I put forward that the Bitcoin acts as a Giffen good; as price rises, so does demand. I believe this is due to the media hype surrounding the Bitcoin. As the price rises, so does the growing media interest. Stories of get rich quick have become common and in a society were news is instant and easy to see, more people are introduced to the virtual currency which drives up demand and therefore price. Another cause of recent price surges is due to Chinese investors who are looking to hoard money outside of China which is reminiscent of previous market bubbles, leaving the Bitcoin closer to a speculative asset than a currency.

Questions over the security of the Bitcoins have also raised concern over the longevity of the online currency. In recent months there has been a surge in Bitcoin theft. In 2013, it was reported that over $100 million worth of Bitcoins were stolen from “Sheep Marketplace”, another illegal online marketplace. An intrinsic flaw in Bitcoin security is also one of its perks; the fact that it is near impossible to trace an individual, means that it is easy to anonymously steal and spend Bitcoins therefore offering low risk gains too many online criminals. Another intrinsic weakness of Bitcoin security is that due to it being not governed or aligned to a central bank or government, consumers and businesses stand to lose vast amounts of money if their Bitcoin reserves are stolen as there is no safety net for investor to fall back on. Steps have been taken to improve confidence in ownership of Bitcoins. In January 2014, the world’s first Bitcoin insurer launched to address the deep concern among Bitcoin users, however, it should be noted that the negative publicity surrounding the nascent Bitcoin means that many insurance firms may think twice before taking the step to insure the currency.

One of the founding ideas behind the Bitcoin is that there is no central authority. No government and no bank tinkering around with inflation. But as its market value and global interest keeps rising, it has forced banks and governments around the world to establish their stance on the currency. Nations such as Germany and the US have come out in their support for the Bitcoin establishing it as a legitimate financial service, therefore allowing the currency to be taxed just like any other tender. The recent US recognition caused a Bitcoin price spike of just over $1,000 due in part to recognition of the Bitcoin as a unit of exchange which helped it unshackle the chains of its former life as a tool for drug trades which damaged Bitcoin’s credibility as an internationally recognized currency.

Nevertheless, not all nations are keen on the Bitcoin. China, the world’s fastest growing economy and once home to the world’s largest Bitcoin exchange has recently restricted its banks from allowing Bitcoin transactions. Worried about its potential to launder money and its instability, the Chinese labelled the Bitcoin as having no “real meaning” as a currency. Prices plummeted after the news. Investors lost confidence in the Bitcoin following the new Chinese regulations, causing floods of panic selling, reducing the price from $717 to $480. This by no means will destroy the Bitcoin, but one would argue that the Chinese trade frontier would need to be included for any future longevity as a global currency.

So is the Bitcoin heading towards longevity? It is to be expected that as time moves on and we all progress further into the digital age, money will become even more digitalised. But I believe that the time is not right for the Bitcoin to take over from a conventional currency backed by a centralised bank. The Bitcoin will eventually end its price run and will no longer be able to support its gargantuan valuation. Unlike most currencies which are based on actual resources such as gold or agricultural output, of a tangible value, the Bitcoin is backed only by what people deem them to be worth. In times to come when it will be clear that the Bitcoin will not attain the role as the world’s standard currency due to intrinsic restrictions such as security issues and new national regulations, demand will fall and prices will plummet. The Bitcoin may not achieve the aims of its staunchest supporters to become the global tender but we can’t take away the effect it has had on society today. We are merely seeing the tip of the iceberg in the potential of a digital currency. Just like Napster, Bitcoin has unleashed an idea that has captured the public’s imaginations of free worldwide transactions which cannot possibly be avoided by the governments around the world; bringing about the new frontier of exchange.

Contributed by Jack Albert

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