Soaring Bitcoin: If It’s A Bubble, When Will It Burst?

By | December 14, 2017
Bitcoin - Legal Bites

“Bitcoin is the beginning of something great: a currency without a government, something necessary and imperative.”

– Nassim Taleb, Author of The Black Swan


Introduction

Bitcoin and bubble have become virtually synonymous in the minds of many cynics since this year’s breathtaking rally. While the digital currency has defied doomsday prophesies, there’s a number of ways this party could end badly for the swelling ranks of bulls. There are a lot of controversies, on the one hand, bitcoin is declared to be a bubble and can be expected to burst soon whereas, on the other hand, it’s future is described in a completely contradictory manner.

What is Bitcoin?

The Bitcoin software was released in early 2009 by a mysterious creator who went by the name of Satoshi Nakamoto. The search is still on for the true identity of Satoshi. Bitcoin is a cryptocurrency, or a digital currency, that uses rules of cryptography for regulation and generation of units of currency. Bitcoin falls under the scope of cryptocurrency and was the first and most valuable among them. It is commonly called a decentralized digital currency.

What is cryptocurrency?

  1. A cryptocurrency is a digital currency created and stored electronically in blockchains.
  2. It uses encryption techniques to control the creation of monetary units and to verify the transfer of funds. Hence, it is very secure.
  3. It has no physical form and is not redeemable for another commodity like gold.
  4. Its supply is not determined by any central bank or authority and the network is completely decentralized.
  5. Examples: Bitcoin, Litecoin, Namecoin, etc.

Why Bitcoins?

Bitcoins can be used to buy merchandise anonymously. In addition, international payments are easy and cheap because bitcoins are not tied to any country or subject to regulation. Small businesses may like them because there are no credit card fees. Some people just buy bitcoins as an investment, hoping that they’ll go up in value.

Eg: Bitcoin can be used to book hotels on Expedia, shop for furniture on Overstock and buy Xbox games and son on

What is the value of one Bitcoin today?

One bitcoin is worth rough about $16,442, now. When converted into rupees, somewhere around Rs. 10,52,195.

And the unlikely traditional currency that is inflationary in nature, the bitcoin is a deflationary currency. In other words, if there are only so many bitcoins in use and the demand for those rises, the value of a bitcoin would logically rise.

How does Bitcoin work?

Bitcoins are completely virtual coins designed to be ‘self-contained’ for their value, with no need for banks to move and store the money.

Hitesh Malviya, Bitcoin Expert explains the working as, “Once you own bitcoins, they possess value and trade just as if they were nuggets of gold in your pocket. You can use your bitcoins to purchase goods and services online, or you can tuck them away and hope that their value increases over the year.”

Who can you send Bitcoins to?

You can send bitcoins digitally to anyone who has a bitcoin address anywhere on the globe. One person could have multiple addresses for different purposes- personal, business and the like.

Receivers can get to spend them within minutes of receiving the coins. Once given away, like currency, there is no getting them back, unless the receiver decides to give them to you. A bitcoin is not printed currency but is a non-repudiable record of every transaction that it has been through. All this is a part of a huge ledger called the blockchain.

Where do you get Bitcoins?

Bitcoins are available on Bitcoin exchanges. You could also purchase bitcoins from other users. A Bitcoin exchange-traded fund could be another source in the near future. You can become a bitcoin miner by investing in software and hardware. More the power of the hardware that helps with encryption technology, higher the probability of your earning bitcoins. Unocoin is a Bengaluru-based company that allows users to buy, sell, store or uses bitcoins. While bitcoin usage is certainly not mainstream, there are said to be more than 500 merchants who accept bitcoins for payment in India.

How are Bitcoins owned?

Bitcoins are stored in a “digital wallet,” which exists either in the cloud or on a user’s computer. The wallet is a kind of virtual bank account that allows users to send or receive bitcoins, pay for goods or save their money. Unlike bank accounts, bitcoin wallets are not insured by the FDIC.

Anonymity with regard to Buyer and Seller

Though each bitcoin transaction is recorded in a public log, names of buyers and sellers are never revealed- only their wallet IDs. While that keeps bitcoin user’s transactions private, it also lets them buy or sell anything without easily tracing it back to them. That’s why it has become the currency of choice for people online buying drugs or other illicit activities.

What is Bitcoin Mining?

Bitcoin mining refers to the process through which new Bitcoins are created and given to computers helping to maintain the network. The computers involved in Bitcoin mining are in a sort of computational race to process new transactions coming onto the network. The winner — generally the person with the fastest computers — gets a chunk of new Bitcoins.

There is generally a new winner about every 10 minutes, and there will be until there are 21 million Bitcoins in the world. At that point, no new Bitcoins will be created.

Every Bitcoin in existence was created through this method and initially given to a computer helping to maintain the records. Anyone can set his or her computer to mine Bitcoin, but these days only people with specialized hardware manage to win the race. Bitcoin - Legal Bites

How does the payment system work?

When you send a bitcoin to a receiver, the transaction is included in the blockchain and broadcast to the network. The blockchain ensures that the same bitcoin is not spent twice by the same user. A computer network validates the transaction using algorithms so that the transaction becomes unalterable. Once validated, the transaction is added to others to create a block of data for the ledger.

Gopal Jiwarajka, President, Ph.D. Chamber of Commerce and Industry says, “Bitcoin is fraught with risks and not backed by any tangible asset. But the number of investors is still growing, which is a concern.”

Factors driving price of Bitcoin

1) Animal spirits

Economists have long had a notion that psychological factors affect investor decisions. This is called ” animal spirits”  and refers to investors making decisions based on the behavior of other market participants and their own intuitions, rather than hard analysis.

Analysis of the price of Bitcoin shows that positive media coverage is one of the main factors driving the price.

2) Political risk

Political risk around national currencies can also affect the price of Bitcoin as people use it to hedge against price movements in a particular currency, or they need to quickly move large amounts of value out a country or currency.

3) Regulatory moves

Regulators around the world have had to catch up to the rise of Bitcoin. They must decide, for instance, how it will be treated by the tax system, or whether and what regulation applies to its use.

4) Bitcoin’s governance

Although Bitcoin is a decentralized currency, some decisions about how it will work or evolve need to be made from time to time. These also have an impact on the price.

5) The Many Functions of Bitcoin
  • Bitcoin has many functions and uses, and these functions are responsible for determining the soaring of its price but the ones that are salient to price fluctuations are:
  • Bitcoin Payment Network – Bitcoin as a currency.
  • Bitcoin Storage and Transfer – Bitcoin as a store of wealth and medium of value transmission.
  • Bitcoin Exchange Rate – Bitcoin as a market instrument and commodity
6)  Buying Bitcoin

Every Bitcoin exchange transaction that involves the purchasing of Bitcoin via another currency, whether fiat or cryptocurrency, has the effect of pushing the bitcoin price up. Because the bitcoins are changing hands – from the exchange’s wallet to the buyer’s wallet – there is an accompanying Bitcoin network transaction.

7) Selling Bitcoin

Every exchange transaction that involves the selling of bitcoin, i.e. exchanging for fiat or another cryptocurrency causes a downtick in the price of Bitcoin.


“Bitcoin is a technological tour de force.”

– Bill Gates, Microsoft co-founder


What are the dangers of getting into this market?

Lack of oversight means that no one is checking that the exchanges are properly securing their customers’ money or that large players are not able to manipulate the price. One of the largest exchanges in the world, Bitfinex, has been hacked numerous times and provides little transparency about where it is keeping its money.

Once people buy Bitcoin, they are often targeted by hackers who have become experts at penetrating Bitcoin accounts. And also, bitcoin “wallets” are vulnerable to new kinds of attacks that are not an ordinary problem of bank accounts.

Most importantly, in contrast to money in a bank account, when a Bitcoin is gone there is essentially no way to get it back and no insurance covering its loss. Few other dangerous are:

  1. Extreme volatility
    Investing in cryptocurrencies involves very high risk, as prices have been extremely volatile. Many experts are skeptical about bitcoin as an investment primarily because there is nothing for them to analyze. Since these cryptocurrency prices are not regulated, as more people enter the market lured by the high prices, the prices climb ever higher. This might lead to the formation of a bubble that will eventually burst and cause widespread losses.
  2. Neither commodity nor currency
    The lack of clarity about its origin is another big issue related to bitcoin. In olden days,  highly priced metals like gold, silver, etc. were used as currencies. Then came currencies printed by governments (or central banks) and these are called ‘fiat currencies’. Though its proponents claim that cryptocurrency is ‘mined’ using complex mathematical formulae, they are reluctant to call it a commodity. They also claim that it is not controlled by any government and so, it is ‘democratic’. Therefore, cryptocurrencies don’t fall into the ‘currency’ category either.
  3. Don’t invest if you don’t understand
    Some global bankers and experts have warned investors against investing in cryptocurrencies because they are of the opinion that it is nothing but a bubble that is just about ready to burst.
  4. An unregulated space
    Unlike other investment avenues, cryptocurrencies are not regulated by government entities or banks. “There is no authority like SEBI that you can approach for grievance redressal,” says Vikram Pandya, Director, Fintech, S.P. Jain School of Global Management. Sharma concurs, “If we buy something with a credit card and get ripped off, we can call the bank and ask to be compensated. But if we get ripped off in a bitcoin transaction, it is impossible to get the money back
  5. The issue of legality
    One major hurdle in the path of Indian investors who are interested in investing in cryptocurrency is the confusion about its legal status. While they haven’t been declared illegal, cryptocurrencies are not recognized by the Reserve Bank of India (RBI) or any other authority in India, as a ‘currency’.
  6. Prone to illegal activity
    Due to the lack of government control, terrorists and extortionists are also utilizing the cryptocurrency space to their advantage. “Bitcoins users on either end of a transaction can remain relatively anonymous and cybercriminals have found ways to mask their addresses, so it can be difficult for government authorities and companies to trace such illegal activities,” says Reshmi Khurana MD and Head of South Asia, Kroll says, a cybersecurity and risk consultation firm

Why are criminals allured to Bitcoin?

  1. Criminals have taken to Bitcoin because anyone can open a Bitcoin address and start sending and receiving Bitcoins without giving a name or identity.
  2. There is no central authority that could collect this information.
  3. More recently, Bitcoin has become a method for making ransom payments. For example, when your computer is taken over by so-called ransomware.

Why won’t the government just shut it down?

The records of the Bitcoin network, including all balances and transactions, are stored on every computer helping to maintain the network — about 9,500 computers in late 2017.

If the government made it illegal for Americans to participate in this network, the computers and people keeping the records in other countries would still be able to continue. The decentralized nature of Bitcoin is also one of the qualities that have made it popular with people who are suspicious of government authorities.

Future of  Bitcoin: A Dusk or a Dawn?

No one knows what will become of bitcoin. It is mostly unregulated, but some countries like Japan, China, and Australia have begun weighing regulations. Governments are concerned about taxation and their lack of control over the currency. After looking at bitcoins from all the dimensions, yet it is difficult to arrive at a conclusion at this very point as to whether bitcoin will act as an advantage in the coming future or will grow dark over the time.

Conclusion

The future of this market is mired in uncertainty. The pushes and pulls on the Bitcoin price are diverse. Some are slow but steady, while the others are violent and sentimental. Banks and governments are for the most part reacting inappropriately to the Bitcoin disruption because while some are embracing the innovation while, the others are stuck in hubris. Hence, it’s little difficult to declare bitcoin as a bubble at the first place and if so, predicting the timing of its burst cannot be foreseen, as it greatly depends on the role that several factors will be playing lately.


Sonika Choudhary

Content Writer @ Legal Bites


Related Links

1) Digital Signature and Electronic Signature

2) Cyber Crimes: An Ethical Dilemma

3) Role of Public Sector Units in Development of a Country

4) Value Added Tax (VAT) and its Impact on Revenue Generation in India

5) Allotment of shares

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