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Mehreen Mir

ECON 3312
Professor Kiser
14 Dec 2013
Bitcoins Virtual Currency or Risky Asset?
The Economist wrote an article called Digital Money: The Bitcoin Bubble on
November 30, 2013, explaining the virtual currency of Bitcoin. Bitcoin is a virtual
currency created in 2009 that is not backed by any central bank or government. It is
mined or created through computers solving complex mathematical problems. The first
to solve the problem gets to add their block to the blockchain, which is a global shared
register, and receives credit in Bitcoins. It is a solution to the problem of double
spending that fiat currency can face. Bitcoins are also not under any single entitys
control, so there is no political pressure to increase or decrease the supply of the
currency. It is all controlled through cryptographic software.
Bitcoins, however, may not fall under the definition of a currency. It is money,
because it is a medium of exchange, unit of account, store of value, and standard of
deferred payment. The problem with Bitcoins being a medium of exchange is that it is
not accepted universally. It is still a relatively new form of payment, and many
businesses have yet to accept Bitcoins as a form of payment. Another risk of using
Bitcoins as money is that it has no backer. While the dollar is merely just pieces of
paper, it still is a store of value because it is backed by the United States government. If
the value of Bitcoin falls, there is no Federal Reserve System, or any central bank to
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save it. At the same time, if you do not back your digital wallet with your Bitcoins, and
your computer crashes, you also risk losing your money.
Bitcoin has a supply cap of about 21 million Bitcoins to support its price. This cap
is programmed into the Bitcoin virtual market, and as the supply of Bitcoins gets closer
to this cap, the mining of Bitcoins becomes increasingly difficult. The benefit of the
supply cap is that there is no endless supply of the currency that could cause inflation
due to an oversupply of money. However, the price can still be threatened from
competitors creating similar virtual currencies.
There are advantages of using Bitcoins, or any virtual currency. The transaction
fees for merchants and businesses is much lower than using credit cards such as
American Express and Visa. It is also a much quicker way to transfer money globally,
and more reliable. While there is anonymity in the transactions, every Bitcoin
transaction is stored to ensure there is no double-counting.
The early success of Bitcoins, and the high risk, high reward causes many risk-
taking investors to use it as an asset to invest in, instead of using it as a medium of
exchange. In order for a good to be money, it must be a unit of account, medium of
exchange, store of value, and standard of deferred payment. The problem with Bitcoin
is that its value fluctuates every day, causing it to be very volatile. It is also cannot be a
universal currency, because it is not a generally accepted medium of exchange. Many
businesses do not accept Bitcoins, but some are starting to because it has cheaper
transaction costs than using credit cards. It is also easier for transactions globally,
because one party does not lose money from the exchange rate that they would lose if
the two parties were using different currencies.
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It does have an anonymity factor that can help facilitate illegal activity, because
although the transactions are stored, fake addresses can be used. Each owner of the
Bitcoin has an individual key to access their own virtual wallet, so no other person can
freeze or seize the wallet unless they prove it belongs to the criminal. Because of
financial innovation, there is not much regulation surrounding the world of Bitcoin and
virtual currency. The policy makers are most likely stuck in the data lag and recognition
lag stages of policymaking, because they are still trying to understand Bitcoin, and the
regulation it needs.
Two-thirds of global Bitcoin transactions occur in China, because investors are
interested in diversifying their assets. Due to their closed capital account, investors do
not have much alternatives besides real estate and domestic bank deposits. Recently,
China has banned the use of Bitcoins by financial institutions, and any online Bitcoin
exchanges must have trading records. The European Banking Authority has also
warned against the risks of buying Bitcoins, because their value is not stable, and the
virtual wallet the Bitcoins are stored in could be hacked. Theft of bitcoins is already
occuring, and some Bitcoin bank accounts have been shut down due to not following
U.S. regulations already in place. It is also difficult for the state and federal government
to prosecute individuals who steal Bitcoins, because this occurs over cyberspace, and
not through tangible items.
The value of Bitcoins fluctuates from publicity, and media hype, as well as government
provisions. When the U.S. Senate said that virtual currencies were a legitimate
financial service, the value exponentially increased. When China passed the new
mandate stating banks were banned from using Bitcoins, the value decreased. The
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other problem with Bitcoin as currency is that money is not meant to be hoarded,
waiting for the value to increase. It is meant to be spent and facilitate transactions, and
make the economy rich as a whole, not just the early investors of Bitcoin. This hoarding
makes Bitcoin less of a currency, and more of a risky asset to invest in. The price has
increased from less than $15 in January 2013, to almost $1000 by the end of November
2013. Some believe that Bitcoin is a bubble that will burst, and those still holding onto
it will lose greatly. Bitcoin may not become standardized currency, but it has brought
financial innovation and revolutionized the world of virtual currency. There are already
new virtual currency competitors, such as Litecoin, Peercoin, and Anoncoin, which try to
fix the limitations and problems that Bitcoin has. The invention and refinement of virtual
currency will increase, bringing increased financial regulation along with it.