Bitcoin: A fad, a bubble, the future, or something else
Recently the University of Nicosia proudly announced that it intends to become the 1st university in the world to accept Bitcoin for tuition payments.
Additionally the university announced the launch of a new MSc programme on digital currencies.
The university’s vice rector says in his introduction to the course:
While digital currency is a relatively new concept, currency is one of the oldest human inventions.
Actually it’s not as new as people think. The 1st instance of a digital currency appeared during the dot.com bubble in the mid 90s.
E-gold was the first digital currency (or the first digital commodity to be more precise) to appear online in 1996 (older than google.com) that was shut down by the US government over fraud allegations, identity theft, enabling criminals to whiz funds anonymously.
At its height e-gold had a market capitalisation of 2bn USD and over 5 million users.
Sound familiar?
E-gold is no more, however there is a new crop of digital currencies with Bitcoin being the best known and by far the largest digital currency in terms of market capitalisation. As of Nov.25 around Bitcoin had a market capitalisation of 9billion USD, for reference the second largest cryptocurrency Litecoin, has a market capitalisation of around 230million USD.
There is one (and only one) fundamental difference between e-gold and Bitcoin and Bitcoin imitators (30+ as of the time of writing). They are decentralised, systems, meaning that unlike e-gold no one single entity regulates/controls the process.
And as an aside Bitcoin would never see the light of day had it not been for the economic crisis and people losing their faith in national currencies.
Advantages
1. Bitcoin is relatively immune with issues plaguing fiat currencies (such as the dollar, the pound sterling or the euro). The Principal-agent/conflict of interest issues are non existent as no one single entity can control the entire system.
Note* The University of Cornell in a recent paper states that there is a possibility that eventually Bitcoin will cease to operate as decentralised system as private groups can take over. Takeaway phrase The Selfish Miner.
2. Unlike Online transaction clearing houses such as Paypal, bitcoin does not charge fees to its users. Merchants using the Paypal platform to sell their wares pay a fee per transaction (not to mention bank fees) resulting in additional cost.
3. Bitcoin is currently unregulated (for how long remains to be seen) and as such is not subject to any form of restrictions such as capital controls or quotas. As such Bitcoins can enter and exit any country in the world, even places such as Cyprus or Argentina.
In fact Bitcoin’s meteoric rise is mostly attributed to Chinese users. As the Financial Times indicate, Bitcoin’s appeal to the Chinese is a matter of our cleanest dirtiest shirt. The renminbi is not a freely floated currency and as the Chinese people amass more wealth they seek to invest their money abroad, the chinese government controls are a hindrance so Bitcoin is a way to bypass the obstacles.
4. Bitcoin is akin to cash and carry, transactions are processed with only minimal delays of 10 minutes. Transactions processed through banks/Paypal/credit cards may take several hours if not days to process.
Disadvantages
First off we have to tackle this issue once and for all. Bitcoin is a very poor construct to run an economy with.
There is no point in mentioning the FACT that bitcoin is deflationary by design, that much has been documented and known from the onset. The bitcoin protocol has a ceiling of available Bitcoins that can be mined set arbitrarily at 21 million BTC’s, ergo a supply limit with no possibility of ever expanding the monetary base.
Additionally if any country were ever to use bitcoin as its monetary unit, it will in effect deprive policy makers essential tools for resuscitating their economy during a crisis. Consider what’s going on in the Euro area right now. Greece needs to devalue the euro to become attractive but it ceded their monetary policy tools to the ECB.
I do not think Bitcoin creator/creators ever espoused their construct would ever replace real currencies. As such I shan't consider these arguments any longer.
Bitcoin exists online and online only but even in its natural habitat it is far from being a safe heaven.
1. Bitcoin is highly susceptible to fraud and theft. Consider that during the last 4 weeks hackers stole a total of 5-6million worth of bitcoins from online exchanges in China.
While 6 million is not a lot consider the scale we’re discussing, 6 million stolen out of a total of 5 billion worth of bitcoins or 0.12%.
The percentage is simply staggering.
To put things in perspective let’s imagine a real life scenario.
According to the ECB ‘s balance sheet, money supply for September 2013 was 9,852 billion euro. Had the euro been as vulnerable as Bitcoint then at 0.12% robbers would have stolen from Europe 11 billion euro in just 4 weeks.
There is already a dedicated blog registering major bitcoin thefts globally, the numbers are alarming!
Here’s where regulation and having a centralised authority may be useful. Individuals who lost their Bitcoins due to the theft from online Exchanges/e-wallets etc can expect no reimbursement of their funds ever.
In your traditional brick and mortar bank various savings schemes guarantee your funds and in the event of a bank robbery the bank will reimburse.
And it gets worse. A gaming company software engineer from the czech republic inserted a bitcoin mining botnet into one of the company’s download clients (legitimate software). The botnet once installed on the end user’s computer mined for Bitcoins. The scam resulted in creating 3.47 million worth of Bitcoins that ended up in the bank account of a company employee.
Unfortunately this is a persistent and sticky issue that won’t go away. A central clearing house might do away with these fears but that’s tantamount of creating the Bitcoin Central Bank defeating the currency’s initial purpose.
2. Bitcoin is volatile vis a vis other currencies.
Bitcoin is highly volatile take the pair BTC/USD in mere hours Bitcoin went from 800 Dollars per Bitcoin Unit to 500 Dollars per Bitcoin Unit.
Such volatility if not careful may cause damages to both parties on any transaction using the Bitcoin platform.
In addition it is worth noting that Bitcoin trippled in value against the dollar in just 10 calendar days.
Some argue that this is because bitcoin is a new currency and there is bound to be some volatility to it. However this is a wrong approach. Bitcoin behaves unlike any other new currency mostly because it’s unlike any other currency out there (decentralised, p2p). All models that applied with the Dollar Euro etc don’t apply here. Bitcoin is uncharted territory as currencies go.
As any savvy investor will say such high yields are nothing less than a speculative bubble and with Bitcoin it is even more speculative due to the secretive nature of the currency. That being said the final decision on how to treat Bitcoin rests with the individual investor.
In the words of Warren Buffet
Risk comes from not knowing what you’re doing
And
Never invest in something you don’t understand
In conclusion
For this author at this stage Bitcoin benefits (no restrictions, no fees) do not outstrip its disadvantages (theft, volatility). It’s still too early to tell whether Bitcoin is a fad but one thing is certain.
Bitcoin cannot continue AS IS. The currency is still in its nascent phase and some volatility might be expected but at this stage, it is too dangerous to even contemplate having Bitcoin as the primary currency even inside the Web. Furthermore there are obvious security issues that stem from the fact that the currency is decentralised and unregulated.
This entire debate over the future of bitcoin reminds me of the whole dot.com bubble in the mid 90s when people and tech firms were evangelising that a bright future lays before them,with early adopters were praising and fiercely defending their gadgetry.
Then it all came crushing down.
