The upstart electronic currency bitcoin has soared from zero five years ago and under $150 apiece six weeks ago to above $600 Monday – more than a share of Apple Inc. (AAPL) is worth, and quite a sum for an instrument with only limited use as money and which few consumers understand.
The confusion surrounding bitcoin, which has attributes both of a currency and a speculative investment, has prompted U.S. authorities to weigh in on its legitimacy.
The Justice Department told Congress that it and all electronic payment technologies have benefits for consumers, while of course asserting it will seek to root out any illicit transactions made in bitcoin. The Securities and Exchange Commission, meantime, suggested bitcoins “likely” meet the definition of securities, and thus could be subject to SEC regulation.
No one needs bitcoins
To begin at a basic level, no one on the planet actually needs bitcoins. Once someone exchanges dollars or another established currency for bitcoins in an online account, there is a growing but still narrow group of Web merchants and physical retailers, including WordPress.com and two Subway stores, that accept it as payment. True, transaction volumes are soaring, though from a very low base. At today’s price, the total value of bitcoin in circulation is $7 billion. To make a slightly unfair comparison, the amount of physical U.S. currency in circulation is $1.2 trillion.
Bitcoins are “mined,” or created, by programmers who set their computers to compete to solve math problems. The pace of creation of new bitcoins, now about 12 million, is set in advance. The supply of bitcoins will ultimately peak, forever, at 21 million.
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Each bitcoin can be divided into ever-tinier pieces to use in transactions, and the price per bitcoin is theoretically unlimited, so advocates of the currency say its market value can continue growing after that cap is reached.
Still, the perception of built-in scarcity is clearly driving the speculative surge in bitcoin’s value, while simultaneously diluting its utility as a currency. Neither buyers nor sellers of goods and services would want to rely on prices set in a medium of exchange that can swing so violently in value relative to other currencies or “real” assets.
The supply cap in bitcoin seems ultimately suited to encourage saving, or hoarding, them – especially to the extent a buyer believes they will become more mainstream over time. It is implicitly “deflationary,” or likely to pressure prices lower in bitcoin terms, which itself creates incentives to forestall spending and save more.
The main philosophical benefits of bitcoin are its decentralized creation and processing protocols, free of any government control or endorsement; the anonymity of bitcoin users; global fungibility; and the fact that, unlike traditional money controlled by central banks, it can’t be created without limit. On the flipside, it has no intrinsic value, the encryption and processing system is untested and government action could, in theory, restrict or forbid its use.
A complicated evolution
Bitcoin’s historical association with illicit trade in drugs, weapons and money laundering has also complicated its evolution. When the rogue online underground site Silk Road was shuttered by authorities Oct. 2, it reportedly left a trove of bitcoins frozen out of circulation. This might have fueled the recent rise in price as it created acute scarcity and left those who owe money in bitcoin scrambling to secure some.
Also, newly created programs effective at “mining” bitcoin more quickly may have sidelined less-efficient traditional Bitcoin creators, concentrating the number of suppliers and encouraging more hoarding. The opening of a popular Chinese bitcoin exchange, BTC China, has also been said to have drawn eager mainland buyers of the virtual currency. BTC China recently became the largest trading platform for bitcoin, replacing Mt. Gox.
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Nearly everyone on all sides of the debate over the legitimacy and usefulness of bitcoin grants the intellectual impetus and technological infrastructure behind bitcoin are brilliant. And the world of mobile, global, electronic payments is advancing quickly along a number of fronts, while concerns about central-bank money creation have become more intense.
But this doesn’t mean that bitcoin at $550 or $600 or so – or at any price much higher or lower – is anything but a speculative frenzy with a techno-idealist overlay.
For about the same number of dollars as it takes to buy a single bitcoin now, one could by a share of Apple that represents about 1/900 millionth ownership of the most valuable company in the world. This entitles the holder to $12.20 a share in cash dividends a year (which will likely grow) and a small voting say in who governs the company. While its price can – and sometimes does – stray far from any sober calculation of underlying value, it represents a claim on Apple’s future cash flows in perpetuity; this year’s per-share profit is on track to exceed $40.
Though there is no cap on how many Apple shares can be created, the company is now committed to shrinking its share count through a huge stock buyback. In a distressed scenario currently hard to imagine, that Apple share would probably be worth at least something in a corporate liquidation.
Sure, no one “needs” to own Apple either. But at least paying $523 for the stock now doesn’t require one to have a strong view on the sustainability of an online feeding frenzy, the opinions of government authorities as to the legitimacy of the securities or the very future of money for the next millennium.