The Big Fat Bitcoin Bubble

If you are an investor who is even remotely connected to financial markets, the odds are that you have heard about the spectacular rise of Bitcoin. The crypto-currency has grown from $10,000 to $17,000 in a week. Many believe that this is a bubble. However, there are others who believe that the rise of Bitcoin is based on genuine underlying factors. In this article, we will have a closer look at the Bitcoin phenomenon to determine whether its sky-high valuation is justified.

Bitcoin comes into existence through mining. In common words, this means that people have to lend the processing power of their computers to process Bitcoin-related transactions. Users are then rewarded with a Satoshi which is a smaller unit of a Bitcoin.

The idea of a currency which can completely bypass the fiat currency model seems fascinating to many investors. Investors are tired of the constant inflation that government-issued currencies bring along. $1000 invested in United States dollars in 2013 would have a purchasing power of only $900 or so. On the other hand, $1000 invested in Bitcoin in 2013 would today be worth millions in 2017! Bitcoin has by far outperformed every central bank issued fiat currency.

Several investors view Bitcoin as an alternative to fiat currency. The Bitcoin algorithm has been developed to prevent inflation. The maximum amount of Bitcoin currency has been capped at 21 million.

The short answer would be no. The long answer is a little bit more complicated. Here are the details:

• The function of money is to be able to facilitate the exchange of goods and services.

• This means that other people must be willing to accept the currency in barter transactions. It is therefore imperative that the currency has a value of its own. For instance, gold can be used in a barter transaction. The recipient of gold may decide to keep gold as it is or exchange it for other goods and services.

• Bitcoin does not have any intrinsic value. It cannot be seen or touched. It is only a digital currency and the only reason merchants accept it is because they can later exchange it for Fiat currency.

• It would, therefore, be inaccurate to say that Bitcoin is money in its right. It is just a method of using the existing money, i.e., the fiat currency. It can be compared to financial instruments like debit cards and credit cards which are also a medium of exchanging money. The most important feature of Bitcoin is that it allows people to avoid regulation. This is the real reason behind its popularity.

• Bitcoin does not serve many functions of money. It is not accepted in the payment of taxes. It cannot be used as legal tender to discharge debts.

For a currency to be useful, it must have a relatively stable value. This means that consumers must be able to exchange the same amount of currency for the same amount of goods and services. The higher this stability over a period of time, the better the currency is!

Bitcoin fails this test. The value of Bitcoin is very volatile on a day to day and even minute to minute basis. Consumers who use Bitcoin will not be able to budget their weekly or monthly expenses given the volatility that this cryptocurrency is subject to. It will be even more difficult for merchants to price their goods and services in terms of Bitcoin given the time lag between production and sales.

A stable currency does not try to forcibly lock in its users. However, that is exactly what Bitcoin does. The transaction charges related to Bitcoin are prohibitive. At the present moment, Bitcoin users have to pay over $13 as transaction charges for every transaction! As the number of Bitcoin mined decreases, the transaction fee is likely to increase over the long term making matters worse.

This means that even if they buy a cup of coffee worth $5 with Bitcoin, they still have to pay $13 for the transaction fee. This is why Bitcoin is not a stable currency but instead a volatile investment.

Apart from being expensive, Bitcoin transactions are also inconvenient. Consumers are used to instant payments and receipts. On the other hand, Bitcoin transactions take over an hour to process. As Bitcoin is not an organized currency, you cant really call up customer service and check the status of the transaction. Bitcoin is not a viable alternative to fiat currencies because of the sheer inconvenience it causes. Trade and commerce would drastically reduce if every transaction took over an hour to process!

Bitcoin requires a huge amount of electricity. Each transaction processed by Bitcoin consumes more electricity than a United States household would consume in an entire week! This is what makes Bitcoin unviable for more than three-fourths of the world. The developing world is facing a shortage of power even for meeting daily necessities. A currency that consumes enormous amounts of electricity would simply be unviable in most parts of the world.

It would, therefore, be safe to say that at the moment, Bitcoin isnt a practical alternative to fiat currencies. Speculators and gamblers instead of consumers lead the current Bitcoin boom.