Bitcoin: The future of currency?

In the aftermath of the financial crisis and the resulting monetary easing policies, Bitcoin was created to alleviate growing concerns of government manipulation of currency. Bitcoin is a virtual peer­-to-­peer currency that was introduced in January 2009 by a programmer or group of programmers using the name Satoshi Nakamoto. Bitcoin is designed as a decentralized currency that is not subject…

Bitcoin is designed as a decentralized currency that is not subject to fiscal manipulation by central banks. It provides users with an anonymous and secure means of exchanging goods and services electronically, without any intermediary such as a bank or credit card company. It is not backed by any precious metal and derives its value from complex mathematical coding.

“Bitcoin gives us, for the first time, a way for one Internet user to transfer a unique piece of digital property to another Internet user, such that the transfer is guaranteed to be safe and secure, everyone knows that the transfer has taken place, and nobody can challenge the legitimacy of the transfer. The consequences of this breakthrough are hard to overstate.” – ­Marc Andreessen

Bitcoin users can create or “mine” new Bitcoins by lending their computer resources to the network so that the validating and processing transactions can occur. The supply of Bitcoin is permanently limited to 21 million, of which approximately 12.5 million are currently in existence. These 12.5 million bitcoins can be broken down into infinitely small units. Therefore, the finite supply of the currency should not impede its circulation.

CURRENCY

There is growing debate as to whether Bitcoin demonstrates the necessary values to be considered a successful currency. Money is economically defined as anything that can be used as a medium of exchange, unit of account and a store of value.

Bitcoin, a currency still in its infancy, may or may not demonstrate the values of a successful currency. There are a few key events that must occur for Bitcoin to become a sustainable currency. First, the price volatility of Bitcoin must stabilize. Bitcoins began in 2013 at a valuation of $13 per coin, and ended the year at $800 per coin. This volatility will prevent widespread adoption of the currency, which is the second component necessary to make Bitcoin successful. Currently, 47 people own 29% of all Bitcoins, 930 people own 50%, and 10,000 people hold 75% of all Bitcoins in existence. This disproportional distribution of Bitcoins is an obstacle because approximately 90% of all Bitcoins are hoarded for speculative purposes. A survey conducted by The Street concluded that 74% of the public have never used a crypto­currency and did not have the desire to do so. However, more stable and secure exchanges could reduce the liquidity problems Bitcoin currently experiences. The collapse of Mt. Gox, a Bitcoin exchange based in Tokyo, Japan, after 850,000 bitcoins, the equivalent of $450 million, was stolen, exemplifies the need for secure and reliable exchanges. The final element Bitcoin needs for success is the presence of start­ups to create products supporting its usage. There has been $117 million invested in Bitcoin start­ups worldwide, and there have been numerous supporters in Silicon Valley who see Bitcoins as a transformative technology with significant potential.

BITCOIN AND GOVERNMENT REGULATION

The issue of potential regulation of Bitcoin is controversial. Though only a fledgling currency, Bitcoin has already survived major scandals. One such scandal involved Silk Road, an online black market that specialized in the exchange of illegal drugs and other illegal products. Silk Road used Bitcoin’s technology, which allowed buyers and sellers to be connected and anonymously exchange goods. The FBI shut down Silk Road in October 2013, and seized 174,000 bitcoins, worth around $34.5 million, approximately 3.5% of all the Bitcoins in existence. This scandal raised questions about the legitimacy of Bitcoins, and resulted in several countries releasing statements detailing their stance on Bitcoin.

Both China and Russia have declared bans against the use of Bitcoins. This regulation prevents Bitcoin being used for legitimate business practices. It is also inefficient since the major appeal of Bitcoin is that it can be used anonymously. Other countries such as Germany have made official statements that Bitcoin is not legal tender and cannot be used to satisfy legal obligations. Canada has taken a different approach and declared all Bitcoin transactions are taxable.

The United States has made strides to regulate Bitcoin to make it safer for consumers. In February 2014, New York State Department of Financial Services held a two­day conference to discuss the regulation of Bitcoin. This department is pushing for the issuance of “Bitlicenses” which will provide regulation to Bitcoin operators. Although no official requirements have been announced, Benjamin Lawsky, the head of the department, has indicated it will be looking for appropriate cyber security measures, capital reserves and a strong management team. These are key in order to ensure Bitcoin exchanges are a secure, liquid and a safe investment for its customers.

BITCOIN’S POTENTIAL FOR LONG-LASTING IMPACT

The advent of Bitcoin creates a host of interesting new avenues for businesses, the first of which is in emerging markets. Currently, only 20 countries in the world have fully developed brick­and­mortar modern banking and payment systems. This prevents fully­online services from capturing these markets. However, Bitcoin provides a secure reliable payment system where businesses can receive payment from anyone, anywhere. Due to this important feature, Bitcoin can bring an important feature to businesses in emerging markets that do not yet have modern banking and payment systems.

Bitcoin has the possibility to greatly reduce the amount of money people pay throughout the world. There are two major groups that this will impact. First, there are remittances that emigrants send back to their home countries. These payments are estimated at $550 billion this year according to World Bank, and commercial banks charge 9% remittance fees and an additional 5% if the consumer wants to turn the payment into cash. Using Bitcoin technology, Buttercoin, a start­up company, is proposing to transfer remittances for under 1% commission. Allowing these workers to send money home will increase the general usage of Bitcoins.

Additionally, Bitcoins will make it easier and cheaper for companies to accept online payments. Bitcoins have no transaction fees like banks or credit card companies. Using products like Bitpay, another start­up using Bitcoin technology, companies are able to turn their Bitcoins into immediate cash.

THE FUTURE

Looking towards the future, what would it take for Bitcoin to become a successful business currency? The most pressing step is the need to make Bitcoin a generally accepted method of payment. Bitcoin has a little or no transaction fees, which makes it very appealing to businesses with low margins. However, many businesses are skeptical to use Bitcoin because of the risk involved. In order for Bitcoin to become a universally accepted form of currency, there would need to be increased security measures to prevent the theft of Bitcoins. This is where government regulation should step in, in order to make sure that these companies are legitimate and safe for consumers. As the infrastructure for Bitcoin’s continues to develop, it is definitely a currency to watch.

 

Jack Henry Kapp (jhk248@cornell.edu) is a freshman at Cornell University majoring in Hotel Administration.