Bitcoin – Page 5 – Digital Finance Analytics (DFA) Blog

Bitcoin Down, Down, Down

The fall in the price of bitcoin continues, to a new 2018 low. More evidence of the volatility of this commodity, which further undermines its potential as a virtual currency. After all, the whole point of a currency is to have some relatively stable view on its value. Yelland’s “This is a highly speculative asset”, looks right.

Other major cryptocurrencies – including Ripple XRP, Ethereum and Bitcoin Cash – are also falling. Many of them are seeing more dramatic swings even than bitcoin.

A few factors are playing here. Facebook has banned cryptocurrency advertising on its platform.

There have been several bitcoin exchange hacks, including the now famous US$534m job on Coincheck.

And South Korea, one of the main trading centres, has banned anonymous trades, effective 30th January 2018. Also the country’s customs service says that around 637.5bn KRW (US$598.6m) worth of foreign exchange crimes have been uncovered. That said, South Korea is not planning to ban cryptocurrency trading, the country’s finance minister has said.

After China shut down the largest cryptocurrency exchanges last September, and also banned Initial Coin Offerings, Japan has taken on the mantle of bitcoin’s new capital, where strong interest in currency trading AND technology align. In fact Japan had 51% of global trading volumes in January 2018. Bitcoin is also recognised as a payment mechanism there, and regulators there have introduced measures to monitor transactions on the lookout for criminal activity.

Today Japan’s financial regulator on Friday swooped on Coincheck Inc with surprise checks of its systems and said it had asked the Tokyo-based cryptocurrency exchange to fix flaws in its computer networks well before hackers stole $530 million of digital money last week, one of the world’s biggest cyber heists.

German President Frank-Walter Steinmeier on Thursday warned the financial sector that it had a responsibility to prevent speculation and the formation of trading bubbles in the cryptocurrency market. Steinmeier told about 1,000 guests at a Deka Bank event in Frankfurt that a new debate was needed about regulating cryptocurrencies, given recent gyrations in their valuations.

Ajeet Khurana, the head of the India’s blockchain and cryptocurrency committee, told the YourStory website, the government, like all governments in the world apart from Japan, did not recognise cryptocurrency as money. Many websites have been reporting, falsely, that Indian Finance Minister Arun Jaitley told parliament while presenting the national budget that India would make cryptocurrencies illegal.

Locally, Assistant Treasurer Michael Sukkar, speaking at a financial services briefing on Wednesday night, confirmed the Turnbull government is investigating how it could tax digital currencies like bitcoin.

In the U.S., Bank of America is now the largest lender barring customers from using credit cards to buy cryptocurrencies. According to Bloomberg, the policy was made known to employees yesterday and took effect today. Neither Discover nor Capital One allow crypto transactions on their cards. JPMorgan still does.

Expect more volatility ahead.

How Australian Regulators Would Handle a Cryptocurrency Hack Like Coincheck

From The Conversation.

New risk rules for cryptocurrency exchanges will be put to the test with the latest hack on Japanese exchange Coincheck. Hackers stole US$660 million worth of NEM (its native cryptocurrency).

In the past eight years, more than a third of all cryptocurrency exchanges have been hacked. The total losses exceed US$1 billion. Because cryptocurrencies are almost untraceable, the rate of recovery after a hack is very low.

A number of countries (including Australia) have enacted legislative provisions to regulate the conduct of cryptocurrency exchanges. Regulators hope these will reduce the risk of attack and make operators more accountable for losses suffered by customers when an attack does occur.

These hacks don’t just expose gullible investors to risk. They mean funds could be flowing undetected into the hands of money launderers and terrorists.

While cryptocurrency exchanges may operate like banks, they are not regulated in the same way as banks. There is no depositor’s insurance and most exchanges remain unregulated.

Due to the almost anonymity afforded to users of Bitcoin and other cryptocurrencies, it is very difficult to trace missing funds. When a hack occurs, the attacker gains access to the virtual wallet operated by the exchange and then transfers the cryptocurrency to their own virtual wallet.

The Coincheck Hack

The Japanese exchange Coincheck hack dwarfs an earlier hack on Bitcoin exchange platform Mt Gox in 2014, which saw the theft of US$480 million worth of Bitcoin.

The operator of Mt Gox, Mark Karpeles was arrested and jailed for his role in the collapse. At the time Mt Gox was the world’s biggest Bitcoin exchange.

He was charged with falsifying records and embezzlement, but there were no laws in place at the time to regulate the Mt Gox exchange and its trade in Bitcoin.

So as to bring virtual currency exchanges in line with international anti-money laundering and counter-terrorism financing measures, Japanese lawmakers enacted the Amended Settlement Act. Under these new laws, all exchanges operating in Japan must register and comply with rules. These rules include knowing their customers, employing sufficient staff, keeping balance sheets, and (critically) must keep all customers’ deposits in “cold storage” (that is, on a computer hard drive that is not accessible via the internet).

These new laws mean that when an exchange is hacked or collapses, operators can be made liable for the way that they managed their customers’ funds. Japanese authorities are threatening to prosecute the operators of Coincheck for their failure to comply with the new laws.

In their online apology, the operators of Coincheck have admitted that the hacked deposits were in a “hot wallet” (connected to the internet instead of being offline) and that this was due to “staff shortages”. Both of these failures to comply will give the Japanese authorities good reason to prosecute.

Close scrutiny of the accounts will be likely to reveal other irregularities. But this is little comfort for Coincheck’s investors. Coincheck has promised to return 90% of the lost NEM to its customers, but has yet to say how or when this will happen.

How would Australia’s regulator react?

Japan is not alone in its scramble to regulate cryptocurrency exchanges. Just this month, the Australian government announced the Australian Transaction Reports and Analysis Centre (AUSTRAC) will have new powers to monitor Bitcoin and other cryptocurrencies. New legislation also forces cryptocurrency exchanges to disclose details of investors and transactions.

The new laws are part of the government’s efforts to combat money laundering and terrorism financing. Exchanges will be required to identify customers more stringently and report suspicious transactions.

All transactions of A$10,000 or more must reported to AUSTRAC. The report must include the names of the customers conducting the transaction, the names of the the recipient of the proceeds of the transaction, and how the transaction was effected.

Any failure by an operator to comply with these laws would result in heavy fines and possibly imprisonment. However, as breaches are almost impossible to detect, enforcement of these laws depends on honesty of the exchange.

One way to detect reportable transactions is to monitor the size of the deposits made into the exchange’s bank account. However, individuals can create fake trading accounts and money-laundering syndicates breakup deposits into smaller amounts, so as to avoid raising suspicion.

Complying with AUSTRAC’s new regulations will be expensive for exchanges. With Australia’s new data breach notification laws coming into effect next month, gathering and securing sensitive information about customers and their deposits will be more onerous than ever.

The problem that faces regulators and investors is that the cost of compliance acts as a deterrent to registration. And because registration requires compliance, exchanges need to outlay significant capital before they start to trade. The sheer size of Coincheck’s losses indicates it was a high-volume exchange and yet, at the time of the hack, its registration was still pending.

Traditionally, when a foreign exchange collapses and is unable to return customers’ deposits, the regulator might prosecute the directors for operating without a licence, failure to comply with financial services regulations, or for insolvent trading. Insolvent trading, for example, attracts both civil and criminal sanctions.

When a cryptocurrency exchange is hacked, the operators and their customers are all victims, but the operators will be made liable for those losses. Under Australia’s current laws, a major hack of a cryptocurrency exchange will be met with similar challenges as those facing the Japanese authorities in the wake of the Coincheck theft.

Any investigation of an exchange could involve the Australian Securities and Investments Commission (ASIC), the Australian Taxation Office (ATO) and AUSTRAC. The level of scrutiny that would follow, could reveal a multitude of sins, including some that are unrelated to the hack.

For example, ASIC has the power to prosecute for insolvent trading, operating a Ponzi Scheme and breaches of financial services legislation. The ATO could investigate whether GST was being paid on trades.

Frustratingly for the customers and investors, seeing the operators punished does not reimburse them for their financial losses. Repaying deposits after a hack depends on whether the operators remain in the jurisdiction and have any funds of their own.

Author: Philippa Ryan, Lecturer in Commercial Equity and Disruptive Technologies and the Law, University of Technology Sydney

Why Bitcoin is taken more seriously than Dogecoin

From The Conversation.

As Bitcoin loses value, it may seem like it’s just as useful as the cryptocurrency invented for a joke – Dogecoin.

But there are genuine differences between these cryptocurrencies, and it’s not just because one is “much currency, such volatility”.

There are 1,448 cryptocurrencies around the world, by some counts. For every Bitcoin you have a programmable coin like Ethereum, or a coin that acts like a token for specific services, like Augur.

Some of these coins earn better reputations because of their usefulness, the people who made them, or the tech itself. They are not all taken seriously by investors, researchers and users.

The developers behind these cryptocurrencies are also important as they convince other people to adopt them and write new code for the technology to evolve. This new tech attracts new users into the system.

Different functions

Cryptocurrencies can be divided into several types. Cryptocurrencies like Bitcoin, Litecoin, and Dogecoin only provide basic functions such as transferring value from one party to another.

The next category are smart contract cryptocurrencies like Ethereum, Cardano, NEO, and Waves. These cryptocurrencies can be programmed, and so can become the basis for applications like games and digital markets.

The third type are cryptocurrencies designed to preserve your privacy like Monero and Zcash. These claim to be “untraceable” although transaction records are still available.

Then there are tokens, which are built with smart contracts to serve many purposes. They are often sold to raise funds to build services, and used as tickets for the services (such as Augur and Power Ledger).

Technological differences

The differing technologies in these cryptocurrencies mean that certain coins have more potential than others.

IOTA is used for “Internet of Things” devices (such as a smart kettle). But it has a special kind of blockchain (the technology that tracks transactions) and so can achieve much higher speeds of transaction and quicker confirmation of trades than Bitcoin.

Others like Nxt, and Ardor have built-in features that let users to do other things than just sending coins, such as creating marketplaces and even messaging.

People use cryptocurrencies like Zcash and Monero to settle transactions with “zero-knowledge”. This means the cryptocurrencies hide the information of the real payers and payees, and even the amount of coins transacted.

Monero has largely replaced the use of Bitcoin in exchanges on the dark web.

And smart contracts built with cryptocurrencies like Ethereum have countless potential usecases, from property transactions to digital asset management and fundraising.

The technology also means that one cryptocurrency might use significantly less electricity than another.

Limitations

The major cryptocurrencies, like Bitcoin and Ethereum, are slow because of their inability to handle massive amount of data being sent by users. The technology used to secure the data are expensive and inefficient.

Bitcoin can only handle a maximum of seven transactions per second; Ethereum can handle 15 transactions per second. Compare this with the VISA payment system, which can process up to 56,000 transactions per second.

But new entrants, such as Red Belly from the University of Sydney, might be able to solve this problem, handling up to 660,000 transactions per second.

Smart contracts can also run into problems if they contain bugs. When a decentralised organisation built on Ethereum was hacked in 2016, US$50 million in Ether was stolen.

When something achieves the success of Bitcoin we’re bound to see competitors entering the market, hoping to grab a share.

This explains the explosion in cryptocurrencies since the Bitcoin source code was released under an open licence. Anyone can copy, modify, and release a modified version of Bitcoin.

By looking at the current trend, we will see more cryptocoins in the near future.

But as we can see, “cryptocurrency” is a term that encompasses a wide range of different technologies, communities and uses. It’s all of these factors that inform whether users, investors, developers and researchers take a coin seriously.

Author: Dimaz Wijaya PhD Student, Monash University

Bitcoin Takes A Dive

Further evidence of the volatility of Bitcoin, the virtual distributed ledger currency, which operates without supervision, or central bank support.

Bitcoin touched an all-time high of $19,896 on December 17 having passed the $15,000 mark on December 7. It’s slumped over the past few days, to a low of $12,504 before recovering somewhat. It is still up over 1,100 percent this year. Bitcoin is not alone, the other 20 or so crypto-currencies also retraced.

Many say serious numbers of unsophisticated investors have been piling in (even buying Bitcoins on their credit cards!). This volatility is likely to continue, and prospective investors need to be aware they may loose their investment, they may not – there can be no certainties.

Opinion is split as to whether this is simply a speculative bubble similar to “Tulip Mania” or whether there is more here about a potential digital replacement for the US$. We suspect the former is closer to the truth.

The classic bubble shape of the South Sea Bubble is often cited and is an interesting case study.

A bubble? We don’t even know how to value Bitcoin

From The Conversation.

Bitcoin is a “speculative mania” according to the governor of the Reserve Bank of Australia. But it’s not so easy to say that Bitcoin is a bubble – we don’t know how to value it.

Recent price rises (close to A$18,000 in the past three months) may be too great and can’t continue. But the Bitcoin market is only just maturing as an investment and as a currency, and so it may still have room to grow.

A bubble is when the price of an asset diverges from its “fundamentals” – the aspects of an asset that investors use to value it. These could be the income that can be earned from a stock over time, a company’s cash flow, the state of a country’s economy, or even the rent from property.

But Bitcoin does not pay out profits (like shares) or rent (like property), and is not attached a national economy (like fiat currencies). This is part of the reason why it is hard to tell what the underlying value of Bitcoin is or should be.

In the search for fundamentals some have suggested we should look at the supply of Bitcoins in the market (which is regulated by the technology itself), the number of Bitcoin transactions through the market, or even the energy consumed by Bitcoin miners (the computers that validate transactions and are rewarded with Bitcoins).

Diverging from fundamentals

If we take a close look, we can see how the price of Bitcoin may be diverging from these fundamentals. For instance, it is becoming less profitable to be a miner, especially as the energy required increases. At some stage the cost may exceed the price of Bitcoin, making the network less worthwhile to both mine and invest.

Bitcoin may be the best known cryptocurrency but it is also losing marketshare to other cryptocurrencies, such as Ethereum and Litecoin. Bitcoin currently accounts for 59.4% of the total global cryptocurrency market, but at the beginning of 2016 it was 91.3%. Many of these other cryptocurrencies have more functionality than Bitcoin (such as Ethereum’s ability to execute smart contracts), or are more efficient and use less energy (such as Litecoin).

Government policy, such as taxation or the establishment of national digital currencies, may also make it riskier or less worthwhile to mine, transact or hold the cryptocurrency. China’s ban on Initial Coin Offerings earlier this year reduced the value of Bitcoin by 20% in 24 hours.

Without these fundamentals the price of Bitcoin largely reflects speculation. And there is some evidence that people are simply buying and holding Bitcoin in the hope it will keep rising in value (also known as Greater Fool investing). Certainly, the cap on the total number (21 million) of Bitcoins that can exist, makes the currency inherently deflationary – the value of the currency relative to goods and services will keep increasing even without speculation and so there is a disincentive to spend it.

Bitcoin still has room to grow

Many big investors – including banks and hedge funds – have not yet entered into the market. The volatility and lack of regulation around Bitcoin are two reasons stopping these investors from jumping in.

There are new financial products being developed, such as futures contracts, that may reduce the risk of holding Bitcoin and allow these institutional investors to get in.

But Bitcoin futures contracts – where people can place bets on the future price of stocks or markets – may also work against the price of Bitcoin. Just like gamblers place bets on horse races rather than buying a horse, investors may simply buy and sell the futures contracts rather than Bitcoin itself (some contracts are even settled in cash, rather than Bitcoin). All of this could lead to less actual Bitcoin changing hands, leading to less demand.

Although the rush to invest is apparently encouraging some people to take out mortgages to buy Bitcoin, traditional banks won’t lend specifically for that purpose as the market is too volatile.

But it’s not just on the finance side that the Bitcoin market is set to expand. More infrastructure to support Bitcoin in the broader economy is rolling out, which should spur demand.

Bitcoin ATMs are being installed in many countries, including Australia. Bitcoin lending is emerging on peer-to-peer platforms, and new and more regulated marketplaces are being created.

Many companies are accepting Bitcoin as payment. That means that even if the speculation dies down, Bitcoin can still be traded for some goods and services.

And finally, although the fundamentals of Bitcoin are still up for debate, when it comes to transaction volume through the network there appears to be a lot of room for growth.

It’s good to remember that people have been calling Bitcoin a bubble for a long time, even when the price was just US$35 in 2013.

In the end, this is uncharted territory. We don’t know how to value Bitcoin, or what will happen. Historical examples may or may not apply.

What we do know is that the technology behind most cryptocurrencies is enabling new models of value transfer through secure global consensus networks, and that is causing excitement and nervousness. Investors should beware.

Authors: Alicia (Lucy) Cameron, Senior Research Consultant, CSIRO;
Kelly Trinh, Data Scientist, CSIRO

The ‘utopian’ currency Bitcoin is a potentially catastrophic energy guzzler

From The Conversation.

The recent upsurge in the price of Bitcoin seems to have finally awakened the world to the massively destructive environmental consequences of this bubble.

These consequences were pointed out as long ago as 2013 by Australian sustainability analyst and entrepreneur Guy Lane, executive director of the Long Future Foundation. In recent months, the Bitcoin bubble has got massively bigger and the associated waste of energy is now much more widely recognised.

In essence, the creation of a new Bitcoin requires the performance of a complex calculation that has no value except to show that it has been done. The crucial feature, as is common in cryptography, is that the calculation in question is very hard to perform but easy to verify once it’s done.

At present, the most widely used estimate of the energy required to “mine” Bitcoins is comparable to the electricity usage of New Zealand, but this is probably an underestimate. If allowed to continue unchecked in our current energy-constrained, climate-threatened world, Bitcoin mining will become an environmental disaster.

The rising energy demands of Bitcoin

In the early days of Bitcoin, the necessary computations could be performed on ordinary personal computers.

But now, “miners” use purpose-built machines optimised for the particular algorithms used by Bitcoin. With these machines, the primary cost of the system is the electricity used to run it. That means, of course, that the only way to be profitable as a Bitcoin miner is to have access to the cheapest possible electricity.

Most of the time that means electricity generated by burning cheap coal in old plants, where the capital costs have long been written off. Bitcoin mining today is concentrated in China, which still relies heavily on coal.

Even in a large grid, with multiple sources of electricity, Bitcoin mining effectively adds to the demand for coal-fired power. Bitcoin computers run continuously, so they constitute a “baseload” demand, which matches the supply characteristics of coal.

More generally, even in a process of transition to renewables, any increase in electricity demand at the margin may be regarded as slowing the pace at which the dirtiest coal-fired plants can be shut down. So Bitcoin mining is effectively slowing our progress towards a clean energy transition – right at the very moment we need to be accelerating.

How much energy is Bitcoin using?

A widely used estimate by Digiconomist suggests that the Bitcoin network currently uses around 30 terawatt-hours (TWh) a year, or 0.1% of total world consumption – more than the individual energy use of more than 150 countries.

By contrast, in his 2013 analysis, Guy Lane estimated that a Bitcoin price of US$10,000 would see that energy use figure climb to 80 TWh. If the current high price is sustained for any length of time, Lane’s estimate will be closer to the mark, and perhaps even conservative.

The cost of electricity is around 5c per kilowatt-hour for industrial-scale users. Miners with higher costs have mostly gone out of business.

As a first approximation, Bitcoin miners will spend resources (nearly all electricity) equal to the price of a new Bitcoin. However, to be conservative, let’s assume that only 75% of the cost of Bitcoin mining arises from electricity.

Assuming an electricity price of 5c per kWh and a Bitcoin price of US$10,000, this means that each Bitcoin consumes about 150 megawatt-hours of electricity. Under current rules, the settings for Bitcoin allow the mining of 1,800 Bitcoins a day, implying daily use of 24,000MWh or an annual rate of nearly 100TWh – about 0.3% of all global electricity use.

Roughly speaking, each MWh of coal-fired electricity generation is associated with a tonne of carbon dioxide emissions, so a terawatt-hour corresponds to a million tonnes of CO₂.

So much energy, so few users

An obvious comparison is with the existing financial system.

Digiconomics estimated that Visa is massively more efficient in processing transactions. A supporter of Bitcoin, Carlos Domingo, hit back with a calculation suggesting that the entire global financial system uses about 100TWh per year, or three times as much as the Diginconomics estimate for Bitcoin.

As a defence, this is far from impressive. First, as we’ve seen, if the current high price is sustained, total annual energy use from Bitcoin mining is also likely to rise to 100TWh.

More importantly, the global financial system serves the entire world. By contrast, the number of active Bitcoin investors has been estimated at 3 million. Almost all of these people are pure speculators, holding Bitcoin as an asset while using the standard financial system for all of their private and business transactions.

Another group is believed to use Bitcoin for illicit purposes such as drug dealing or money laundering, before converting these funds into their own national currency. The number of people who routinely use Bitcoin as a currency for legitimate transactions might be in the low thousands or perhaps even fewer.

Shifting the whole global financial system to Bitcoin would require at least a 200-fold increase, which in turn would entail increasing the the world’s electricity use by around 500%. With the current threat of climate change looming large globally – this constitutes an unthinkably large amount of energy consumption.

Better alternatives to Bitcoin

The disastrous nature of Bitcoin’s energy consumption should not lead us to abandon the associated idea of blockchain technology altogether.

There are alternatives to the “proof of work” method of validating changes to the blockchain, such as “proof of importance”, which is analogous to Google’s page ranking systems. Projects such as Gridcoin are based on calculations that are actually useful to science. But these ideas are in their infancy.

For the moment, the problem is Bitcoin and how to deal with it. There is no obvious way to fix the inherent problems in its design. The sooner this collective delusion comes to an end, the better.

Author: John Quiggin, Professor, School of Economics, The University of Queensland

Bitcoin’s rise will have ‘disastrous’ consequences for the planet

From The New Daily.

The Bitcoin frenzy currently gripping the world is taking an unexpected toll on the planet – in the form of a carbon footprint almost as big as New Zealand’s.

And with the cryptocurrency’s astronomical growth showing no sign of slowing, this carbon footprint is likely to grow – prompting some commentators to warn of an “environmental disaster” in the making.

The culprit is Bitcoin ‘mining’, the little-understood process that both secures the existing Bitcoin system, and creates new Bitcoins.

This process, according to Digiconomist, is incredibly energy intensive, and is fed largely by China’s highly polluting, carbon-intensive coal-fired power stations.

These revelations come as the Australian Securities Exchange revealed it would be using the same technology used by Bitcoin – Blockchain – to run its system, the first stock exchange in the world to do so.

Writing in The Conversation on Monday, Professor John Quiggin said the rise of Blockchain itself should not be prevented, as there were other ways to use it that were not as energy intensive.

But he said that Bitcoin itself should be abandoned, describing it as a “collective delusion” with “massively destructive environmental consequences”.

Bitcoin’s rise continues

On Monday, the value of a single Bitcoin reached $A22,343, more than 20 times its value a year ago.

The unprecedented surge – offering massive returns on small investments – has proved irresistible to everyday investors, pushing more and more to buy the currency, and forcing its value into what many warn is bubble territory.

But a more sophisticated, select group – Bitcoin miners – is also seemingly increasing, likewise attracted by the rocketing value of a digital currency that many called the gold of the 21st century.

How Bitcoin mining works

Bitcoin mining involves using a computer to solve a mathematical problem posed to it by the Bitcoin system.

When the computer solves this problem, it validates previous Bitcoin transactions, increasing the security of the Bitcoin system. In return for performing this service, the miner – as likely as not some teenager working from his or her bedroom in Shanghai – is rewarded in Bitcoins.

The video below attempts to explain the whole thing in simple terms (with questionable success).

As the video explains, Bitcoin mining requires a truly phenomenal amount of electricity – currently 32 terawatts a year, according to Digiconomist.

To put that in context, Australia uses 224 terawatts of electricity a year, while New Zealand uses 40, according to figures published by the US Central Intelligence Agency.

If Bitcoin were a country, it would be the 60th-biggest consumer of electricity in the world, ahead of 160 other countries. In other words, Bitcoin is becoming a significant contributor to climate change.

And the likelihood is it will get worse, for two reasons.

First, there is only a finite number of Bitcoins that can ever be mined. Currently around 17,000 have been mined. The limit is 21,000.

The closer we get to the 21,000 figure, the harder it is to mine Bitcoins. As a result the computer power required to mine Bitcoins increases, with the electricity used going up as a result.

(All this, by the way, puts a huge strain on miners’ computers.)

And second, as the value and profile of Bitcoin increases, the number of aspiring miners will also likely increase, further pushing up electricity usage.

Supporters of Bitcoin would like to see it become a global currency to rival the US dollar. But Professor Quiggins warned against this.

“Shifting the whole global financial system to Bitcoin would require at least a 200-fold increase, which in turn would entail increasing the world’s electricity use by around 500 per cent,” he said.

“With the current threat of climate change looming large globally – this constitutes an unthinkably large amount of energy consumption.”

Bitcoin isn’t a currency – and unless it becomes one it could be worthless

From The Conversation.

Bitcoin is in decline. Not its price, which has increased 900% this year and (at the time of writing) stands at over US$12,000 per unit, but its actual use as a currency. And this makes its rapid appreciation all the more puzzling.

A few years ago, enthusiasts triumphantly shared announcements from businesses that had started accepting Bitcoin. Over the last couple of years, such announcements have become scarce. Instead, businesses that once accepted the currency have begun to drop it.

The BBC contacted ten businesses in London that once advertised accepting Bitcoin. Four no longer accepted it, and two that did said they hardly ever received payments in Bitcoin. The same is even true online. The Wall Street Journal, citing a report by Morgan Stanley, recently reported that Bitcoin is now accepted by just three of the top 500 global online merchants, down from five last year.

If growing adoption as a currency can’t justify Bitcoin’s rapid appreciation, what can? Many enthusiasts have started to promote the idea of Bitcoin as a store of value. In economics, this is usually defined along the lines of “an item that people can use to transfer purchasing power from the present to the future”. In simple terms, it’s somewhere safe to invest your wealth that won’t lose its worth over time.

Apples can be used to barter services from a neighbour while they’re still fresh, but their purchasing power will disappear as they rot. The purchasing power can be retained into the future by exchanging the apples for money, gold, government bonds or some other store of value.

Some items have attributes that make them better stores of value than others, whether we are talking about physical items or digital objects. Gold is a good store of value because it’s durable. Electronic bond certificates are also durable as long as banks’ systems don’t fail, and have the added benefit of being easier to secure than physical valuables. Money, both physical currency and digital bank money, has the advantage of being very liquid, so it’s easy to convert into a purchase when needed.

Bitcoin does share many of these attributes of a good store of value. It also offers potentially high levels of financial privacy, somewhat similarly to the offshore banking system. This is an important attribute of a store of value for some people, although it also creates a lack of accountability and the potential for tax evasion.

But the most important attribute of a store of value is that it’s valuable. Gold is valuable because it has many industrial and decorative uses. Its price can fluctuate because of speculation on financial markets, but it can never fall to zero. There will always be someone willing to accept gold because it’s a useful commodity.

Similarly, US government bonds are ultimately valuable because they entitle the owner to a relatively secure flow of interest payments. Dollars and euros are valuable because they are widely accepted as a means of payment, and will continue to be so in the foreseeable future. In contrast, the future acceptability of the Venezuelan bolivar is in doubt, so people are desperately trying to exchange it to better stores of value.

Is Bitcoin valuable? It has no industrial or decorative uses, and it doesn’t entitle the holder to receive interest. It was intended to be valuable as a currency that is accepted the world over, but that doesn’t seem to be happening. The only major value that Bitcoin has now is its exchange value. Many people are willing to pay a lot of money today to get hold of some Bitcoin.

But what they are getting for their money is simply the hope that another buyer down the line will pay even more money for the coins. Once the music stops, there is no fundamental value to prevent the coins’ price from falling close to zero, save for their tenuous position as the currency of choice in the online drug trade and grey-area gambling.

Beanie Babies lessons

The idea that Bitcoin is valuable because it’s a store of value is upside down. In reality, something becomes a store of value because it’s valuable. In the 1990s, people started to trade Beanie Babies on eBay. Prices of these limited-edition plush toys rose to thousands of dollars, and by 1997 they made up 6.6% of the entire site’s transaction volume.

Some people invested their life savings into Beanie Babies, fully expecting their value to be preserved and more. But eventually people came to their senses and the market bombed. Beanie Babies are useful as toys and collectables, but that doesn’t justify thousand-dollar valuations.

My advice to individuals and institutions tempted by the headlines is to keep their savings away from Bitcoin and other cryptocurrencies and “initial coin offerings” (ICOs). I know serious blockchain developers won’t mind me saying this, because they see speculative bubbles and bursts as a distraction. For Bitcoin to truly function as a store of value, it first has to gain acceptance as a currency.

Author: Vili Lehdonvirta, Associate Professor and Senior Research Fellow, Oxford Internet Institute, University of Oxford

RBNZ Looks At Crypto-currencies

The Reserve Bank in New Zealand has released an excellent Analytical Note on Crypto-currencies “Crypto-currencies – An introduction to not-so-funny moneys“. It is one of the best I have read, so far!

The paper introduces the distributed ledger technology of crypto-currencies. They aim to increase public understanding of these technologies, highlight some of the risks involved in using crypto-currencies, and discuss some of the potential implications of these technologies for consumers, financial systems, monetary policy and financial regulation.

Crypto-currencies have no physical existence, but are best thought of as electronic accounting systems that keep track of people’s transactions and hence remaining purchasing power. Cryptocurrencies are typically decentralised, with no central authority responsible for maintaining the ledger and no central authority responsible for maintaining the code used to implement the ledger system, unlike the ledgers maintained by commercial banks for example. As crypto-currencies are denominated in their own unit of account, they are like foreign currencies relative to traditional fiat currencies, such as dollars and pounds.

They conclude that Crypto-currencies offer some distinct features, such as quicker cross-border transactions, possibly lower transaction fees, pseudo-anonymity, and transaction irreversibility. These features help to explain the growing demand for crypto-currencies, even though they fail to satisfy many of the basic functions of money.

Most crypto-currency accounts lie dormant and many of the active accounts are used only for online gambling or speculative purposes. Perceptions of anonymity have also created a demand for such currencies to facilitate illegal transactions, but the anonymity embodied in crypto-currencies has been over-stated. There have been a significant number of crypto-currency prosecutions in relation to money laundering and other crimes, illustrating that there is no guarantee of anonymity.

While crypto-currencies are growing in popularity, they currently facilitate a very small proportion of transactions. Because crypto-currencies intermediate such a small proportion of transactions, central banks do not presently view crypto-currencies as a material threat.Since crypto-currencies are not well-adapted to the provision of borrowing and lending, we also foresee an enduring role for traditional financial intermediaries.

Crypto-currencies and blockchain technology could well become an important part of global payment systems, but wide-scale adoption will depend on competition from alternative transaction technologies, and on regulation to provide users with security. Crypto-currencies will also need to address technical, scalability issues if they wish to intermediate the volume of transactions undertaken globally.

We conclude that all crypto-currencies are experimental in nature and users face material risks by transacting with them or by holding significant crypto-currency balances. Individual cryptoReserve Bank of New Zealand currencies may be more Betamax than VHS, and more MySpace than Facebook. Even if some of the constructs are enduring, such as distributed ledgers and the use of cryptography, specific crypto-currencies may be supplanted by competing transaction technologies. We close with a Latin expression much-beloved by contract lawyers and economists alike – caveat emptor – buyer beware.

The Analytical Note series encompasses a range of types of background papers prepared by Reserve Bank staff. Unless otherwise stated, views expressed are those of the authors, and do not necessarily represent the views of the Reserve Bank