Bitcoin is taking the internet by storm. It was the top performing currency in 2016, gaining more than 126% against the US dollar. And its 300 000-strong daily transactions power a digital economy worth between $200 million and $300 million per day, according to a joint study by the University College London, Deutsche Bundesbank and the University of Wisconsin-Madison.
For those familiar with the cryptocurrency, it holds enormous potential and threatens to upend the global payments landscape. For others, the question remains: is it really revolutionary or is it just magic pixie dust?
So what is Bitcoin and where did it come from?
Bitcoin, as defined by the pseudonymous Satoshi Nakamoto, is a “peer-to-peer version of electronic cash which allows online payments to be sent directly from one party to another without going through a financial institution”.
The Nakamato persona, who is credited with creating the Bitcoin protocol, first floated the idea of the currency in an academic paper in 2008 and was active in the official Bitcoin forum before disappearing. To this day, various attempts to unmask Nakamoto have failed.
Bitcoin is created through a process called ‘mining’, in which specialised computers called ‘miners’, process data related to the currency network in compensation for Bitcoin. Bitcoin has a finite supply, as the protocol allows for only 21 million Bitcoins to be mined. Each Bitcoin can be split into 100 000 000 units, with each unit or 0.00000001 Bitcoin called a ‘satoshi’.
A full “history” of each Bitcoin and every satoshi is stored in an immutable public ledger, the blockchain.
How do I get Bitcoin?
Bitcoin can be purchased online through one of the many exchanges and trading platforms. Since the exchanges operate in an unregulated space, neither the South African Reserve Bank nor the Financial Services Board regulate the cryptocurrency or register the exchanges – it is important to vet them in the same way one would do when buying shares in a company.
The failure of Mt Gox, from which around $400 million in Bitcoin was stolen, and the $65 million hack on Bitfinex, highlight the importance of interrogating an exchange’s security.
Upon purchase, Bitcoin owners are issued with a public key, which can be verified against the ledger, and a private key. Both keys are necessary to transact and can be stored in Bitcoin wallets, which are similar to bank accounts.
Bitcoin is typically used to spend, invest and trade.
Spend
A growing number of South African merchants accept Bitcoin as realtime payment for online purchases. But to protect themselves and customers from fluctuations in the Bitcoin price, payments are processed using rand spot prices.
Invest
Bitcoin is also regarded as an investment tool, and in some cases an alternate to gold.
According to Capital Economics’ global chief economist Andrew Kenningham, Bitcoin and gold are similar in that they are independent of governments and central banks, are in finite supply and have no identifiable income streams which make them hard to value.
He said gold and Bitcoin are likely to be inversely correlated, with gold doing well in periods of uncertainty and Bitcoin more likely to benefit from high levels of risk appetite.
Bitcoin may have the potential to directly compete with trillion dollar markets such as the $2 trillion annual market for electronic payments, the $1 trillion annual e-commerce market and the $4.5 trillion cash market among others.
As with all investments, buying Bitcoin carries risk. But whether South Africans can seek advice from financial advisers is debateable. Bitcoin is not recognised as a regulated product which advisers may advise on.
Trade
Volatility in the Bitcoin price, which is often more dramatic than that of fiat currencies, also draws traders.
The Bitcoin price does however appear to be linked to sentiment in China, which makes up around 98% of global trade volumes. Statements from the People’s Bank of China have caused wild fluctuations in the Bitcoin price in 2017. It’s said that the central bank wants Bitcoin exchanges to comply with the regulations as a means to control the outflow of yuan.
Regulation
In a 2014 position paper, the South African Reserve Bank said it would not oversee or regulate the space. It was believed that currencies did not pose a significant risk to financial stability, price stability or the national payments system.
The SA Reserve Bank, however, is known to have a team that observes developments in the fintech space and regularly engages with cryptocurrency stakeholders.
Industry stakeholders are said to welcome regulation as it will bring legitimacy to market, build trust for businesses and safeguard consumer rights.
Revolutionary or pixie dust?
There’s no denying it, in less than ten years Bitcoin has created its own economy of sorts, generated enormous hype, spurred several copycat cryptocurrencies and caught the attention of regulators. However, much of its future growth and widespread adoption hinges on it being viewed as legitimate legal tender and shedding its reputation as a currency that powers the dark web. Until then, it may well just be pixie dust to the average consumer and investor.
(This piece has been adapted from a recent article which first appeared in “Moneyweb Investor”)