For as many new trends as there are in fashion, there are just as many in business and finance. Some advisors subscribed to the Modern Portfolio Theory for several years and tech stocks in the late 90’s were wildly popular, but the online retail industry has been rocked by the perceived success of a new digital currency, Bitcoin.
The Bitcoin software was developed in 2008 and was marketed as a peer-to-peer electronic cash system. In Layman’s terms, you can pay friends or online retailers who are also Bitcoin users with Bitcoin’s without having to go through a bank, sort of like PayPay but with no central authority. The Bitcoin website even refers to the currency as the “Future of Payments,” in reference to their upcoming conference in San Jose.
We have seen Bitcoin users hailing that this is the future of online retail and that this concept is interesting and will change the world. In fact, the concept of a digital currency is by no means revolutionary. Since 1996 several companies have attempted to enter that space, companies like e-gold in 1996, Digital Monetary Trust in 1999, and Ven in 2007 (Ven is the only one still in business). Since Bitcoin’s inception, there are now at least 5 companies that have spun off from the original Bitcoin concept, and operate in Bitcoin denominations.
The system is unique in the sense that Bitcoin offers a way to conduct international transactions without the high fees from banks and credit card companies. However, there are quite a few issues with Bitcoin to be wary of. One is the fact that they are completely unregulated. I know, the reader probably thought they would never hear a Treece promote regulation; however we like to see sound regulation, not a high volume of regulations. The only thing keeping Bitcoin from flooding the market with a bunch of Bitcoins to meet demand (which would in turn devalue the “currency”) is their word.
Second, Bitcoins are not widely accepted. While many users online will accept individual payments in Bitcoin, you cannot take your Bitcoin to McDonald’s and buy a BigMac.
Third, Bitcoins fluctuate in price dramatically. In just the last 5 months we’ve seen the price of a single Bitcoin go from $20 all the way up to $250 and back down to $150. If a nation’s currency did this, their economy would be in absolute shambles.
The most important flaw with the system comes from the perception of value. One cannot possibly imagine that Bitcoin is paying for all of their servers and IT systems with their own product. They take transaction fees and are covering their overhead with real, tangible currency. What does that say about a business, which promotes an online currency, yet is unable to pay their employees with this “Future of Payment?”
While many do not like to admit it, the fact is that the USD is still the world’s reserve currency. While we certainly have problems within our Treasury Dept and the Federal Reserve, there are aspects to the USD which we do not see on a day to day basis that prove its strength. For example, John Mauldin wrote in one of his newsletters that if there are financial difficulties in Argentina (to which he travels frequently), the Argentineans do not buy gold or silver or Bitcoins or Euros or Pound Sterling; they buy dollars as a hedge.
The concept behind Bitcoin is a unique one, however it will be short lived, constrained or both. Either regulators will come in and make the system nearly impossible to operate, or the banking sector will lobby against Bitcoin in an effort support their own business. Those two scenarios are both based on the assumption that Bitcoin is able to manage high volatility of the currency and attract new vendors.
Moral of the story: Don’t empty your checking account in to Bitcoin just yet, you may end up holding on to them like those good ol’ Iraqi Dinar that you bought 5 years ago…