“As with all emerging
technologies, the federal government must make sure that potential threats and
risks are dealt with swiftly; however, we must also ensure that rash or
uniformed actions don’t stifle potentially valuable technology”
-From a letter by The U.S. Senate, Homeland
Security and Government Affairs Committee (8/12/2013)
It seems pretty clear, at this point, that Bitcoin is not
going anywhere any time soon, so where exactly does it fit into the markets?
Bitcoin is a peer-to-peer, encrypted digital currency, a first in its class. It is now in its third
year of operations and has already been exposed to more than its fair share of
success, criticism, and controversy. Despite these challenges, Bitcoin does appears
to have some staying power and now regulators, economists, and private
interests are left with the task of trying to figure out what to do with this
dynamic new virtual currency; and how can it be put on a safer, more
sustainable path.
In late August, lobbyist on behalf of Bitcoin met with the U.S.
Secret Service, the IRS, the Federal Reserve, and at least 4 other government
agencies. This meeting followed growing concerns surrounding current and potential
misuses of Bitcoin to finance illicit activities, and law enforcement’s lagging
ability to monitor and respond to highly sophisticated cyber criminals.
These concerns are not unfounded.
Unlike most fiat currencies, bitcoins are digitally transferred
between anonymous users anywhere in the world in a matter of minutes; without the
need for financial intermediaries or third-parties and with as much ease as
sending an email. Although every transaction ever made using the virtual currency
is a permanent public record in the blockchain
ledger, transactions are still extremely difficult to trace back to
individuals or the item(s) that were purchased. Obviously, privacy is the most attractive
feature of Bitcoin to its growing base of users—a feature that law enforcement
officials believe will also makes it more attractive to criminals. Despite this
criticism, Bitcoin’s popularity has grown virally, prompting some technology
and internet privacy advocates to question whether the government can get the poorly
understood currency under regulatory control.
Needless to say, federal and state law enforcement agencies
have already begun responding.
In the last 3 months
alone, 22 companies, some of which were reported to have merely expressed
interest in Bitcoin publicly, received subpoenas inquiring into their business
practices; the world’s largest Bitcoin brokerage, Mt. Gox, had close to $3
Million in assets seized by The Department of Homeland Security; and The Silk
Road, described by the FBI as “the most sophisticated and extensive” online
black market which used Bitcoin, was shut down. NY’s chief financial regulator,
Benjamin Lawsky, regarding the aforementioned subpoenas that were served from his office,
stated, “If virtual currencies remain a virtual Wild West for narcotraffickers
and other criminals, that would not only threaten our country’s national
security, but also the very existence of the virtual currency industry as a
legitimate business enterprise.” Putting aside the facts that Bitcoin itself is
not illegal and is in no way culpable for its own abuse at the hands of
criminals, it’s pretty clear that the intense political pressure surrounding
Bitcoin is enough to dissuade private interests from embracing the technology,
which could prove to be the virtual currency’s biggest barrier to stabilization.
Notwithstanding the legal and political framework,
economists are skeptical of the economical framework underpinning the virtual
currency; a few even doubt its practical use as money in "real"
transactions. Money, simply put, is a unit of exchange; it need not be physical
in nature, it just has to be accepted as such and it has to be a relatively stable store of
value—the problem for Bitcoin stems from the latter.
Bitcoins are extremely volatile.
Since January, the price of one Bitcoin has skyrocketed 1300% with a standard deviation of $47.70. Bitcoin’s FX market has grown rapidly, but it’s still tiny compared to the traditional FX markets. Furthermore, the supply of bitcoins grows at constant rate, but it’s long-run money supply is capped at just $21 million. Seems a bit arbitrary. Far different from traditional money regimes, the limits of Bitcoin’s money supply are imposed explicitly by an algorithm. It's small size makes it possible for a few investors with a large amount of bitcoins to have influence over the entire market.
Bitcoin's FX doesn't fit any of the criteria for an efficient market. Economists predict that the wild fluctuations in price will continue as a direct result of Bitcoin's unconventional approach to money, making it a very risky asset not suitable for everyday purchases.
Bitcoins are extremely volatile.
Since January, the price of one Bitcoin has skyrocketed 1300% with a standard deviation of $47.70. Bitcoin’s FX market has grown rapidly, but it’s still tiny compared to the traditional FX markets. Furthermore, the supply of bitcoins grows at constant rate, but it’s long-run money supply is capped at just $21 million. Seems a bit arbitrary. Far different from traditional money regimes, the limits of Bitcoin’s money supply are imposed explicitly by an algorithm. It's small size makes it possible for a few investors with a large amount of bitcoins to have influence over the entire market.
Bitcoin's FX doesn't fit any of the criteria for an efficient market. Economists predict that the wild fluctuations in price will continue as a direct result of Bitcoin's unconventional approach to money, making it a very risky asset not suitable for everyday purchases.
Governments may be a little uncomfortable with Bitcoin, and
economists aren’t sold on it either, but speculators love it.
Bitcoin speculators have generated enormous returns trading bitcoins. According to one famous story, one man bought 27 bitcoins in 2009 which he later forgot about, only to realize this year that his investment was worth well over $800K. Bitcoin has already made quite a few millionaires already. Ironically, the very characteristics which, economists say, makes Bitcoin a poor choice for spending money are the exact same traits that make it an excellent choice for arbitrage traders. Even though Bitcoin FX pairs exhibit a strong and positive correlation their spot FX equivalents, the instability of the Bitcoin market creates sizeable exchange rate deviations above and below the Spot FX exchange rates, thus, making arbitrage opportunities possible.
Bitcoin speculators have generated enormous returns trading bitcoins. According to one famous story, one man bought 27 bitcoins in 2009 which he later forgot about, only to realize this year that his investment was worth well over $800K. Bitcoin has already made quite a few millionaires already. Ironically, the very characteristics which, economists say, makes Bitcoin a poor choice for spending money are the exact same traits that make it an excellent choice for arbitrage traders. Even though Bitcoin FX pairs exhibit a strong and positive correlation their spot FX equivalents, the instability of the Bitcoin market creates sizeable exchange rate deviations above and below the Spot FX exchange rates, thus, making arbitrage opportunities possible.
Interestingly enough, the rapid inflow of Bitcoin speculators
hoping to exploit these disparities have also increased market volume and competition
which, in turn, has reduced the very disparities which were created by the inefficient conditions in the first
place. Simply put, Bitcoin traders have improved the market's efficiency. From
2011 to 2013, The spread or the difference between major Bitcoin FX pairs and their respective
spot cohorts in absolute terms has decreased steadily.
This finding is crucial because it suggests that even a digital currency, like Bitcoin, is not immune to market-based corrections and
that, as market participation increases over time, bitcoin prices will become more precise estimate of "real world" money. It's not likely that Bitcoin, in it's current state, will ever be able to compete with the dollar, but is it a stable currency?
Not yet, but it's getting there.
Not yet, but it's getting there.
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