In a digital world such as ours, currency is almost becoming obsolete. With so many smartphones and debit- and credit-card readers being used for point-of-sale transactions these days, the paper and metal currency and coins that we have used for more than two centuries have now become quaint.
In a digital world, money has moved from cotton paper to a series of zeroes and ones. It would make sense that in this new world, a new currency for online and digital transactions would be formed for these specific purposes. But there are a lot of questions about this new currency, called Bitcoin – namely, what is it really, and how prevalent can it be in an economic universe in the tens of trillions of dollars when there is less than $20 billion worth currently in circulation? (Two billion is 0.2 percent of 1 trillion. Just so you get a picture of the small universe we’re talking about here.)
What is Bitcoin, Anyway?
How to define Bitcoin is pretty dependent on who you ask. According to the “official” Bitcoin website, Bitcoin is actually a “consensus,” decentralized, peer-to-peer payment system that uses digital money. Bitcoins are used in this system for transactions much like cash would be used in brick-and-mortar stores. There is one government agency that considers Bitcoin a commodity (we’ll look at that in a minute), and there are others in the financial world that see it as a currency. Commodities and currencies have different regulations for their use, so the distinction is important.
The Bitcoin Market
As Bitcoin soars to a new high in value (nearing $1,200 per coin), the market for bitcoins is pretty expansive for it being a small universe. At last count, there were more than 100,000 merchants that accept Bitcoin as a valid form of payment for online and web-based transactions. The currency and the payment system have been growing slowly since its inception in 2008 and it currently has a universe worth about $18 billion. At the current valuation, that means there are about 15 million bitcoins currently in “circulation” – a sort of misnomer, as bitcoins are not circulated in the public monetary system but just within the Bitcoin system.
Bitcoins in some ways are a lot like foreign currencies compared to the U.S. dollar. The U.S. dollar is generally stable in value inside its national borders, and it compares to other currencies in exchange according to the market supply and demand of the various currencies in each country. With that, bitcoins will fluctuate in value, which means if you were to buy something with a bitcoin, it doesn’t have a stable rate of exchange like a $100 bill does. It is almost like selling the bitcoin for cash according to the value of the bitcoin at the time of the transaction.
Currency or Commodity?
That is a very good question, because it’s not as obvious one way or the other. On the one hand, bitcoins are used to pay for goods and services online and in an exclusively digital environment. In that sense it is a currency. On the other hand, Bitcoin is a decentralized payment network that does not have a central bank or central processing, so it’s like using a commodity like gold bars in a sort of barter system, where one trades bitcoins for a good or service that another possesses.
And because bitcoins do not have a face value on them like regular currency, it can be thought of as a commodity because the value of a bitcoin fluctuates wildly according to market forces within the Bitcoin network. While a bitcoin may be worth nearly $1,200 today and was worth about $1,100 in 2013, in between the value plummeted as low as $200.
An Investor’s Take
While an institutional investor like Goldman Sachs is on the record as investing in Bitcoin, it doesn’t mean that you, as an individual investor, should do it. The bitcoin market is very small in relation to the overall economic universe, and because it is small, the value of bitcoins will be perhaps the most volatile of any currency or commodity on the markets. And if you want to think of it as a commodity, that means you will want to invest and hold the bitcoins, which means you would be reluctant to engage in the Bitcoin system and network.
And with only 15 million bitcoins in “existence,” holding a few of them can cause the value of the bitcoins to ebb and flow according to how many others hold it like you would, or how many will use and spend them freely in the network.
Bitcoins are treated like a currency, but are looked upon as a commodity in need of regulation according to the Commodity Futures Trading Commission (CFTC), which wants to provide regulatory oversight of the Bitcoin network. Bitcoin is an interesting concept, but getting involved in such a small universe as an investor would involve an awful lot of risk – perhaps too much for all but the most daring individuals who may have some money to gamble, when the casino or the horse track aren’t interesting.
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