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Bitcoin mania: here’s all you need to know

Lounge finds out why bitcoins still hold an appeal despite questions over their legality and value

Most governments remain non-committal on the legality of bitcoins since it is not regulated by central banks. Photo: iStockPhoto
Most governments remain non-committal on the legality of bitcoins since it is not regulated by central banks. Photo: iStockPhoto

Ever since the price of bitcoins skyrocketed from a little under $1,000 (around Rs63,400 now) in 2016 to touch nearly $20,000 last year, people have been posing a Hamlet kind of question: to buy or not to buy?

Their dilemma is understandable. On the one hand, there is the fear of losing out on an opportunity to make money hand over fist by investing or trading in bitcoins since their price rose by around 20-fold since the start of 2017. On the other hand, there is the nagging feeling that one may end up investing in a virtual currency whose price is extremely volatile and whose true value cannot be assessed.

Adding to the confusion, most governments remain non-committal on the legality of bitcoins since it is not regulated by central banks. Some have explicitly warned investors to exercise caution while those like the Indian government have begun imposing a tax on the gains from the sale of bitcoins.

For instance, soon after the South Korean government said on 11 January that it plans to ban cryptocurrency trading, the news sent bitcoin prices plummeting to $13,945 on 12 January on the futures exchange CME (Chicago Mercantile Exchange).

Further, citing unnamed sources, Bloomberg reported on 15 January that China is clamping down on cryptocurrency trading.

The fact is that a bitcoin has value only because believers in this virtual currency buy and sell it among themselves. Ever since the bitcoin code was first released on 9 January 2009, by a person who assumed the name Satoshi Nakamoto, the digital currency has been adopted for everything from international money transfers to online narco-trafficking.

It is now even being used to extract money from unsuspecting online users who inadvertently download malware called ransomware. Hackers then demand a ransom in bitcoins to decrypt the documents that they have encrypted using the malware.

Why, then, do bitcoins still hold an appeal?

For one, bitcoins are not regulated by governments. Not yet. Second, a bitcoin is an open source peer-to-peer electronic cash system that runs on blockchain technology, which is a distributed ledger that contains details of every transaction, allowing a user’s computer to verify the validity of each transaction of this virtual currency. Hence, the transactions are transparent to every user.

Selling bitcoins is also easy as the money gets directly deposited into your bank account.

Third, a digital signature protects the authenticity of each transaction, which is why the digital money is also known as a “cryptocurrency".

Fourth, anyone can use specialized hardware to process transactions and earn a reward in bitcoins for the service. The process is known as mining. Of course, this is an expensive exercise.

Fifth, it is easy to buy bitcoins. In India, you can buy bitcoins from dedicated exchanges like Unocoin or Zebpay by downloading apps or using websites. You can buy bitcoins using your local currency (e.g. the rupee) from any online banking service (or through NEFT/RTGS). Further, you can purchase bitcoins in smaller denominations too, which implies that even if a single bitcoin looks beyond your wallet’s reach, you may be able to buy a fraction of it.

Selling bitcoins is also easy as the money gets directly deposited into your bank account. Users, though, will need to undergo the know-your-customer (KYC) process and provide details such as their permanent account number, address proof and bank account details. Moreover, exchanging bitcoins for rupees or dollars involves a transfer fee.

Bitcoin appears to behave like a Giffen good because unlike what the law of demand in economics dictates, the demand for bitcoins increases despite an increase in its price. And a big reason for this trend is the fact that the supply of bitcoin has been capped—there are only 21 million bitcoins that will ever be in circulation. Currently, there are around 16.80 million bitcoins in circulation.

However, after the last whole bitcoin is mined, thus reaching the upper limit, the value of the currency is bound to obey the laws of supply and demand.

Big companies that currently accept bitcoins include, Subway, Microsoft, Reddit, Virgin Galactic and Expedia. Experts, though, remain divided on the value of bitcoins as an investment proposition.

On 25 December, for instance, when the price of the bitcoin was around $14,400, a article pointed out that a “Morgan Stanley analyst James Faucette and his team sent a research note to clients a few days ago suggesting that the real value of bitcoin might be...$0. That’s zero dollars."

On 9 January, JPMorgan Chase chairman and chief executive officer Jamie Dimon told Fox Business in an interview that he regretted having called bitcoin “a fraud at a September banking conference" but added that he wasn’t interested in the “subject" (bitcoin).

Zach Pandl, co-head of foreign exchange and emerging markets strategy at Goldman Sachs, wrote in a note on 10 January that despite the fact that bitcoin and other digital currencies “face significant practical hurdles to wider adoption—including potential government regulation and excessive volatility", bitcoin could succeed as a form of money. He wrote, “ theory, yes, if it proves capable of facilitating transactions at a low cost and/or providing better risk-adjusted returns for portfolios. In practice, however, the bar looks high."

However, on 11 January, the CEO of the multinational conglomerate Berkshire Hathaway, Warren Buffett, asserted that “I can say almost with certainty that cryptocurrencies will come to a bad end."

Despite these dissenting views, experts agree that even if the bitcoin does not survive as a form of money, its underlying technology—blockchain—holds promise and will find wide acceptance in the industry.

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