Bitcoin, an electronic currency not issued by the central bank of any country, although it has been around since 2009 and publicly traded since 2010, has been firmly thrust into the media limelight this year based on its appreciation and volatility.
What prompted this post was a downdraft in the currency from Dec. 15 to Dec. 18 when the value of one bitcoin went from $928 to $455. The Wall Street Journal reported that a popular Chinese bitcoin exchange stopped exchanging yuan for bitcoin, explaining part of this selloff.
Conventional foreign exchange trading of sovereign currencies takes place around the clock from 5 p.m. Eastern Standard Time on Sundays through 5 p.m. EST on Fridays. While currencies appreciate or depreciate in FX trading, most currencies are quoted out to four decimal places -- except for the Japanese yen, which is quoted out to two decimal places. A 0.0001 move in a currency is called a pip (a percentage in point). In dollar terms, a pip is 1/100th of a penny. A 40 pip move can be a big day for a currency. Bitcoin's $473 price swing in a three-day period is 4,730,000 pips.
The point is that this isn't how a currency should behave. The price swings make trading in bitcoins a speculation, not an investment or a store of value. While a bitcoin can serve as a method of payment, with its current volatility it puts too much price risk into transactions.
My economics professor taught me that there are four reasons to hold cash: transactions, speculation, liquidity and as a store of value. From my perspective, bitcoins fail the liquidity and store-of-value standards. As currency, it isn't ready for prime time.
A currency without borders has some attraction. The move to the euro shows that, although that currency has had some growing pains, too.
Bitcoin supply is limited, with a cap of approximately 21 million bitcoins scheduled for around the year 2140. Bitcoins are created by mining them on a computer, by solving a mathematical problem that creates a block of 25 bitcoins. The value of a block is halved every four years. The first halving took place in 2012, when the value of a block went from 50 bitcoins to 25 bitcoins. The last halving is expected to take place in 2140. While 21 million bitcoins doesn't sound like much, the minimum denomination 0.00000001 of a bitcoin, called a satoshi for the founder of Bitcoin, makes it all work.
What do you think? Is Bitcoin a fad or the future? Do you want in or are you happy to watch from the sidelines?