Bitcoin, Blockchain, and Bubbles.

“As a medium of exchange, bitcoin offers several unique innovations to currency: global nature, infinite divisibility, and easy to carry” stated Edmund Moy, former director of the United States Mint.  “It will be a disruptor to the traditional notions of currency.  In the end, currency will be better for it” he calimed.

Bitcoin is the booming virtual currency currently taking over the world (or so it seems).  It is hard not to notice people everywhere advertising they have gotten rich off bitcoin, or proclaim it the currency of the future.  Though bitcoin may be revolutionary, it is also likely to be a flash in the pan.

So what is bitcoin?  Bitcoin is a digital currency that operates independently of a central bank.  Sounds exciting doesn’t it?  What may be even more exiting is the encryption technique used to regulate the generation of bitcoin and verify the transfer of funds, or more commonly known as ‘the blockchain.’  Before we discuss the blockchain, let’s first unpack the potential upsides to virtual currencies.

By operating on an open source platform, bitcoin has low barriers to participation.  At least in theory, if you owned a computer, you would not only be able to use, but mine bitcoin as well.  This is one key factor Mr. Moy pointed out previously ‘global in nature… easy to carry.’  Unlike traditional currencies, bitcoin is seen as a global and all-inclusive currency.  As the world becomes more efficient and globalization becomes increasingly prominent, humanity is likely to need a global currency to facilitate a broader scope of exchange.  Bitcoin offers this.  No longer would a consumer need access to anything other than a computer and the internet to participate in meaningful transactions.

Secondly, bitcoin offers much sought after anonymity to its holders.  The blockchain ledger only lists encrypted addresses of those involved in a bitcoin transaction.  Those addresses are held by individuals, so no one would know your address, unless you specifically told them.  Why is this attractive?  Financial institutions account for roughly 1/5 of all data breaches.  The blockchain enables bitcoin to operate in a more secure, private way.  Privacy of information carries almost unlimited value as we store more and more information in virtual capacities.

Lastly, bitcoin operates as a decentralized currency.  Because bitcoin verifies transactions in a way not dependent of a third party, there is no need for a backing financial institution, government, or other body to be involved.  This allows for unregulated peer-to-peer transactions.  Furthermore, as Edmund Moy previously stated, this allows bitcoin to become a serious threat to traditional currency.  When a transaction needs to be verified, the first ‘computer’ to solve for the unique transaction ID is rewarded bitcoin (this is known as mining), and because it is almost infinitely divisible, there is no need for a centralized body to control it.  By taking out the middle-man, bitcoin provides a more efficient way of connecting buyers and sellers.

Though bitcoin seems to have incredible upside, it is unlikely to replace ‘the notions of traditional currency.’

Underestimating the power of monetary policy is very easy to do.  Because there is no body behind bitcoin, it may not ever be a medium of exchange at all.  Due to the lack of a third party, bitcoins value is incredibly volatile.

Think about buying a home.  Today, you may be able to buy a house for 10,000 BTC (bitcoin), however; tomorrow, BTC is quoted at a much higher price.  Due to volatility, your home is now worth 5,000 BTC.  If you would have waited to buy, you would have twice the wealth you have today.  Situations like this cause will cause buyers to hold their funds, and markets will freeze.  In contrast, while purchasing in a form of currency backed by a third party, consumers do not experience a fear of missing out and markets become more fluid.

“But bitcoin will solve problems of scarcity and inflation.”  This is another misguided belief held by many.  Though bitcoins supply is limited at 21 million, there are currently more than 1,300 other forms of virtual currency, including two additional forms of bitcoin.  The virtual money supply is unlimited, as is true for traditional currency.  Despite this, many believe bitcoin will replace the U.S. Dollar and has led to a virtual gold rush, creating a very dangerous bubble.

Aside from bitcoins doubtful outlook, one thing is for certain: the blockchain is here to stay.  Not only the financial industry, but every industry will soon be using blockchain technology in one way or another.  The use of modern computing power to verify information and validate transactions is sure to be one of the keynote accomplishments of our era.

The example of fraud prevention is an easy example of how useful the blockchain can be.  For example, if insurance companies operated from an open sourced ledger, and its customers could be assigned an encrypted ID number, it would be impossible for someone to commit insurance fraud. If their ID number was subject to validation on a public ledger, multiple claims for the same event would never be validated.  Less fraud and increased efficiency (in theory) would translate to lower insurance rates, as non-healthcare based insurance fraud is estimated to be north of $40 billion per year.  The blockchain is sure to increase effectiveness, efficiency, and security of every industry it is applied to.

Although bitcoin may be exciting, it may be helpful to take a step back and try to grasp the larger picture.  Bitcoin may be no more than a bubbled investment that gained its value from a successful application of the blockchain.  After its first major success, it is increasingly exciting to see what changes blockchain technology will provide in coming years.  Industries such as transportation (autonomous driving), healthcare, and finance are sure to be largely impacted.

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