Bitcoins: Here to stay…

Bitcoins are already being used as an alternative to national currencies in a wide variety of transactions from both the illegal, such as purchasing drugs, to legal transactions ranging from purchasing food to cars. They are divisible, fungible and countable and possess a value that is desired by those looking to make quick, easy and untraceable transactions particularly where central banking systems pose difficulties.

As Bitcoins increase in acceptance by individuals and businesses, the characteristics that make it a currency (medium of exchange, unit of account, store of value) will strengthen as will its potential to act as an alternative to national, fiat currencies. The value of of Bitcoin is tied not only to the forces of supply and demand but also, unlike fiat currencies such as the US Dollar, the real value of the computing and electrical power required to create them. They can be sent instantly to anyone with a Bitcoin virtual wallet anywhere in the world, without the fees and delays associated with traditional banking.

As the number of Bitcoin exchanges continues to increase around the world, and mainstream companies like Amazon, Virgin, and TD accept them as a form of payment, Bitcoins will continue to supplement and not replace national currencies. It is because of the quick, easy and untraceable features of this crypto-currency that make it a popular alternative rather than the belief that Bitcoins will overtake national currencies.

To best demonstrate how Bitcoins are already being used as an alternative currency, one only needs to look at countries such as Iran, Argentina, and the EU.

Iran, a country plagued by capital controls and international sanctions, has seen tremendous growth in the use of Bitcoins as Iranians use the virtual currency to move money overseas and keep their holdings in the virtual currency which has proven less volatile than the Iranian rial.

Argentineans see Bitcoins as a safe haven and stabilizing force after years of strict banking restrictions and notorious inflation rates that have diminished the worth of their peso.

The crippling financial crisis of the Euro zone has disillusioned Europeans with fiat currencies and central banking norms, particularly in countries like Spain and Cyprus where people have begun converting portions of their savings to Bitcoins due to economic uncertainty and reports that their governments plan to tax saving accounts to pay off public debt.

The common theme here is that Bitcoins have flourished in countries that have battled with inflation, economic crises, and strict and centralized capital controls.

 
The Problem of Volatility

Since its inception in 2008 Bitcoins, initially valued at less than a US dollar, have shot up in value while experiencing wild fluctuations. The most recent volatile period from November to February 2014 saw prices rise from USD$130 to $1,242 then back down to $455 and finally stabilizing at around $900.

Such fluctuations pose serious concerns for those hoping to use the virtual currency for the long-term as volatility decreases the effectiveness of any currency as a store of value. This kind of significant volatility also points to concerns over long-term stability and confidence.

A possible explanation for this is that some users treat Bitcoins as a currency while others as an investment. This is problematic as it is not useful to anyone for their unit of account to behave and fluctuate in price like a stock should. Constant and unpredictable fluctuations due to buying and selling would only dissuade future long-term buyers and institutions from adopting the virtual currency for what it’s intended to do.

However, upon closer inspection of the Bitcoin market it appears that there is a predictable pattern that explains the volatility while alsohinting at a more stable future.

First, media attention attracts new Bitcoin users which in turn creates a bubble as prices rise wildly followed by a bursting of the bubble…

…As falling prices lead to panicked selling and an exit of the new-time buyers, the price of Bitcoins bottoms out and is then driven up again but at more steady rates as long-term users buy more Bitcoins. At this point most Bitcoins are held by those with long-term interests which allows prices to stabilize until the next bubble occurs.

It is important to note that at the end of each cycle, the price of Bitcoins is significantly higher than before and periods of price stability have never been followed by significant price drops.

As well, each new bubble brings a significant amount of new users that hold on to their Bitcoins even during major sell-offs. This means that the long-term Bitcoin userbase is in fact growing, and as publicity increases to the point that the virtual currency is known to most people, there will be no more room for growth. Once this maximum growth point is reached coupled with increasing acceptance worldwide, the Bitcoin exchange rate will no longer be affected by new users looking to make short-term gains and so the rate will stabilize.

While Bitcoins are not intended to replace national fiat currencies they do make an effective alternative, particularly for those countries affected most by unstable financial systems. It is no coincidence that such a decentralized, unregulated and digital form of currency has arrived at the heels of the worst economic crisis of the global financial system. Despite the dangers of volatility, hacking, and uncertainty, people all over the world have embraced this form of currency and are using it to fill voids that traditional central banking has failed to adequately address.