13 Apr 2013

My 2 bits about the Bitcoin phenomenon

Raj Bhatt

There is a lot of discussion about the BitCoin, the digital currency which is to be issued in finite quantity (21 MM Bitcoins in the next few years). The BitCoin has seen a sudden rise (and then a significant reversal) in its value over the past 2 months.

People who try to justify the value of the BitCoin point to its advantages:
1) Frictionless medium of commerce, devoid of banking interchange fees
2) Ability to conduct commerce across borders and circumvent local governmental/regulatory money restrictions

This logic holds good if the BitCoin holds its value over time or has a mildly increasing value over time (as was the case from its inception till early April 2013). Merchants who held the currency had the added advantage of BitCoin appreciation in addition to the 2 points above.

But the last few days (the decline from $266 to $120 per BitCoin) shows the risk of this ‘asset’ for merchants. Imagine a merchant that sold a widget worth $266 for a Bitcoin at the peak of its value. If the merchant held on to the BitCoin and exchanged it for dollars today, he would have to take a loss of more than 50%!

Clearly the lack of stability is a bigger negative than the 2 points noted above (unless you are a merchant in a country where you are willing to take the risk of getting an X% lower payment in an international currency than your local currency).

Thus I feel the usage of the BitCoin for international commerce will diminish.

Some of the latecomers to the party don’t seem to fully comprehend the economics of this ‘asset’. They think that the finite liquidity of the BitCoin, along with the divisibility of the BitCoin (upto 0.00000001 Bitcoins) make this a viable ‘asset’ class and medium of exchange (along with points 1 and 2 noted above).

I think the whole BitCoin phenomenon is similar to the Dutch Black Tulip bubble in the 17th century.

Companies that solve complex problems are issued BitCoins (similar to lucky or meticulous Dutch farmers who produced a single deviant tulip). This process is called ‘mining’. These ‘miners’ are the only group of people on the planet who are given economic benefits by a herd of cheering ‘investors’, for doing an activity that adds no economic value to humankind (solving meaningless math problems).

I think this is going to end badly unless the Central bankers/ Governments caution investors against the perils of this digital tulip.

Bitcoin, black tulip, value

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