Yes, bitcoin is real and it is a legitimate financial asset, much like any commodity. I use the word “commodity” because that’s what this particular cryptocurrency behaves like. Many comparisons have been made to gold, which is reasonable because the value of bitcoin is not derived from any functional use. Its price is completely driven by supply and demand combined with a good measure of euphoria.
But those thinking (or perhaps hoping) the bitcoin bubble will pop instantly will be humbled by the development of a regulated bitcoin derivatives market, recently introduced by the CBOE and even more recently by the CME. They are treating bitcoin futures like those of any other financial asset. Positions are marked daily and gains/losses will be recognized as income as a result (which marks a departure from one of the privileges bitcoin users have enjoyed – being out of reach of the IRS).
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So, do the $18,000 USD (at the time of this writing) price and support of a regulated derivative market legitimize bitcoin as a mainstream virtual currency? No, it doesn’t. And here’s why.
The very limited supply of bitcoin was the initial driver of its derived value. Bitcoin was embraced by a very small number of individuals and its rarity helped propel bitcoin’s price into the hundreds of dollars per unit that we saw a few years ago. Market dynamics have since driven it to unexpected levels, yet the simple fact that supply is so constrained — and is expected to be stable into the future — suggests that only a sharp drop in demand will pop the bubble.
That said, it is the limited supply that actually hurts bitcoin’s scalability as a legitimate virtual currency. Even using fractional units does not provide enough bitcoin to satisfy mainstream personal or commercial finance needs. There is not enough bitcoin to facilitate even 1 percent of daily P2P or B2B payment activity. The rare nature of bitcoin drives both its success (in dollar terms) and its failure as a mainstream currency, which it was never designed to be in the first place.
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Many technologists have argued that the most interesting part of bitcoin is the Blockchain technology that supports it. And they’re right. Blockchain, which has evolved to be a part of a distributed ledger movement, offers interesting advantages over existing information-sharing technology, including within finance and treasury. The ability to simultaneously update all participants to a transaction(s) offers a level of non-repudiation that treasury teams have dreamed about in their world of sending payments, especially when they look to bypass traditional bank payment networks.
But the Blockchain supporting bitcoin was not built for large volumes. Different reports peg maximum throughput of 6-7 transactions per second (TPS), which is miniscule compared to card processors that routinely manage several thousand TPS. Bitcoin simply wasn’t built to support the volume of activity that it would need to be a legitimate conduit of financial transactions.
So what is interesting about bitcoin then?
Bitcoin was the first popular virtual currency. Before bitcoin, cryptocurrency wasn’t a word and now it’s a recognized term that everyone (mostly) understands. Whether cryptocurrencies replace fiat currencies or not doesn’t diminish their growing role in electronic commerce, including for cross-border payments where most payment-focused FinTechs are currently focusing their efforts. What may be most interesting to watch will be the effect on bitcoin as other cryptocurrencies rise in their own popularity. Bitcoin, due to its constraints, is not the only virtual currency in town and others will solve the issues bitcoin has not been able to overcome. At that point, if not before, the value of bitcoin will fall simply because it will no longer be a perceived category of one.
That doesn’t change the fact that bitcoin is a pioneer and should be celebrated as such. It’s just too bad you can’t frame one on your wall to treasure it, although those that would want to physically look at a bitcoin miss the point of bitcoin in the first place.