What the FinTech is Bitcoin?

Posted: 6th May 2017

Overview

A currency more volatile than the annual fluctuations of global currencies? You’d be mad to go anywhere near it. But for millions globally, they can't get enough of it. Bitcoin (BTC) again claimed the title of best performing currency in 2016 after it more than doubled in value (126% gain). The closest competitor was the Brazilian Peso with a “mere” 21% gain. This is not an anomaly though. It has held the title every year since its creation in 2008 (except 2010).

The graph below illustrates BTC’s meteoric rise in value against the USD from around $200 to $1200 (April 20, 2015- April 20, 2017)

Source: winkdex.com

What is Bitcoin?

Bitcoin is a cryptocurrency, but this answer raises more questions than we started with. Essentially, a cryptocurrency exists without the support or regulation of a central bank. Instead, its control comes through a series of complex algorithms and encryption techniques.

BTC is produced through a process known as mining. Anyone can mine BTC from home using a particular computer setup although the process is long and somewhat unrewarding especially nowadays. While over 16 million coins have been mined since the creation of BTC in 2009, only 5 million will be mined until 2040. The creator of BTC capped the supply at 21 million.

Once a Bitcoin or part thereof is mined, it is transferred to a “wallet”. BTC can then be transferred to any wallet anywhere in the world almost completely anonymously - this is where some controversy arises. Wallets can be opened in seconds. Unlike bank accounts there is no lengthy identity verification process meaning anyone, anywhere can use Bitcoin. The disadvantages of which are obvious and will be covered below.

Why are they valuable?

BTC is owned as a speculative investment for many although this is not their only function. Increasingly, BTC is being accepted as a method of payment for day to day transactions. To complete a transaction, the balance is scanned by a smartphone wallet app and the corresponding amount in Bitcoin is transferred to the new account. It may seem overly complicated but may be useful when travelling (eliminates the need to exchange currency) as well as providing anonymity.

In late March, the Japanese government officially recognised BTC as legal tender. From 2015 to 2016 the number of stores accepting Bitcoin grew from 900 to 4 200. Following the government’s recognition, one of Japan’s leading point-of-sale transaction management services, Recruit Lifestyle, announced it would enable Bitcoin payments in its systems increasing the number of stores who could accept bitcoin by 260 000. Though this is only one country, it illustrates not only the willingness of governments to embrace cryptocurrency but also provides a blueprint for other countries to follow.

Limitations

The level of anonymity often spurns controversy regarding the cryptocurrency and acts as a threat to its long term value and usefulness. While many users enjoy the benefits of the anonymity solely for their own personal privacy, this anonymity can be exploited. Bitcoin is an accepted and seemingly popular method of payment on online illegal marketplaces such as Silk Road which allows merchants to sell just about anything from drugs to weapons. Since BTC is almost completely anonymous, customers are able to buy such products without being traced. This limits the long term adoption of BTC as governments may become hesitant to support something they have so little control over. Although cash shares this issue of anonymity with BTC, governments have developed procedures to trace currencies including unique identification numbers. While illegally buying drugs online may only represent a minor use for Bitcoin, it presents a very real and effective way to hide black money as well as providing a means for more large scale drugs and arms trades. Despite the presence of anonymity, investigators, with the aid of those who built bitcoin platforms, are slowly working towards tracing transactions back to the parties involved.

Moreover, given so little is known about BTC by the everyday public, its wide scale adoption is limited. People don’t have confidence in this virtual currency as the statistics below illustrate. Part of the problem stems from the fact that nothing physical is held.

Source: http://www.pbs.org/newshour/rundown/americans-unfamiliar-wont-use-bitcoin/

Note, the above statistics are from 2014 so attitudes and knowledge have likely changed since.

Another limitation is the instability surrounding BTC storage and threat of cyber attacks. As has been established, BTC is stored in wallets. Mt. Gox was the worlds’ largest BTC exchange until 2014, handling 70% of transactions. In February 2014, Mt. Gox filed for bankruptcy following the theft of 850 000 BTC from their wallets. Only 200 000 BTC were ever recovered following the theft. The obvious issue is the vulnerability of wallets especially when controlled by the biggest exchange in the world (Mt Gox at the time) - another factor limiting the growth and adoption of bitcoin.

Bitcoin Electronically Traded Fund (ETF)

A potential solution to the shortcomings of BTC is an ETF. An ETF is essentially an index of shares, commodities or currencies traded on securities exchanges. While shareholders of ETFs do not directly own the contents of the ETF, they still receive benefits such as dividends.

A pair of Harvard educated, Olympic rower twins were the major drivers of a Bitcoin based ETF - the Winklevosses. The ETF would allow regular traders to be a part of the BTC market, avoiding the risk of holding an actual bitcoin (wallet hacking for example) as well as allowing the option to short BTC. These are merely two benefits. Ultimately, the ETF was rejected by the Securities and Exchange Commission (in February) because it did not meet the diversification or classification criteria and with it came a 20% price drop which has now been recovered.

The above provided a basic overview of what BTC is as well as a brief history. Is it the global currency of the future? If it is to become the next big thing it has many issues to iron out- this will take time. For now, we can only speculate. You can get involved for as little as $10. There is a BTC ATM (BitRocket) in Surry Hills which lets you buy BTC with cash. With some predicting a rise to $40 000USD over the next few years, it may be worth a punt.