Bitcoin, the world’s largest and most popular cryptocurrency, has recently dominated the news cycle. Numerous articles comment on how much money you would’ve made if you invested only a year ago (739%). In fact, I first heard about Bitcoin in late 2013 when its price was around $130/BTC. $1,000 invested then would be worth $36,863 today. Shoulda, woulda, coulda…
For those that do not know, Bitcoin is a virtual currency that is math-based digital assets in which transactions can be performed cryptographically without the need for a central issuing authority. This has major implications. To learn the basics of Bitcoin, the best way to begin is to watch the official introductory video.
Full disclosure – I am not an expert on cryptocurrencies, but these two NYU professors are and they offer a great primer on cryptocurrencies here. Additionally, Bitcoin is not the only cryptocurrency out there. Other major currencies include Ethereum, Ripple, Litecoin, NEM, etc. For the purposes of this short post, I mention only Bitcoin as it is the largest and most widely-adopted cryptocurrency by a large margin.
IS BITCOIN CURRENTLY A BUBBLE?
Probably. Though, it was also a bubble in 2011, 2013, and 2014. So yes, it is likely a bubble. But that doesn’t mean it will disappear after the bubble pops, perhaps even declining by 50%-80%. For a bit of perspective, if Bitcoin were to fall 80% from its current levels ($4,792), it will still be worth $958. It is not unusual for something this young, especially an innovative technology, to experience wild volatile swings. It is still trying to find its place in this industry and speculators have have gotten in on this trade. But they can just as easily exit this trade when things go south.
So, what are the long-term implications of cryptocurrencies like Bitcoin? I think it is too early to tell. It is reckless to take a firm stance either way. But one cannot simply state that Bitcoin is a fad and that it is akin to the Snuggie blanket or the Furby doll. Bitcoin is too big and too important for it to disappear over the short-term. It has survived far too many pitfalls, such as the Mt. Gox bankruptcy disaster and the U.S government shutting down Silk Road. Bitcoin has, without a doubt, shown staying power.
THE ATTRACTION OF BITCOIN
Most Bitcoin enthusiasts prefer it over a fiat currency because it is decentralized and it offers anonymity. Their goal is for Bitcoin to become the currency of choice, beating out the U.S. Dollar, the Euro, the Yen, and others. This is a massive goal that governments will likely oppose, or at least attempt to control. No government will leave a major currency completely unobstructed.
On one hand, I can’t imagine living in the U.S., purchasing goods with anything but the Almighty Dollar, especially if that is a crypto-currency. On the other hand, the U.S. Dollar is simply a note issued by the Federal Reserve and its intrinsic value is established as a money by regulation. In other words, the U.S. Dollar is not back by anything except by the full faith and credit of the U.S. government. This allows the Federal Reserve to “print as much or as little money as it deems appropriate. There are powerful advantages to such an unconstrained system. Above all, the Fed is free to respond to actual or threatened recessions by pumping in money.” (Paul Krugman)
However, gold bugs often say that history has proven time and time again that all fiat currencies (which the US Dollar falls under this category) fail over time. However, this is not entirely true. The gold standard has failed over time, simply because “it prevents the central bank from fighting recessions by outsourcing monetary policy decisions to how much gold we have — which, in turn, depends on our trade balance and on how much of the shiny rock we can dig up.” (TheAtlantic).
HOLD ON TO YOUR HATS
So, what does the future hold for Bitcoin? As the currency continues to move higher up the adoption curve, it will likely face higher levels of government pressure, not just here in the U.S., but globally. And how governments respond to Bitcoin will ultimately define its future. Though, the biggest hurdle I see with Bitcoin is the inability for any regulating body to print as much or as little of the currency during times of economic strain. The freedom for a government to do this was the primary reason why the U.S. abandoned the gold standard in 1933 and cut the link between the dollar and gold in1971. This has absolutely helped keep the value of inflation more stable. Check out a great article that I stumbled across, aptly named “Why the Gold Standard Is the World’s Worst Economic Idea, in 2 Charts” makes a great point regarding price stability.
In light of these facts, I would imagine that any government operating a fiat currency system will have a difficult time giving up this type of control.