Bitcoin – An Asset Or Currency?

In the story of the evolution of money, we have come a long way from barter to cowries, coffee beans to coins, paper currency to plastic currency and the latest one on the line is “Bitcoin”. It is a “decentralised virtual currency” that took its shape after the subprime crisis of USA in 2008.

Ever since then, it has been awarded a number of hit and trials- being used a currency, in black marketing, round tripping, drug selling, hoarding (virtual gold) and as a ransom; as in case of ransomware attack by “wannacry”.

The latest proceedings about bitcoins suggest that it is a “valuable asset” rather than a “means of transaction”. While this question is open to debate, we will look at the various aspects of bitcoin and its utility, both as a currency and asset.

Blockchain and bitcoin

Bitcoin is an application of the Blockchain technology.

To put the understanding of Blockchain technology into simple words, let’s understand it through an example:

Now a person can check the history of this sharing of information by just viewing the exchange of codes in the public server.

Similarly, the bitcoins are used for the transaction of money. They can be used for transactions and payment of bills. The public server on which the history of transactions will be available is known as “public ledger”. This way, no person can perform “double spending”, which was the technical problem in earlier virtual currencies. This was solved by the use of Blockchain technology and it makes bitcoins a trustworthy virtual currency.

Why use bitcoin when we have dollar, pound, euro etc?

Because bitcoins are decentralised i.e. they are not controlled by any of the central banks of the world. Their rates are determined solely by the market conditions and demand.

After the subprime crisis of 2008, the Federal Reserve opted for a “hawkish policy”, the dollar was weakening. This gave rise to the demand of an unregulated currency by the anarchists and a man named Satoshi Nakamoto came up with the idea of Bitcoins.

If we can call directly, send texts directly then why do we need to trust a third party (a fiat currency) to complete our monetary transactions? This was the concern raised by the anarchists which lead to the creation of bitcoin. It is an open decentralized database of every transaction involving value, creating a record whose authenticity can be verified by the entire community by the use of Blockchain.

The bitcoins are obtained by solving algorithms, this process is known as “bitcoin mining” that leads to the generation of new bitcoins every time. This newly generated bitcoin can either be kept by the user or can be used to pay bills or can be transferred to another user. The other user can buy the bitcoin in his fiat currency, without actually performing the process of “bitcoin mining”.

Over the years, there were questions raised upon the exhaustiveness of bitcoins and it was made clear that only 21 million bitcoins can be mined, though they have been broken into a smaller entity called Satoshi (1 Satoshi= 10^-8 bitcoin).

With increasing popularity of bitcoins, people are eyeing to mine and own a greater number of them. This leads to a demand-supply constraint, the demand is more and supply is limited, so people are ready to pay greater amounts for bitcoins. These results in dwindling prices of bitcoins and their prices have risen exponentially since it was first introduced in 2009.

There has been a 140% rise in the price of bitcoin in 2017 itself and the demand is ever increasing. This surge in prices has resulted in “hoarding” tendencies of people. Bitcoins are being seen as a luring investment option especially after various countries have started paying attention towards bitcoins and are working towards their regulation.

Now the question becomes contentious whether they can be used as a currency or as an asset.

Bitcoins as currency

To define a currency, it is a unit of comparison for various goods and service. When barter used to be a mode of transaction, there required to be a “double coincidence of demand” which means that suppose I had wheat and I wanted tomatoes, I would have required finding a person with tomato, who wanted wheat so that we both could exchange it.

This is not required in case of a fiat currency- paper or coins. There is a definite value of wheat as well as a tomato; I can buy either of them, depending upon my requirement with the help of currency.

Is double coincidence of demand required in the case of bitcoins?

The answer is yes and no both. Yes; because the goods and services can be valued in bitcoins, so you need not find someone with same demand and supply. But, the number of users of bitcoins is very less, so they might not want to keep bitcoins. This problem will cease to exist when bitcoin will be in greater circulation.

The fiat currencies are regulated by the central banks of various countries. They depend upon a number of factors which include social, political and economic conditions. But bitcoin provide an option to its users to regulate its value. This can be done by speculating higher demands for bitcoins so that their price would rise.

People in distress also take a resort in bitcoins, like in Venezuela where there is hyperinflation of about 720%, people are concerned about the price of their currency- Bolivar. The people in the country have been investing heavily in bitcoins, so as to gain some confidence in transactions and payments as there lingers distrust in their currency.

While its volatility might sound like an advantage, it is one of the biggest drawbacks of bitcoins a currency, the other being its delayed payment. The “great bubble of 2011” displayed the risk attached with the volatile pricing of bitcoins. In 2011, it saw a dip of 68% in just four months after which many people speculated that the time of bitcoin has come. Apart from that, it was being used for many black marketing and terrorist activities which brought it under the glass of suspicion. A payment or transaction is not done instantly like RTGS or credit/debit card payments. The reason is that corresponding bitcoins are mined before they are used for the transaction. As the number of bitcoins will increase, the transaction can be made faster.

Bitcoin as an asset

The most viable option for a user to enter in the bitcoin market is the electronic exchange. So new and more users will be registering there and getting bitcoins in exchange of their domestic currency.

Assuming that bitcoin is used as a “digital currency”, there should be an increase in the bitcoin network transaction volume because as more people would be acquiring bitcoins, they’d be using it to buy goods and pay for services.

Following this correlation analysis, it is clear that if a user wants to use bitcoin as an asset, he will just get registered to buy a bitcoin and will not enter the bitcoin transaction system as he is not trading anything. This is, in fact, the most common practice! Various evidence suggest that most of the first time users of bitcoins usually keep it in the wallet instead of using it for further transactions speculating price rise in future.

This analysis pushes governments to research whether bitcoins are actually being used as a currency at all? This is perhaps the reason why most countries are rendering bitcoin as a “valuable asset”. Following is the stand of various countries about bitcoins-

 

The hypothesis of bitcoins as being used an asset can also be supported by the fact that no negative news of bitcoin, whether regulation by central banks, security issues or infrastructure failures have affected the purchasing of bitcoins because all the users can see is the sky-high prices of bitcoins which is ever rising. Even if the situations are moving against them, they tend to hold on, in the purview of the expected rise in future. They are not even interested in the three distinguishing features of bitcoins- ease of bilateral transactions, anonymity and security as they are not actually using the network. Finance pundits even render it as the next investment option, after gold which makes it the “virtual gold”.

As people become aware of the bitcoins and its investment capabilities, they buy number of bitcoins, which is evident from the following graph:

Conclusion

The earlier digital currencies were usually operated by the central banks, so they were an online mode of payment and were still being regulated by a central authority. They also suffered from the drawbacks of limited usage, like online gaming, grocery shopping. The ones that were not controlled by the central banks had the problem of “double spending”.

Bitcoins were a major breakthrough that solved all the concerns of former digital currencies.

Its volatility, regulations by various governments should be taken into account when we are exploring the option to use it as an asset. Evidence show that it is being used as more as an asset rather than as a currency. The regulations should provide a safeguard to the investors as the bitcoin market values 14 billion dollars currently.

In order to make it a better currency, the loss of private key should be made recoverable. Alongside, an end to end encryption of transactions should be done, in order to provide security to the system. They need to be made faster in the transaction as well.

Bitcoins can be a “currency of future” and make transactions easier, provided that it is used more as a currency.

[This article has been contributed by Shruti Pandey]