Is Bitcoin the New Kleenex?

Boston University Finance Professor, Mark Williams, in a published Forbes article today, suggests that Bitcoin will become a shorthand name for digital currency, equivalent to Q-tips for cotton swabs, Kleenex for tissues and Xerox for copies.  Bitcoin is the next “BIG” thing, but Bitcoin is NOT a stock, bond or even company. Rather, it is a virtual currency. In 2013, Bitcoin cost $13/coin, today it is at $864.70/coin. Many speculate that Bitcoin could reach unprecendented values for coins ($100,000) due to a finite amount that can made (21 million to be exact). So, WHAT is this crazy phenomenon called Bitcoin and is it here to stay or is it just speculative?

 

According to Bloomberg Businessweek,

“Bitcoin is the digital currency that thrills nerds, inspires libertarians, and incites the passions of economists who debate the value of money made from nothing but ones and zeroes.”

Bitcoin’s main selling point is that it is decentralized and does not have to go through a clearing house. Bitcoins are “made” on the internet, by mining (a free application that allows you to create these things, albeit not easily). Bitcoins are adjusted by the network site to ensure that the amount is predictable and limited (think supply and demand analysis here in order to keep prices increasing for investors, supply must be increasing slower than demand).  Supply can only expand 25 Bitcoins per 10 minutes. You can use Bitcoin not only as an investment vehicle, but also to pay for many items on the Internet such as food, clothes, toys, computers etc. However, what is the incentive for a company, like Target, to start accepting Bitcoins for payments? Well, Bitcoin charges no fees, so accepting them is financially free, unlike using Google’s payment system or Visa. Further, many exchanges have popped up so a store that accepts Bitcoin, such as Target, can convert Bitcoins into dollars or euros.

 

With nearly a 64% return in a year, Bitcoin is drawing lots of attention, but many question whether it a ‘real’ thing since it closely resembles a commodity, yet, the government is not involved in regulating it.  Investors are putting faith behind Bitcoin because it is fully open-sourced. This means anyone can verify the source code and know exactly how Bitcoin works. Payments can be made without a third-party system and to ensure no fishy business is going on there are peer-reviewed cryptographic algorithms to verify the payments. Remember when I said you can actually “mine” or make a Bitcoin, but it wasn’t easy? Mining is making cryptographic algorithms that certify transactions before anyone else can do it to earn Bitcoins as a payment.

“It’s like a worldwide math competition that resets six times an hour. There are a total of 21 million possible Bitcoins; about half are currently in circulation. The last will be mined in about 2140 at the earliest.”

To be clear, each new algorithm that is computed to verify a transaction makes it more complicated to solve the next algorithm. How complicated are things getting? Well, in 2010, ordinary desktops become too slow for the mathematical crunching needed. Large computers are required to mine the data with savvy math and computer knowledge required to keep up with the mathematical coding. However, 10 minutes of your time can pay 25 Bitcoins (~$25,000).

Also, in terms of trusting Bitcoin, no one organization or individual can control Bitcoin, or so the site’s fact page boasts. However, 47 people own 29% of all outstanding Bitcoin; and 75% is owned by just 10,000 people. The last 25% is owned by roughly a million small investors. In comparison to Google, 1,667 institutions hold approximately 87% of Google shares in which these institutions (such as Vanguard, State Street, J.P. Morgan Chase) each have millions of individual investors. So, are the elite few that own Bitcoin the ones speculating and really driving up the prices? Many countries seem to think so. Bundesbank, Germany’s central bank, is warning people of the speculative risk or in other words irrational exuberance behind the stock’s inclining value. China went ahead and blocked the country’s Bitcoin exchanges from accepting new Bitcoin “cash” and banned anyone from accepting Bitcoin trades.The EU even warned that they will take no part in bailing out losses from Bitcoin and warned against the investment.  The U.S. so far has not made such a bold statement, but economists everywhere are collecting data. In a National Bureau of Economic Research (NBER) working paper, economist David Yermack shows that Bitcoin is more volatile than any sovereign currency and does not serve a traditional money role as a unit of account or store of value, although it is performing as a medium of exchange.  Based on the volatility of Bitcoin, he claims that the inclining in values are due to speculation and not actual value that people should put faith in.

Based on economist predications, I think there is still time to invest and make some money, if you have $864.70 for one Bitcoin that is.  With the potential returns high and intellectually stimulating work, computer geeks, math whizzes and technology gurus are flocking in droves to mine for Bitcoins first.  A start-up company claims that one fast computer working to come up with these algorithms can yield approximately $150,000/year.  Therefore, I see no reason in the immediate future for Bitcoin to run dry since demand is very high right now, while supply can only make incremental, steady increases. However, in the long term I do not think Bitcoin is a viable alternative to dollars as it stands little chance to run free too long. With high profits to be made, everyday citizens are not just the ones who want in, but surely the government will, too. Taking a cut of the profit from investors in Bitcoin clearly takes away the competitive advantage Bitcoin serves as an Internet marketplace currency.

If you want to buy Bitcoins or learn how to get some, here is a pretty good site to help you get started.

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2 thoughts on “Is Bitcoin the New Kleenex?

  1. Pingback: SolarCoin: The “GREEN” Bitcoin? | Economics & Institutions
  2. Pingback: Troubles in Paradise for Bitcoin | Economics & Institutions

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