It seems as if Bitcoin, a five-year old digital currency, is constantly in the news. In early March a reporter claimed to unveil its mysterious creator, Satoshi Nakamoto—setting off a media frenzy complete with a car chase as journalists raced for the interview of a lifetime … in which the poor fellow they hounded claimed he isn’t their man. I can see why he wouldn’t want to be: About two weeks ago, roughly $460 million worth of Bitcoins vanished into thin cyberspace. Yet, while the victims are on the rampage, many Bitcoin devotees seem unfazed—to them, Bitcoin is viable, unstoppable. Though, even setting aside recent developments, I haven’t seen much evidence Bitcoin is ready for primetime. Its technology has potential,but its volatile exchange rate, low liquidity and security flaws make it less than ideal as a store of value or medium of exchange for goods and services.
Individuals can acquire Bitcoins a number of ways. They can “mine” them—using powerful computers to solve complex math puzzles—and purchase them on exchanges for a nominal transaction fee, with the exchange rate varying in part due to each exchange’s perceived “safety net.” Or they can transfer Bitcoins off an exchange, in private transactions. Once people obtain Bitcoins, they can store them in virtual wallets—existing in the cloud or on a desktop computer.
Many owners hold Bitcoins as a speculative tool—betting on future gains. But Bitcoin is first and foremost a currency, and folks do use it to purchase goods and services. Where they can, that is—while a growing number of businesses do accept them, many larger, well-known businesses don’t, despite the rise in point-of-sales services and mobile payment apps.
Sure, it’s technologically easy for businesses to accept Bitcoin. And cheaper! Bitcoin allows merchants to bypass credit and debit card transaction fees. But, convenience and fees aren’t everything. Bitcoin’s huge exchange rate volatility can be a barrier to businesses’ accepting the cryptocurrency. Just last year, one Bitcoin would buy you anywhere from $100 to more than $1200, depending on the day. As you can imagine, goods and services are tough to price in Bitcoin—or, at least, to advertise in Bitcoin-denominated pricing.
This volatility also means significant risk, should a business not immediately convert. Can businesses rely on Bitcoin’s exchange rate to pay for new employees and inventory six months from now? What about R&D? It’s a gamble—why most merchants who “accept” Bitcoin use programs that convert it to dollars first. In the end, it makes Bitcoin more useful as a cheap transaction mechanism—an alternate point-of-sale system.
To gain broader acceptance—and long-term viability—lower volatility is likely crucial for Bitcoin. Two factors seem to stand in the way presently: lack of exchange rate uniformity across exchanges and sheer lack of actual deep, liquid markets. As of December, 29 percentof Bitcoins in circulation were owned by 47 people and 98 percent by less than half a percent of total wallets. Considering Bitcoin issuance is capped, those folks’ buying and selling is likely necessary to boost liquidity and market efficiency.
Lastly, there is the matter of security. Bitcoins are stolen frequently, and stolen Bitcoins are lost forever thanks to the system’s irreversible transaction policy. No deposit insurance (i.e., FDIC protection), means no safety net. To date, the largest heist of all is that mentioned earlier: the $460 million lost when Tokyo-based Bitcoin exchange Mt. Gox filed for bankruptcy after revealing the roughly 850,000 Bitcoins stored there—750,000 of which belonged to individuals—were stolen by hackers. (A terrible irony considering Mt. Gox’s original founder was Jed McCaleb, a known hacker himself.)
Partly as a result, many governments are warning citizens off it or just plain banning it, further limiting its effectiveness as an exchange mechanism.
In my view, while we may have yet to uncover who Bitcoin’s founder actually is, we’re arguably closer to solving that riddle than Bitcoin is to being a viable currency with broad acceptance.
This constitutes the views, opinions and commentary of the author as of March 2014 and should not be regarded as personal investment advice. No assurances are made the author will continue to hold these views, which may change at any time without notice. No assurances are made regarding the accuracy of any forecast made. Past performance is no guarantee of future results. Investing in stock markets involves the risk of loss.
By Talia Hosenpud, who writes about markets, investing and the economy for Fisher Investments’ daily commentary website, www.MarketMinder.com.