Bitcoin: Bubble or paradigm shift?

This week, Bitcoin breached the $12,000 mark for the first time. The total value of all Bitcoins is now approaching $100bn. Nine years ago, this phenomenon didn’t even exist. As of now, it has rocketed from the remote fringes of finance into the global spotlight at breakneck speed. In 2017 alone, its value has risen tenfold. In fact, it has more than doubled in just the last couple of months.

So, what on earth is Bitcoin? And is it a bubble waiting to burst, or the dawn of a new, enduring era?

Understanding Bitcoin and cryptocurrencies

In 2009, and on the back of the worst financial meltdown in nearly 80 years, the first ever cryptocurrency, known as Bitcoin, was invented. Initially, it was the preserve of tech boffins who had to ‘mine’ the virtual currency using Blockchain technology. But today, it’s direction of travel towards the financial services mainstream is exemplified by the fact that it can be purchased by anyone via debit or credit card from specialist exchanges.

As is the case with subsequent cryptocurrencies that have followed, it is stored online in a digital wallet, and can be used to pay for goods and services whose provider has a wallet of their own, and accepts Bitcoin as a medium of exchange. It can also be exchanged for traditional currency. Or, it can simply be purchased as an investment. And for those who got a foot in the door a few years ago, a very lucrative one at that.

Is the boom sustainable?

The recent gold rush has largely been fuelled by increased involvement of institutional investors and hedge fund managers, with their esteemed endorsement seen as having a self-fulfilling effect. Nevertheless, there is widespread concern that the exponential growth in Bitcoin’s value in recent times is unsustainable, and that it is only a matter of time before the bubble bursts. The implosion of the so-called dotcom bubble in the year 2000 offers a sobering precedent, which is still fresh in many people’s minds.

One of the fascinating elements of Bitcoin is that, owing to complex algorithms generated by its creator, Satoshi Nakamoto (a pseudonym), there can only ever be 21 million Bitcoins in circulation. In this respect, it boasts scarcity – something which is not true of traditional currency, whose supply is typically controlled by central banks. As such, there is no money creation. There is no inflation. And there is no scope for corruption, given that it is a wholly decentralised, securely-traded asset.

It is possible to purchase as little as 0.00000001 Bitcoins, which does put the ideal of scarcity in perspective. Then again, more than three quarters of the allotted 21 million Bitcoins have already been mined, so who knows what effect the inevitability of the full complement being in circulation will have on value.

Yet the volatility of Bitcoin was put into sharp focus this week. There is grave concern that cryptocurrencies are a great enabler for illicit activities such as drug dealing and prostitution, given that they afford near-complete anonymity to traders. It was thus always likely that regulators would seize upon Bitcoin and the likes, and the Treasury (along with other EU equivalents) announced a crackdown on digital currencies on Monday, stating that trader identities will need to be disclosed, and regulation of activity brought into line with anti-money laundering and counter-terrorism financial legislation. As news filtered through of these developments, Bitcoin’s value dived by over $1,000. Even though it has since recovered that lost ground (and then some!), it might be interpreted as a warning shot for enthusiasts who are considering putting their bottom dollar into the cryptocurrency.

What about blockchain?

Blockchain technology is a digital public ledger, which takes the form of data-structure blocks containing masses of individual cryptocurrency transactions. The key benefit behind it is that digital currencies can be traded securely (and anonymously), as it creates an indelible record that cannot be altered, and thus does not require any centralised authority to verify its authenticity. It is also highly efficient, and thus very cheap to operate.

It was originally developed as the accounting method for Bitcoin, and is still primarily used as a means to record cryptocurrency transactions. However, blockchains have since expanded to various commercial spheres and channels, as any type of document is theoretically compatible with the technology. As such, Blockchain’s scope for growth is widely considered to be limitless, given that the technology can be incorporated into realms beyond financial services. Ultimately, it isn’t just a means to facilitate the movement of money – it is an append-only database (with immutable data storage) with secure, time-stamped data which can be publicly audited. The extent to which such data protection properties can be augmented into other aspects of business and industry remains to be seen, but one thing seems certain: blockchain is here to stay.

Embracing a new world

For those who are less au fait with such advances in technology, it can all sound a bit confusing, and, even intimidating. But while the sustainability of Bitcoin’s performance is open to question, there can be little doubt that the technology behind it is enduring; and, if harnessed and regulated appropriately, can be a force for significant good.

After all, the weaknesses of the incumbent financial and banking systems have long been in evidence – fractional reserve banking to name but one. Any innovations which can legitimately reduce our dependence on central authorities at the heart of this, and carve out safe, stable and efficient alternatives, will improve the health of our economy no end.

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