NOT FOR THE FAINT OF HEART POV: IN THE NAME
Cryptocurrency Bitcoin has created the biggest bubble since the internet. There are 16.7 million bitcoins now in existence, valued at over $267 billion at their price at the time of writing ($16,000 apiece). For perspective, the total value of rupees in circulation, as on December 1, was about $252 billion (assuming Rs 65 = $1). In January 2017, bitcoins were trading below $1,000 and it crossed $20,000 in early December. The 2,000 per cent appreciation has attracted huge trading volumes, and there are now many Indians in the game and many exchanges that allow rupee trades of bitcoins.
The bitcoin is massively price-volatile—20 per cent swings are common in a single session. By comparison, gold has moved about 8 per cent this whole year. The volatility makes it a scary store of value and wildly variable unit of exchange. Today, you can buy a car with one bitcoin, next week it may be two cars or, perhaps, only a two-wheeler. So, if you are trading bitcoin, you’ll be ill-advised to risk your entire net worth on it. Play small.
For newbies, a bitcoin is a string of unique computer code. New bitcoins are created (“mined”) by solving mathematical problems. Each coin can be split into 100 million unique parts called ‘satoshi’, named so in honour of its putative inventor, Satoshi Nakamoto.
Bitcoin is built on clever cryptography. It uses an open, distributed, electronic ledger called the “blockchain”, containing “blocks” of time-stamped transactions. Every transaction made with a bitcoin from its creation is recorded in the blockchain, which is continuously updated. Anybody can download a blockchain copy and check transaction histories for all coins.
Bitcoins are held in digital wallets. Each wallet has a public ID number or public key. Each wallet also has a
private key, known only to the owner. If the private key is lost (because your drive is fried, or you’re hacked), the coins in it are lost with no recourse. Hang on to that key for dear life.
Transactions are made by using that private key along with the public account number to transfer ‘specific coins’ to other wallets. Every transaction creates a unique “hashed” (encrypted) message that cannot be tampered with. Anybody can authenticate the message by running the public key. When a transaction message is sent, users can easily check that: i) the wallet actually contains those specific coins and ii) no attempt at fraud is being made by doing two transactions with a single coin.
Once most users agree on authenticity, the blockchain is updated by adding that transaction to a new “block”. Verification normally takes 10 minutes per transaction. But there can be glitches. Traders are advised to wait an hour or so before accepting a transaction as genuine, even after it is added to a new block.
Cryptocurrency exchanges enable bitcoin trades in many currencies. Exchanges will demand KYC, associating wallets with entities. But off-exchange deals are easy. Create a new wallet, put coin in it and exchange the private key for cash. Anonymously trading bitcoin in multiple currencies is an easy way of making cross-border remittances—a feature that can make regulators and governments legitimately nervous.
Few merchants accept bitcoin. Only Japan, Australia and a few other countries recognise it as currency. Most others (including India) haven’t figured out how to define it, so it’s in regulatory limbo. If more merchants like Alibaba or Amazon accept it, utility will increase. If more nations recognise it as currency, there will be more usage—and likely greater regulation. NASDAQ and the Chicago Board of Trade are offering futures contracts on bitcoin, so there is a hedging mechanism, which could attract more institutional interest.
It’s an attractive asset to trade but it’s also very risky. Right now, we have a bubble, which could continue to inflate if trading volumes rise. The problem with bubbles is that they burst. During the sub-prime crisis, CITI CEO Charles Prince said, “As long as the music is playing, you’ve got to get up and dance.” The music’s still playing for bitcoin, but who knows when it’ll stop?
Bitcoin is in regulatory limbo as most nations haven’t figured out how to define it