Bitcoin – will the hot new digital currency survive?

Speculative investors are embracing the increasing value of the digital currency, but market analysts are a bit more sceptical.

By Steve Blizard     2 Dec 2017

Bitcoin was created about a decade ago as an alternative to government-issued currencies.

As the transactions in this virtual currency exchange allow anonymity, it is popular with people who want to keep their financial activity, and their identities, confidential.

The digital coins are created by so-called “miners”, who operate computer farms that verify other users’ transactions by solving complex mathematical puzzles.

These miners receive bitcoin in exchange.

With supply limited to 21 million, so far, around 16.7 million bitcoins have been released into the system, with 12.5 new “coins” released roughly every 10 minutes.

Bitcoin can be converted to cash when deposited into accounts at prices set in online trading.

Whereas Bitcoin and other virtual currencies were initially used primarily as a method of payment, in recent months they have become a hot speculative investment.

Bitcoin is far from the only “crypto-currency”.

There are now far more than 1000 rivals, according to trade website Coinmarketcap.

Speculative bubble

If you had bought $US1000 of bitcoin at the beginning of 2013, and, assuming you could find a buyer, you would now be sitting on a profit of $US80 million.

Many people consider bitcoin to be more of a speculative commodity than a currency, because of its volatility, increasingly high transaction fees, and the fact that relatively few merchants accept it.

Neil Wilson, a senior market analyst at ETX Capital in London, says bitcoin is “following the playbook for a speculative bubble to the letter”.

“There are no fundamentals or technicals that explain this other than it being a massive speculative bubble.” he said.

At the time of writing, Bitcoin had risen about $US11,000, but later dropping by 20 percent in just a few hours.

The steep rise in the price of bitcoin this year has divided the financial community on their merits and whether or when the value might come crashing back down.

Energy drain

The cypto-currency mining computers require a vast amount of energy to run.

A recent estimate by tech news site, Motherboard, put the energy cost of a single bitcoin transaction at 215 kilowatt-hours, assuming that there are around 300,000 bitcoin transactions a day.

That’s almost the energy as the average American household consumes over an entire week.

The bitcoin mining industry consumes 22.5 TWh of energy annually, which equates to approximately 13.2 million barrels of oil.

To put this in perspective, the total energy consumption of the world’s Bitcoin mining activities is more than 40 times greater than that required to power the entire Visa network.

With investors constantly looking for new ways to gain competitive advantage in this space, the best way to achieve this is by cutting the energy costs of mining the coins.

This has seen some of the computer mining operations relocate to countries with low energy costs, such as Iceland.

Illegal activity

More than 980,000 bitcoins have been stolen from exchanges, either by hackers or insiders, with few having been recovered.

That’s more than $US10 billion in losses, at current exchange rates.

While illegal activity is falling, about a third of the 106 million bitcoin users are using the anonymous digital currency for nefarious activities, according to the research titled, Sex, Drugs and Bitcoin, written by Sean Foley, Talis Putnins and Jonathan Karlsen.

Transaction Costs

Compared with fiat currencies, transaction costs are the biggest problem with Bitcoin.

Painfully inconvenient, Bitcoin is an expensive means of payment.

It operates similar to Uber’s surge pricing, except that the user sets the fee based on how long they’re prepared to wait for the financial transaction to go through.

Bitcoin debit card can be used anywhere the cards are accepted, but the fees charged, on top of the Bitcoin transaction fees, are generally higher than with banked based cards.

There is a notable group of merchants and customers willing to put up with Bitcoin’s inconveniences, primary American marijuana dispensaries and pot users.

Dark Web markets for harder drugs, guns and other restricted items also prefer to use Bitcoin, and, despite a recent crackdown the virtual currency still holds an appeal for Chinese investors trying to bypass their country’s currency restrictions.

William Dudley, president and chief executive of the Federal Reserve Bank of New York, said bitcoin is “more of a speculative activity” than a currency.

“I would be pretty cautionary about it. I think that it’s not a stable store of value,” he is reported as saying.

“I would be, at this point, pretty sceptical of bitcoin,” he added.

Commenting on the idea that the Fed could potentially offer its own digital currencies, he said: “I think at this point it’s really very premature to be talking about the Federal Reserve offering digital currencies, but it is something we are starting to think about.”

Blockchain revolution

Elmer Funke Kupper, former chief executive of the ASX, says that the revolutionary aspect is Blockchain, the backbone that makes the exchange of bitcoins between individuals possible without a central ledger that records who owns what bitcoins.

Today, most experts refer to the technology as a “distributed ledger”.

A distributed ledger allows all those who trade in an asset class to agree on the ownership of the assets in near real-time, without a single ledger that is centrally maintained.

It does this by allowing everyone to hold a copy of the ledger every time a transaction cycle is completed.

Distributed ledger technology has the potential to strip billions of dollars from administration costs.

For equity markets, it should allow for share trade settlement to occur in near real-time, rather than having to wait two days for settlement.

This explains why several exchanges, including our own ASX, are looking at distributed ledger technology to replace ageing central depositories such as CHESS.

Elmer Kupper says the backbone technology and its value to consumers is real.

He believes the technology will survive, but Bitcoin as a digital “currency”, will not.

 

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