Recently we updated an analysis on Gold that focused on it as an investment in several different ways: fundamental, technical and momentum. The allure of gold as an investment is as strong as the length of time individuals have invested in the metal.
However, there may now be a contender to gold as an alternative currency. Interest in Bitcoin (Bitcoin), the code-based currency, has grown in enthusiasm up until the recent money laundering allegations by the CEO of the Bitcoin exchange along with two cyber-attacks.
Still, there is reason to believe that Bitcoin will grow in predominance. We decided to take a look at what it will take for this to happen.
Background on Bitcoin
First and foremost, Bitcoin is a currency. For any currency to operate effectively, it requires trust between the two transacting parties. During colonial days, individuals completed transaction using oyster shells. Now we complete transactions in dollars, yen, euros, etc. What makes any one of these currencies any more trustworthy than the next?
Bitcoin will have to see improvements in the code base and the network configuration for cryptocurrencies to persist. What really makes this system amazing is that the open architecture lends itself to fast advancements, just like other applications on the Internet.
Bitcoin as an Investment
While Bitcoin was developed as a currency, its notoriety is much more as an investment rather than a means of transacting. It seems to have grown in prominence with speculators who are seeing the rise in its value. In many ways, people view Bitcoin as a way of investing in the future of an ecosystem and a technology.
The rise of Bitcoin is evidenced by a few statistics:
- Daily Transaction Volume – In US Dollars is averaging between $40 and $100 million dollars.
- Number of Daily Transactions – Is just about 70,000 transaction a day, indicates Blockchain.com
- Price chart – This shows the price in U.S. dollars. This is basically and exchange rate.
- Market Cap – This is the total number of Bitcoins times the price. The market cap peaked in December 2013 and has been declining. You can also see that the volatility has increased since December 2013 as well.
Bitcoin as Currency
Whether it was the novelty of a new currency or the fact that the momentum became so great, ultimately Bitcoin was developed to make transactions easier. The currency itself is not based on anything other than silicon and networking. The proponents argue that because it is based on a defined algorithm, you don’t have the unintended consequences of quantitative easing. However, to get past the alpha users and move into mainstream circulation, the network would have to gain trust in the transactional utility. To become a common currency, it would have to gain significant trust.
This is more likely to happen in countries and systems where trust is lacking. For example, in a recent article in the March/April 2014 issue of CFA Magazine, Andreas Antonopoulos author of Mastering Bitcoin, and co-host of the internet radio program, Let’s Talk Bitcoin, described an interaction between two late 60-year-olds in Argentina, a country that is rifled with uncertainty and trepidation about its currency. This type of uneasiness gives greater adherence and willingness to transact in a separate currency.
I witnessed a couple of gentlemen in Argentina exchanging escrow funds for an apartment through Bitcoin. They were transacting an entire apartment – just over US $1 million – in Bitcoin. While they were residents of Argentina, they both had their funds outside the country in U.S. bank accounts. The idea of doing that large of a transaction with wire transfers and the resulting costs and counterparty risk was too much, so they actually did the transaction in Bitcoin…. That transaction may have saved them between $100K to $150K in fees and costs.
This size of transaction may not have occurred in the United States, due to the stability of the economy and currency. Individual and businesses within the US are not ready for commerce in Bitcoins because the dollar is the world currency and has yet to experience hyperinflation. However in Argentina, it is much more likely. If a country has an unstable currency, the money is likely in the process of devaluation and residents may be much more willing to take a chance on Bitcoin.
Is Bitcoin Just Another Fiat Currency?
Most modern-day currencies are built behind the trust of a third party to make good on their commitment. Unlike most fiat currencies today, there is a limited supply of units provided. As a result, Bitcoin is favored by those who prefer a standard monetary system that is based on a fixed amount of units, like gold.
The reality is that is will only work as a currency to begin with on the fringes, primarily in emerging economies and smaller banks looking to make a difference.
What Bitcoin will look like in two years is very different from what it is today. How great of an impact to decentralized currency and the development of a cryptocurrency will this be? We will just have to see.