The US department of justice took a soft position on virtual currencies at the senate hearings last month. Libertarians, investors, regulators and critics have different views on how Bitcoin should be handled. The European Union’s banking watchdog and many countries including France and China have called Bitcoin “highly speculative”. The two most common views on Bitcoin tend to be either a speculative bubble or a future currency.
A speculative bubble is typically defined as a phenomenon when the price of a security or an asset rises so sharply, based on over-exaggerated expectations, that the price far exceeds valuations that can be justified by fundamentals, making a sudden fall in price imminent – the point at which the so called bubble ‘bursts’. Critics dismiss Bitcoin as a ‘speculative bubble’, as the rise in Bitcoin’s price is to a large extent based on expectations of future growth, price appreciation and coin hoarding.
A research paper by Princeton University states that speculative bubbles are accompanied by large trading volumes and high price volatility, based on overconfidence and optimistic beliefs. These are all characteristics that we are seeing in the Bitcoin economy today. A recent Forbes article compared Bitcoin price to Dr. Jean-Paul Rodrigue’s archetypal bubble stages chart.
Bitcoin may well in a bubble but having said that, despite negative connotations of the term ‘bubble’ – the existence of a bubble does not in itself discount the value of an underlying asset. Amazon.com stock was in a bubble in the 1990’s, the price rose sharply in 1998 based on analyst predictions, exhibiting all characteristics of a bubble, and then came back down. The bubble did not undermine the underlying value of Amazon’s business. Bitcoin’s technology could prove to be an efficient payment system in the long term (Ben Bernanke agrees). Earlier this month, Bank of America analysts valued the price of a Bitcoin at $1300 and said “Bitcoin can become a major means of payment for e-commerce and may emerge as a serious competitor to traditional money transfer providers”.
A fiat currency derives its value from the fact that it is issued by the government as a formal legal tender. But what makes one currency stronger than the other? One of the many reasons is that a lot of people believe in that currency and are willing to accept it as a form of payment. One of the reasons why Saddam Dinars did not work as intended was that people were not willing to accept them. Swiss Dinars stayed in circulation without formal government backing because people believed in the currency and used it as a medium of exchange.
I believe Bitcoin serves a different purpose from fiat currency. As a medium of exchange, Bitcoin has several advantages. Credit cards companies and Paypal charge per transaction fees that make micro payments virtually impossible. For example, a publisher can not charge 10 cents for reading an article if payment processor charges 20 cents for processing the payment. Most media websites that host content rely on advertising as their primary source of revenue, while others rely on a subscription based model. Every so often I land on Financial Times website, but I can not read the full article without an FT subscription. Apple gets around the issue by using its own payment network; however, that is not an option for small publishers who do not handle the volumes that iTunes handles. Bitcoin micro-transactions could open up new media models for publishers, allowing publishers to charge the visitor a small fee for reading an article, watching a video or downloading a file. Having said that, Bitcoin as a medium of exchange is still very small in size and limited in use. Compare Bitcoin’s 42 transactions per minute to Visa’s 165,000 per minute to get an idea of the size of the Bitcoin economy.
Bitcoin will also impact the traditional e-commerce industry. Lower transaction costs and absence of fraudulent chargebacks would encourage merchants to accept Bitcoin. Price volatility can be mitigated easily as payment processors such as Bitpay allow merchants to convert Bitcoins to fiat currency almost instantly, so merchants do not have to hold any Bitcoins if they do not want to. Merchants will incentivise consumers by offering discounts on Bitcoin transactions. It would work well for both the merchant and the consumer, as the merchant could pass off some of the savings made from lower transaction costs to the consumer, and the consumer would get the product cheaper by paying with Bitcoin. There are other incentives for consumers such as not having to share credit card details on the merchant site and anonymity.
I think Bitcoin will impact the $500 billion international money remittance the most. For example, to send money to Kenya, Western Union and other money transfer companies’ charge 8 to 10% of the amount being sent. Bill Gates wrote about a mobile service called M-Pesa that is being used in Kenya by millions of people for storing and transferring money. I believe Bitcoin opens up a huge space for disruption in money remittance, and I see Bitcoin as more of a payment system than a currency; it’s an open ledger and a platform for innovation. Bitcoin is more of a disruptive technology, a platform on which businesses will be built.