Dr Wafa Sbaiti
A boy asked his dad to buy him 1 bitcoin as a present for his birthday. Dad: “What? You mean $15,554 for a birthday present? $14,354 is a lot of money young man! What do you need $16,872 for anyway?”
Unless you’ve been living under a rock for the past year or so, you must have heard of bitcoin. The digital currency has been making headlines everywhere and one of the most searched for terms on Google in 2017.
The crypto currency has greatly exceeded all expectations and risen to levels that no one could have imagined. However, bitcoin has also received a good deal of criticism, mainly because of its highly volatile nature. If you’ve heard of bitcoin but don’t know enough, this article will help you get up to speed with the crypto currency mania that is sweeping across the world.
What is bitcoin
At its core, Bitcoin is a currency that is based entirely online. Bitcoin was started in 2009 by programmers and technology geeks, mainly from Japan. Though no one is quite sure of who was the original creator, the mysterious name of Satoshi Nakamoto is often credited for having designed the system. Mining operations and transaction servers were set up first in Japan followed by US and elsewhere. According to crypto experts, Bitcoin started as a hobby for tech-geeks more than an attempt to create a digital currency.
Bitcoin supporters claim that it has all the characteristics of regular fiat money. It is a store of value, medium of exchange for trading and easily measurable against other commodities. It is divisible into smaller units and a liquid asset.
The block chain technology
Bitcoin is based on the block chain technology. Block chain is a ledger of accounts that records how many bitcoins are in existence and who owns what amount. The ledger is maintained by a network of bitcoin servers spread around the world. Every time someone tries to make a transaction in the currency, a query is sent to the network to authenticate it. Resolving the query requires solving a complex mathematical equation.
The first mining server that resolves the query in the most efficient manner authenticates the transaction and adds it to the ledger as a new block. Computers on the whole network then update their own record.
In order to get bitcoin, you need an ‘electronic wallet’, which is a bitcoin address specifically assigned to a person. You can get bitcoin by mining or buying them from someone who already has some bitcoins to sell.
The fluctuations in bitcoin
The one good (or bad?) thing about internet is that it speeds up everything. Bitcoin is based entirely online and the quick-paced nature of the internet affects it as well.
Bitcoin was designed to be a decentralized form of currency and there is no central bank or government to control the money supply. This is the reason why the crypto currency is more susceptible to rising and falling demand. Its value goes up and down more than any other fiat currency in circulation.
The Bitcoin protocol also makes it impossible to add more Bitcoin into the ecosystem to cope with rising demand. The maximum number of Bitcoin that can be added through mining is fixed at 21 million and the number that gets mined every 10 minutes diminishes with time. The value of Bitcoin is completely dependent on the market’s demand factor.
When there is an upsurge in demand due to rising awareness and interest, the price shoots through the roof, which can be good for investors.
When people start selling because of bad news in the media, no central authority can step in to keep it from falling which is equally bad. Bitcoin perfectly incorporates the free market economic model which makes it a libertarian dream come true. But this also makes the currency very volatile and a risky proposition invest and hold.
The risks associated with bitcoin
Bitcoin skeptics give four main reasons to be wary of the digital currency. First, many skeptics have pointed out that the currency is made entirely out of thin air. It is nothing more than a record of historic transaction. Some CEO’s and financial analysts have called it a ‘fraud’ and compared it to the Tulip Mania craze that gripped the Dutch during the seventeenth century.
Second, the currency is not backed or accepted by governments around the world. Many have pointed out that the national central banks will never accept bitcoin because they cannot control it. This was one of the strengths of bitcoin as investors buying bitcoin wanted freedom from government control. However, in the long run, it might turn out to be one of the hurdles in its widespread acceptance.
Third, critics point out that bitcoin is in a speculative bubble. The sharp increase in bitcoin price over the last year is unprecedented in recent history. Bitcoin jumped from $1,000 at the start of 2017 to over $17,000 by the year-end. That is an increase of 1700 percent, and skeptics believe that it will crash soon.
Lastly, IT experts have also raised questions on the security measures of the block chain protocol. The online currency will become a target of cyberattacks and hacking, if its value keeps rising the way it is going. Bitcoin transactions are completely anonymous with no way of tracking hackers and thieves.
Most governments around the world have not been happy with the digital currency and attempted to regulate it. China banned Crypto currency exchanges operating inside the county in September. This caused a huge drop in international bitcoin trading from that country. Russia has similarly warned its citizens from trading in bitcoin, calling it a risky and dangerous investment.
Japan and South Korea have been more receptive to bitcoin. Some banks in Japan offer bitcoin deposit accounts and also provide digital currency trading services. Investors from South Korea have been aggressively buying the coin and considered responsible for the price hike.
United States is leading the way in bitcoin trade. The country has more than 500 bitcoin ATMs and trading volumes from the US alone account for roughly 40 percent of international bitcoin trade.
Future options trading in bitcoin
Recently bitcoin received a great boost in credibility and recognition when its real-world trading launched for the first time at US exchanges. Two of the biggest future contract market makers, Chicago Board Options Exchange (CBOE) and Chicago Mercantile Exchange (CME) had announced plans to offer bitcoin future options for their client in mid-December.
Bitcoin launched at CBOE on the 10th of December to a roaring success. Bitcoin which was trading online at around $15,000 online at that time jumped to over $18,000 in the futures market. Bitcoin spot price gradually rose through the week to coincide with the price in the futures market at roughly $17,500.
Financial investors expect great things to happen for the digital currency after it is added to CME, the biggest futures market in the world, on the 18th of December.
Future predictions about Bitcoin
The coin has seen a rollercoaster ride through 2017. Both supporters and skeptics of bitcoin have predicted many things for the crypto currency over time. Supporters had claimed during the year that bitcoin will hit $10,000 before the end of 2017. The coin reached and surpassed that by a long stretch. It is currently trading in the market around $17,900 and may very well end the year over $20,000.
While some of the outspoken critics believe that bitcoin will bust and drop to zero soon, some of the more enthusiastic supporters predict that the coin will reach $100,000 by 2020. The digital currency is so volatile that either one could be correct.- Dr Wafa Sbaiti, Professor of Finance, American University of Kuwait
By Dr Wafa Sbaiti