Bitcoin: Six months on from $1000

comments 4

Comment

share

Share

0

Rate

Nearly six months on since Bitcoin reached the $1,000 mark for the first time, several commonly-espoused theories surrounding the virtual currency need to be re-examined. In order, these myths are that the price surrounding Bitcoin at the time was in some way warranted, that Bitcoin provides its users with a safer means to undertake financial transactions and finally, that Bitcoin is a decentralized currency.

Firstly, the current price of around $500 illustrates that the Bitcoin price of the time was a bubble. By comparison, the value of the Russian rouble has only fallen by around 20% in the same period despite significant political instability surrounding Russia and the Ukraine as well as suggested capital outflows from Russia in the region of $150bn.[i] This conjures up the image of people piling out of Bitcoin and heading for the safety of the Russian rouble – not traditionally a safe-haven for anxious investors it must be said.

Secondly, half a billion dollars’ worth of bitcoins going “missing” in late February of this year draws a line under the claims made by some parties that your Bitcoin wallet is any safer than the traditional version that resides in your pocket. As we are all well aware, financial fraud is nothing new. But a precedent for financial fraud on this scale in such a short period of time is difficult to think of.

Finally, it is worth addressing the myth that Bitcoin is decentralized. Bitcoin has now been legislated for in several large economies. The United States recently made it a property and thus subject to tax, Finland has decided it should be given commodity status, while Sweden says it is an asset.[ii] What all of these actions show is that governments will ultimately decide what Bitcoin becomes – and that is the definition of being centralized.

In the defence of Bitcoin

For all the myth shattering, however, Bitcoin’s resilience in the face of so many challenges is also worth considering. With over $6bn worth in circulation[iii], there are several vested interests in keeping the bitcoin phenomenon alive. And the longer it stays alive, the more credibility is given to it as a form of currency in its own right. Credibility is the same tool that central banks themselves have relied on to keep things ticking over for hundreds of years.

Almost every time a central bank in a country makes a statement about Bitcoin (with the exception of the Danish Central Bank who referred to Bitcoin as “beads of glass”), it gives further credibility to the virtual currency. When the IRS made moves to make Bitcoin taxable, it was a blow to the idealist camp who think of Bitcoin as a currency in its own right but at least provided recognition from a government entity that this is here and it’s likely to be here for a long time.

Longevity also brings depth to the market. With each passing day, more online retailers begin to accept bitcoins for payment (probably just for publicity in some case). More opportunities to trade combined with the increased number of bitcoins on the market means more depth and less volatility. Even if something has no intrinsic value, if enough people believe that it does, well maybe holding small amounts of it isn’t such a bad thing.

Comments

Of course there are the birthing pains to every new 'technology,' but Bitcoin suffers from some deep fundamental problems in the context of ever becoming a store of value. Liquidity, volatility and the concentration of BTC holdings may pass in the long run, but the decentralized nature to the currency provides a flawed foundation for long run viability as any store of value.

Although advocates may praise the decentralized nature as another BTC selling point, with no responsibility comes (1) no backstops when liquidity/confidence turns and (2) no guarantee of value on a relative basis to goods (one's purchasing power of all goods is directly impacted by day-to-day volatility). Taking this view, only can BTC be a medium of exchange if the exchange infrastructure is able to facilitate instant transfers from ___currency to BTC and then to said good or service. A market-maker could collect the spread and maintain liquidity / the exchange.

But why would one want to go through BTC instead of directly though ones own currency? Open to any ideas here. Off the top of my head, if the BTC market-maker had a lower spread in the exchange process than current traditional methods, than the lower transaction costs for a buyer and seller using different currencies would benefit from using a BTC method of exchange. It will be interesting to see how Ebay goes about accepting BTC if they choose to. Avoiding transaction costs would directly threaten their PayPal transfer revenue stream.

Example: A fellow in India would like to buy something from a merchant in the US. The merchant in the US is willing to ship to India, but his online store charges a fee for any transfer of currency for the fellow in India. Under the infrastructure I spoke about, this fellow in India could just complete the transaction for the cost of the spread that the market-maker / exchange charges for a Rupee to BTC and BTC to USD transfer. If the infrastructure grows and liquidity deepens, I suppose such spreads could truly challenge existing fee structures.

Any other ideas?

I have no doubt that the market will find some use for BTC, but I do not think it will ever be a store of value, be taken seriously in any portfolio or come to be used in the traditional ways we are currently thinking. As infrastructure improves, I can only speculate that the technology will serve as a way to reduce traditional transaction costs. Still, infrastructure takes time and special interests may find their way into domestic regulation and disrupt the entire process.

Hi Gregory, thanks for your comments. I agree with just about all of what you say here. A few points I'd take you up on; I believe EBay would sooner introduce their own currency, rather than use Bitcoin, just as Amazon have introduced a local currency. Regarding transaction costs, I believe advocates of Bitcoin are incorrectly discounting its transaction costs (currently it's more risky than normal currency so that has to be built into transactions, it's not accepted everywhere which adds effectively adds more transaction costs and it looks like it's going to become the subject of tax in more and more jurisdictions).

Michael - Saw this today. Looks like 80% of volume is driven by RMB with a logical conclusion that BTC is being used as a mean of discreet, cheap and fast money transfer where it is otherwise regulated. http://www.ft.com/intl/fastft/289502

Thanks, Michael. It's also important to consider the threat that alternative methods of payment and stores of value pose to governments on a general basis. Anti virtual currency rhetoric has been relatively limited out of monetary and fiscal authorities, but I believe this is because they do not fully understand it or see it as mature enough to give comment. Although I personally doubt that BTC or any other virtual currency will ever be a store of value, if I am wrong there are various consequences. Historically, we have not seen governments respond favorably to any threat to their monopoly on money. Put in the context of money theory, I tend to think that a money must first have a concrete value (set to the value of a precious metal perhaps) and establish a healthy market for the money before it can be set 'free' and made fiat. A decentralized currency with no money infrastructure theoretically has trouble to establish itself as a currency replacement, but like I stated in my previous comment the market is likely to find one use for it or another.