Written by: Santhosh Abraham, Faculty Program Director for Accounting and Finance
Author’s Note: The information in the article is correct as of the date of writing, 1/17/18.
Bitcoin currency is generating much interest. In its introduction in early 2009, bitcoins were worth almost nothing, but their value has soared over the past few years. In early January 2015, a bitcoin was worth around $280; in early January 2016, it had almost doubled to $444! At the same time in 2017, it was worth $986 and on the first of January 2018, it was worth a staggering $15,522. More recently, it’s value has dropped below $10K, however. For investors, The New York Times reported in 2017 that the top-performing hedge fund returned 148percent in 2016, while the Pantera Bitcoin Fund (a fund dedicated to virtual currencies) compound annual returns have been around 250 percent.
What Is Bitcoin?
A bitcoin is an electronic token that can be transferred from one user to another anywhere in the world. It refers to both the form of payment, as well as the network through which payment is made, and it is the most popular form of cryptocurrency in circulation. A cryptocurrency uses cryptography— secret codes and communications— to conduct transactions of its digital assets. Ethereum and Litecoin are examples of other types of cryptocurrencies, but they are not as widespread as bitcoin.
Who Regulates Bitcoins?
A central authority does not control bitcoins. This differentiates it from a fiat currency, such as the Dollar or the Euro, which is regulated by a central bank, such as the Federal Reserve in the United States. All bitcoin transactions are recorded on a central ledger that is shared by users, thereby avoiding the need for a third-party regulator. The bitcoin network and transactions are tracked by computers that compete to solve complex math problems in a process known as “bitcoin mining.” Miners are rewarded with new coins released into circulation every 10 minutes.
How Is the Price Determined?
Like any other open exchange, the price of bitcoins is determined by supply and demand factors and seen in the way in which stock prices fluctuate. As previously mentioned, the exception is that there is no central regulator. When bitcoins were first created in 2009, a limit of 21 million coins was set, which formed a ceiling in relation to the total number of coins that would be available. As of January 15, 2018, there are about 17 million bitcoins in circulation. This link provides information on bitcoins in circulation: https://blockchain.info/charts/total-bitcoins.
How Are Bitcoins Transacted?
A bitcoin exchange provides a means to buy and sell the currency. Coinbase is one of the more popular exchanges that help individuals transact in bitcoins by linking to bank accounts. To receive bitcoins, one needs to create a bitcoin address which can be done anonymously, and exchanges, such as LocalBitcoins, allow people to buy and sell bitcoins for cash without the need for any verification.
Are They Anonymous?
While all bitcoin transactions are tracked on a general ledger visible to all users, the users themselves are anonymous and identified by a unique identification number. However, this has raised concerns about its use for criminal activities such as money laundering and hacking. And bitcoin exchanges themselves can be hacked, as evidenced by the case of Mt. Gox. Mt Gox, the world’s leading bitcoin exchange, had to file for bankruptcy after the disappearance of 850,000 bitcoins valued at $450 million in February 2014, along with $27 million in cash (Cyberscoop, 2017). Unlike traditional bank accounts, bitcoin accounts are not insured by the FDIC and are therefore a riskier investment.
Other Concerns: The Bitcoin Bubble
While some big names, such as Microsoft and Expedia, accept bitcoins for payments, major retailers, such as Amazon and Walmart, do not. One major concern is whether bitcoins are experiencing a bubble considering the recent significant increase in value. Furthermore, the significant price volatility raises questions on whether bitcoin can be a store of value as one would expect with money. Plans by the Chinese, Russian, and South Korean governments to crackdown on bitcoin trading has seen prices fall recently (Independent, 2018).
It is still too early to tell whether bitcoins are the future of money, and opinions remain deeply divided. According to Peter Thiel, co-founder of Paypal, bitcoin has an important future: “I do think bitcoin is the first [encrypted money] that has the potential to do something like change the world.” But the perspective of Jamie Dimon, JPMorgan Chase CEO and chairman, is more pessimistic: “If you’re stupid enough to buy it, you’ll pay the price for it in the future.”