Bitcoin is a Bubble Worth Watching

If you have been paying attention to the news recently, then you have likely heard about bitcoin (BTC). Financial market turmoil has driven demand for alternatives to traditional fiat currencies, and investors are looking beyond the traditional defensive stock sectors. That in turn has led to an explosion of interest in bitcoin. Not everyone believes in the long-term viability of this alternative currency. Many see it as a purely speculative fad, like Beanie Babies. But it is hard to deny that BTC is one of the most interesting developments to come out of the financial world in recent times.

Market Turmoil

The recent turmoil in Cyprus is one explanation for the explosion in BTC valuations. Many people have lost faith in traditional financial systems. Obviously, there has not been a wholesale grab on savings or retirement accounts in the Western world. However, investors are still nervous. People living in failing economies have a legitimate fear of wealth confiscation. If it can happen in Cyprus, it can happen anywhere.

But fear only partially explains the recent run up in bitcoin prices. Excessive mining and speculation by investment banks and venture capitalists may be another reason for the rising prices. Large players may be contributing to what many are calling a bubble.

Finally, bitcoin is a very secretive and secure currency.  In Cyprus, many of the largest bank accounts belonged to Russian oligarchs and other semi-criminal organizations, and so an alternative currency that is a bit clandestine is appealing.

So What Is Bitcoin?

According to Bloomberg, it is the most widely used alternative currency in the world. Designed for the digital economy; BTC works using decentralized peer-to-peer networks, digital signatures, and cryptography. Miners acquire new coins by using computers to solve mathematical algorithms in the system. The reward for solving the problem is a block of 50 BTC.

The system adjusts the difficulty of the algorithms in order to regulate the number of BTC introduced each day. The result is a steady supply of new coins. This “drip” mimics the growth of a real world economy. The supply is finite, although they can be split into smaller units. Only 21 million will ever be created. Unlike fiat money, central banks cannot keep printing more.

You can send or receive BTC using a unique address and then store them either on your computer or in an online wallet or exchange. Think of the address as an email address for bitcoin. The address is alphanumeric and approximately 33 symbols long. It always begins with a 1 or 3. For example:

1Df2z8pwLzLy3gfpEeBhKdJCjvf1ccgNqa 

This code is unique to you. You can also set up a temporary online address to forward payments to you anonymously. Online BTC storage can be vulnerable to hackers and people have had their accounts compromised. Storing your address and bitcoins in an offline location can improve security. For example, you can store BTC on a flashdrive and then lock it up in a safety deposit box.

Bad Publicity

Bitcoin is unique because it is completely decentralized and largely unregulated. Governments or central banks cannot really control it, although of course they can try. Governments cannot collect tax on BTC transactions. Some see these features as weakness, while others cite them as strength. The currency has received negative attention for other reasons. You can potentially use BTC, along with anonymizing browsers like Tor, to buy illegal drugs or hire assassins online. But the exact same thing can be said of cash. Anyone can use it to anonymously buy illicit products or services, as most illegal transactions are conducted using cash.

Mainstream Acceptance

The recent US Treasury rulings gave some clarification to the BTC market recently. Although not mainstream by any means, more merchants are accepting BTC.  Taking payment in BTC on a blog or online store is as easy as installing a plug-in, generating an address, and setting up an online wallet. Several large organizations honor them, including Wikileaks, WordPress, and Reddit. A bar in New York City recently started accepting them as well. Many small online businesses like web designers and hosts will take BTC. And a Canadian man just listed his house for sale; he will accept payment in bitcoin.

Is Bitcoin A Bubble?

BTC looks like a bubble. As of this writing, a the major bitcoin exchange it is trading at all time highs. But bitcoin is highly volatile and thinly traded. Current prices seem unsustainable. At this point, it seems foolish to invest a significant amount of money into it.  Even with the recent pullback over the last few days, there is no telling which way the prices will go.

But that does not mean that BTC is going away. In some ways, it seems similar to the internet bubble back in 2000. It may be a bad time to get in, but bitcoin could be a good long-term investment. There may be lots of opportunity for those who are patient. At the very least, it could provide interesting possibilities in the industries that have sprung up around BTC. Despite many new players, the recent overwhelming demand for BTC  has caused problems for both processors and exchanges. This could lead to economic opportunities as new entrepreneurs step in to fill demand for BTC services.

Bitcoin is a way to diversify your assets away from the dollar or other traditional currencies. Prices may have further to run, but even industry insiders agree that the market is beginning to look very risky. And even if bitcoin disappears, another virtual currency is likely to take its place. Either way, BTC is a fascinating development in the world of business and finance and well worth watching.

What are your thoughts on Bitcoin as an investment or as actual currency?