BITCOIN : Is the world ready for Virtual Currency?
Virtual Currency, an Introduction
Since the popularity of Internet in 1990s, many cryptologists started working on Cryptocurrency. There were some attempts made to develop such currency. One of the famous Cryptocurrency /virtual currency called ECash. This system failed because, it was dependent on infrastructures of Government and credit card companies.
With the near collapse of the banking system in 2008, the craze of Cryptocurrency caught up and the front runner was Bitcoin. There are many similar products which came in the market, such as Primecoin, Dogecoin, worldcoin, Ripple, litecoin etc., however, Bitcoin became more popular due to its complex nature of Cryptography and open source policy (anyone can review the code).
Advent of Bitcoins
During the recent financial crisis people lost faith on the banking industry and currency. During this period a Virtual currency or Cryptocurrency came to limelight and one of the products is named as BITCOIN. This happened during 2008-2009
The fundamentals behind Bitcoin are usage of the currency which seeks principles of Cryptography for decentralised, distributed secure information economy. An interesting fact about Bitcoin is that, it was developed entirely on open platform and it is a closed ecosystem value giver, where anyone who is buying and/or selling Bitcoins can trust each other.
With a pseudo founder name Satoshi Nakamoto, who claimed to be creator of Bitcoin with sophisticated computer codes, stumped cryptography world with the complexity of codes till now it is not possible to crack the Bitcoin codes. It has most sophisticated and seemingly secure codes.
With the advent of the Bitcoin, there is a fear among the regulators of real change in the existing financial system which is regulated by Governments.
In the current financial system gold is used as a measure for printing currencies, which means, the value of currency held by common man is guaranteed with equal/defined amount of gold in the government treasury. Effectively, treasury could issue notes only to the extent of Gold reserves or such allowed measures it has got. However, with the quantitative easing and during 2008-09 crisis, US fed and other Governments resorted to printing more money than available gold reserves in order to increase the buying power of the common man. This resulted in reducing the faith on the states and their ability to control fiscal situation of countries.
The Key test of any currency whether it is legal tender or virtual currency is its acceptability. The traders in the world , in the years gone by have only accepted legal tender currency which are made by central banks and are backed by Gold because, they knew that they can exchange it with equivalent gold. Whereas Bitcoins are stateless, so that they cannot be taxed, frozen or easily traced. Unlike its cousins, the paper currency, it can be exchanged freely without charges.
With the advent of the electronic banking and popularity in usage of internet, the trend is seen that, there is an electronic form of Exchange and traders started experimenting on/ have shown interest in Virtual currency namely BITCOINS.
It is presumed that, any electronic transaction of legal tender currency, something electronic can threaten the sheer existence of the current legal tender currency.
How are Bitcoins made?
As stated earlier, Bitcoins are digital medium of exchange; they are created with complex mathematical challenges which are solved either by single person or by group of persons.
There are two ways of acquiring Bitcoins;
- Mining the coins
- Buying it in the market as a tradable commodity
1. Mining the Coins
The process of creating a Bitcoin is called Mining. The mining of Bitcoin is well controlled through various checks and balances which are managed by Volunteers who dedicate their time to mine Bitcoins. The mining of the Bitcoin is done with specific software called Bitcoin miner. The entire system is dependent on User policing. As a reward for giving up some computing power, the user gets 50 coins for the effort. The Bitcoins’ economy consists of a network of its users’ computers. At preset intervals, an algorithm releases new Bitcoins into the network: 50 every 10 minutes, with the pace halving in increments until around 2140. The automated pace is meant to ensure regular growth of the monetary supply without interference by third parties, like a central bank, which can lead to hyperinflation
2. Buying it in the market as a tradable commodity
Bitcoins can be bought through online markets. The price of each Bitcoin is determined based on the demand and supply. During the initial inception stage of Bitcoin, people have acquired Bitcoins as small as 3 cents per coin. Over a period of time, due to increase in the popularity, it has now become more expensive than dollar value. The first publicly traded Bitcoin was on 25 April, 2010. At the current stage the cost of buying one Bitcoin is around $1300/- .
There are many portals like bitonics, bittiraha.fi, bitplaats Nedelands, etc. These portals are registered portals to sell the Bitcoins and same can be exchanged with the value of money.
From the inception of Bitcoin, it was observed that Bitcoins are very volatile in the market. With increase in the acceptance of Bitcoins, the volatility has increased. This prompted various investment bankers, venture capitalists to invest in Bitcoins.
How are Bitcoins spent?
Bitcoins can be exchanged as a string of codes virtually anywhere in the world without any fees.
At the initial stages, Bitcoins were used to buy online products like gaming products, etc. after the increase in the acceptance levels, the Bitcoins are now being accepted some retail stores.
Once users download the Bitcoin app to their machine, spending the currency is as easy as sending an email. The range of merchants that accept it is small but growing. And entrepreneurial bit coiners are working to make it much easier to use the currency, building everything from point-of-service machines to PayPal alternatives.
Positive aspects of Bitcoin
Bitcoin became very popular because it is not regulated by any authorities and is touted to be most secured virtual currency ever that came into existence. Further,
- Few venture capitalists believe that Bitcoin has got endless possibilities. This has lead to creation of asset portfolio.
- Bitcoin technology and its low cost payment system design which is elegant.
- Considering that there are no regulatory frame works, there cannot be any tax liabilities attached to the dealings in Bitcoins. This is one of the ways of savings of potential tax impact on the goods.
- With the reduction in the cost of transaction (there is very negligible transaction cost), the retail segment has shown a very good interest in Bitcoin. The retail stores, who get around 6% as margins, end up paying 3% towards credit card/ debit card charges, which is nearly 50% of their margins. With the acceptance of Bitcoins, the margin payment of 3% to the service providers is eliminated because; Bitcoins can be transferred from one user to another user without any intermediately or charges.
- International transfers of Bitcoins cost almost nothing in comparison with transfer of normal currency which may cost something around 2% to 3% apart from loss in the currency fluctuation charges etc.
- Bitcoin being a single currency, the currency fluctuation risk is purely eliminated and dealing becomes much easier than traditional currencies.
- A major challenge for digital currency was curbing a problem called double spending. In the conventional mode, double spending is controlled by not allowing the spender after his last digital euro/dollar. This control is done by using ledger which is administered by trusted third party. The conventional answer involved using a central clearinghouse to keep a real-time ledger of all transactions—ensuring that, if someone spends his last digital dollar, he can’t then spend it again. The ledger prevents fraud, but it also requires a trusted third party to administer it. However, The Bitcoin has done away with 3rd party administration and replaced with distributing the ledger publicly. This is coined as Block Chain. The Block chain concept uses the power of CPU (Central processing unit) of some users who are willing to dedicate their own CPU power running a special piece of software and they are called Miners.
Risks involving Bitcoin
Before Bitcoin becomes a regular and reliable method for consumer transactions, there are some significant risks/disabilities which need to be addressed;
1. Infrastructure risks/Disabilities
Bitcoin is purely dependent upon Internet and its accessibility. The internet and accessibility is very good in developed nations, however, in the under developed nations, internet and accessibility is very poor. Apart from that, the basis requirement for running the internet is the infrastructure i.e. electricity, telephonic/wired infrastructure, servers etc. In the event of power/ electricity black out or non availability of such resources, Bitcoin concept does not work at all.
2. Risk of Cybercrime/virus acts
Since the advent of Bitcoin, the psedo name Satoshi Nakamoto has been used and the same could not be traced till date. It is presumed that, it can be a team of IT geeks or team of Investment banker and IT geeks who developed the entire system and given a pseudo name. Given that Bitcoin has increased rapidly to $10 billion in value and prospects for commercialisation further, it is puzzling why e-currency messiah is still anonymous and what if such Satoshi Nakamoto is a group of Cyber criminals who can build the value over a period of time by creating investor excitement and run away.
Even it is suspected that, such a cyber coding genius sitting in tax free island and earning money or is a cyber terrorist who upon Bitcoin adoption will activate a virus which can bring down entire Cyber system into stone age !!!
3. Consumer and Investor protection Risk.
The entire concept of Bitcoin is built on the decentralised, uncontrolled, non regulated, non traceable platform and concept. No legal protection is in place to assist the consumer. The unregulated nature of the currency makes it hard to the consumer to know whether it is dealing with a credible party. While the self descriptive warning in the site “howtobuybitcoins.info, it is very unreliable.
The way the system is created, if the payment is made immediately, there is no stop payment system is available. It there is any dispute, then it has to be solved by the parties which made the transaction and there is no 3 party to interfere and solve.
4. Regulatory risk
With the rapid climb in the price of the Bitcoin, some of the world’s wealthiest nations have realised there are numerous risks. The currency is completely unregulated. Even though this is a very cause of the creation, however, irresponsible behaviour of a small group of enthusiasts can cause a turmoil and mayhem in the market.
In some Bitcoin conferences, the panellists have agreed that there should be some kind of regulations needed to be placed. Recently in December, 2013, China has announced that, it would not accept Bitcoin. Other nations like Denmark, Finland, France, India, Norway, Sweden, Thailand and the European Banking Authority have spoken out against Bitcoin.
As Bitcoin is not backed by anything real or tangible, it is difficult to use when it comes to crisis. Reason is, under current gold standards, if something goes wrong, people can trade the legal tender currency to gold and keep it.
Bitcoins are often in picture for trading in drugs or illegal goods.
Increasingly the fate of the commercial viability of e-currencies is moving into the hands of the nations, their regulators and financial protectors and out of the control of Bitcoin enthusiasts.
5. Risk of Bubbled Asset
The supply and demand gap in Bitcoin has recently seen high volatility in the prices of the Bitcoin. It has moved on from 3 cents to more than $1200 in just 5 years. With the price appreciation of more than 9K times, there seems to be a possible bubble which might burst any time. As of now there are approximately, 12 million coins outstanding and maximum of them are hoarded by various investors who wants to cash in when further demand grows. This shows that there is a artificial inflation in the price of the currency.
Apart from that, it was observed that the ownership of the Bitcoins are extremely concentrated which increases market manipulation risks.(
Further, Bitcoin is neither a legal entity, nor a start up, and no stock is available for investors.
Concluding remarks
We see that with the advent of the new electronic generation, the evolution/ existence of virtual currency is eminent, however, due to various infrastructural, regulatory, anonymity, and similar constraints, it is difficult to judge whether virtual currency (Bitcoin) can replace the legal tender currency. Considering total dependency of the virtual world is on Electricity / harnessing energy, electronic devises and Internet connectivity, it seems it may take decades or even a century to conquer or topple the existing monetary system.
We can consider it as a new revolution in exchange mechanism; however, it would take considerable amount of time before getting acceptability as that of current legal tender money and system.
References:
The above document is prepared and compiled after gathering information from the following websites and some webcasts, television networks etc which are listed below;
4) Bbc news (Business) bbc.co.uk (The technology of Business published on 24 January 2014.
12) http://www.dallasnews.com/business/headlines/20140217-authorities-warn-of-a-digital-wild-west.ece
13) http://www.leerzelfbeleggen.com/tips-voor-beginnende-beleggers-leer-van-ervaringen/hoe-winst-maken-met-bitcoins
