November 2013

Bitcoin: The Innovative Future of Currency…or Hyped Up Flash in the Pan?
Bitcoin (BTC) is fast becoming the most talked about subject in financial markets. Can a virtual, non-exchange backed currency depose long held views on what constitutes wealth and the inherent process of exchanging goods and services using ‘money’? The core themes surrounding Bitcoin question the very concept of what ‘money’ is.

Can stores of value underpinning global capital markets such as the US Dollar and Gold give way to Bitcoin on a wider scale? Will it become the preeminent medium of exchange among future societies?

Financial pundits are divided over the revolutionary idea that is swiftly becoming much more than just an online craze. Regulators are beginning to move from outright dismissal to considered integration into wider payments and savings applications as a result of increased transaction speeds, lower costs and outright fungibility.

Less than 1,000 Australian merchants currently accept Bitcoins as a form of payment, indicating it has not moved beyond a method of peer-to-peer payment. This number is expected to rise rapidly however, given the increased focus placed by Bitcoin operators on merchant payment sectors.

Bitcoin now has a market capitalisation approaching US$5 billion, with large scale interest from numerous investors, most notably a commitment of over US$1.5 million by the Winklevoss twins, early investors in Facebook.

The virtual currency was anonymously created by an individual using the pseudonym ‘Satoshi Nakamoto’, who disappeared in 2011 and has not been associated with Bitcoin since. Following the first recorded transaction using Bitcoin – a delivery pizza order - the concept developed a point of valuation and has continued to grow quickly. A residential developer in Shanghai, China is now accepting Bitcoins as settlement, and a young couple successfully experimented travelling for over 100 days using Bitcoins only.

New Bitcoins are issued via ‘Bitcoin Mining’ - a process involving users working together to decipher complex mathematical equations after which they are rewarded with 25 Bitcoins per unique problem. Every four years the amount a Bitcoin Miner is rewarded with is halved, and total Bitcoins in circulation will eventually reach a limit of 21 million.

Each Bitcoin can be broken down into denominations of eight decimal places however. Unlike sovereign currencies that are reserve backed and highly regulated by a number of independent bodies to ensure transactional accuracy and stability, Bitcoin markets are solely managed by peer-to-peer networks only.
Bitcoin miners provide the foundation of confidence in the system and core dispute resolution procedures.

Bitcoin surpassed US$500 for the first time on November 18th 2013, rocketing in value by 16 percent in a single day. Following months of wild swings in value and price volatility that would make even the most grizzled Wall Street trader blush, it is no surprise for Bitcoin market participants to witness price swings of up to 25 percent in a matter of hours.

The new record high was achieved after a surge in value from US$250 in less than a month, trading as low as US$96 in July 2013. Uncertainty and instability among Bitcoin markets, coupled with a well-publicised association with criminal transactions in the now banned ‘Silk Road’ network has limited the wider application of the virtual currency…until now.

One suggestion for the legitimate use of Bitcoin, or ‘crypto currencies’ in general that do not require personal details as credit card providers necessitate, is for its use in FX services. Characteristics such as low cost and high speed are distinct advantages for FX conversions and transfers, but the need to ‘know your customer’ would require a number of changes to the underlying protocol. Without a reduction in volatile price action and lack of security however, Bitcoin would have difficulty in becoming a viable risk management or business FX alternative, however the potential is clear.

Critics have argued that without centralised oversight of any capacity, security concerns and the high level of sophistication required by peer-to-peer operators will limit its inclusion into mainstream transaction banking and payments markets that cannot conform to the ‘crypto currency’ concept without fundamental changes.

Bitcoins essentially shift data from one location to another, but when they are converted to underlying currency such as Pounds Sterling or US Dollars, they re-enter the banking system. This is carried out at ‘Bitcoin Exchanges’ that remain highly unregulated and open to criminal activity such as hacking and identity fraud. It is this exchanges that provide a clear entry point for regulators and banks seeking a method of incorporating themselves into the burgeoning Bitcoin community, however most cases of bank involvement with the virtual currency so far have involved shutting down of deposit accounts linked to the virtual currency.

The threat of a ‘Bitcoin Bubble’ and potential for the market to collapse is clear to those rushing to join the hysteria. As time passes and ‘crypto currency’ continues to become more prevalent however, banks around the globe will surely be asking themselves ‘if we can’t beat them…join them’.

  Jan 2013 Jun 2013 Nov 2013
Transactions per day 27,560 39,879 70,175
Transaction Volume (BTC) 116,294 338,717 817,397
Transaction Volume (USD) 2.63M 28.56M 357.61M
Trade Volume (USD) 245,873 4.73M 17.02M
Market Price (USD) 13.56 114.36 522.98

Source: – Bitcoin Wallet & Block Explorer

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