Q16. It is a blockchain-based cryptocurrency that works in a similar way to Ethereum and bitcoin. It is a peer-to-peer internet currency that allows for instant, near-zero cost payments to anyone in the world. It’s a decentralised payment network that isn’t managed by any central authorities. What is it known as?
The list of people who have been saying that bitcoin is a bubble is growing in tandem with the growth in its valuation. In recent days, many experts have thrown their words of cautions:
1. On Wednesday, Reserve Bank of Australia’s Governor Philip Lowe joined the bandwagon and said that bitcoin is not suitable for mainstream payments. He added that the fascination with the currency is more like a “speculative mania”.
2. Earlier on Tuesday, UBS analyst Paul Donovan said that bitcoin bubble could lead to 'destructive' consequences.
3. Reserve bank of India in multiple press releases has reiterated time and again that the investors should invest in cryptocurrencies at their own risk.
4. Brent Goldfarb, a business professor at the University of Maryland, and William Deringer, a historian at MIT, who have done research on historical bubbles and manias, talking about the surge in valuations, said that there are classic signs of days before the doom. At some point, Goldfarb said, some triggering event will start a panic that will lead to a market crash.
5. Convoy Investment’s co-founder Robert Wu opined that the mania around bitcoin has “surpassed” the Dutch Tulip frenzy in the 17th Century.
Explainer: What is bitcoin and how does it work?
Despite repeated cautions and warnings by established financial institutions, the price of bitcoin has skyrocketed in last two weeks. It is currently trading at USD 16,740 on the US-based Coinbase exchange. Comparatively, on December 1, it was trading at USD 9,740.
So what exactly is fuelling the prices of bitcoins? What has made the investors so crazy that they are repeatedly ignoring the expert advice? The answer could be assessed in three broad points:
How to value bitcoins
Bitcoin defies all the traditional norms of determining the value of anything. Bitcoin does not pay dividends like shares and bonds, nor it pays rent like a property and neither it is attached to a national economy like fiat currencies.
None of the ‘fundamentals’ which are used to determine the value of any asset applies to bitcoin. Hence, there are no known ways it could be answered that what is the optimum value of bitcoins.
That means, no one exactly knows if the current value of bitcoin is inflated or it is yet to reach its worth. In one line, the optimum value of bitcoin is what the next person is willing to pay!
Is bitcoin a currency?
By definition, yes, bitcoin is a currency. But, it is hardly used as one. There are very few merchants which accept bitcoins as an exchange for goods, and fewer customers who are willing to use it as a currency. And, rightly so, why would they use it? The value of bitcoin is appreciating up to 40 percent in a day! It is better to keep it than to spend it, which again leads to it being more of an investment tool than a currency.
Comparison with Gold
Bitcoin’s comparison with gold is inevitable. Both bitcoin and gold, have no intrinsic value. Their value defies the traditional asset valuation methods. Both of them do not pay dividends or rent to their investors. Gold’s value is speculative, and mining (i.e., supply) is one determining factor much like bitcoin.
By design, there is a limit on the maximum supply of bitcoin, much like gold. Only 21 million bitcoin can come into existence, ever.
A large amount of gold is stored in bank’s vaults as a security or bars and coins in the personal capacity. Similarly, there are holders who have kept the bitcoin in their wallet as a long-term investment option.
So, logically, it can be argued that whatever keeps the gold valuable, is responsible for bitcoin’s surge, and speculative trade could be one of those things.