Monday, March 3, 2014

Bitcoin – In Bits and Pieces

On Friday, Feb 28, 2014 Mt. Gox, a bitcoin trading exchange, announced that more than $470 million of virtual currency was wiped out of its digital store house. Mt. Gox has filed for bankruptcy stating that technical issues paved way for fraudulent transactions. The exchange’s bankruptcy underlines a tumultuous phase for bitcoin. The price of bitcoin was $13 at the beginning of 2013, rose above $1,100 in December 2013 and since then it lost around half its value, trading at $549 on Friday. Such wild price swings have hit some investors very hard such as Fortress Investment Group LLC which recorded unrealized losses of $3.7 million on Friday. The internet is littered with stories of people who lost from small amounts to their life savings on bitcoins.

What is bitcoin? It is a peer-to-peer payment system and digital currency introduced as open source software by Satoshi Nakamoto. Bitcoins can be obtained by mining, or in exchange for products, services or other currencies. To the novice, ‘mining’ means completing a few tasks such as solving a small algorithm. You join a pool (a team that combines its computing power to create more bitcoins) and your combined effort will help solve large and complex algorithms, and be awarded bitcoins in blocks of 50. You can also purchase bitcoins using cash just like any other commodity or asset.

Where can you use bitcoin? Bitcoin is gaining popularity across borders as an alternative currency. The popularity of bitcoin has soared among the brick-and-mortar merchants and online merchants. Prominent businesses that accept bitcoin as payment include Overstock, the Sacramento Kings, Tigerdirect, Virgin Galactic, and so on. Bitcoin can serve as an alternate currency where the national currency has faced severe depreciation due to high inflation or other problems. However, bitcoin is roiled in extreme volatility, theft, fraudulent transactions, money laundering, gambling, and illicit drug trades.

In the US there is no regulatory authority to formulate the rules surrounding the currency. Janet Yellen, the Fed chairman recently stated that the Fed does not have the authority to supervise or regulate the bitcoin in any way. The Commodity Futures Trading Commission, Consumer Financial Protection Bureau, and the SEC are still mulling over ideas of formulating regulation for bitcoins. Other countries and regions are not different from the US, and one exception is China which has strict rules governing bitcoin.

The fall of one exchange spawns the rise of many. As Mt. Gox filed for bankruptcy, bitcoin ATM’s started operating in Singapore. Despite the loss of confidence and violent volatility, bitcoins traded at $549 suggests that many people still believe in its potential to improve payments and become a global currency. Until we have rules governing bitcoin transactions and consumer protection is it not better to wait and not get torn into bits and pieces?

This note was compiled from the following sources:
1. “One Bitcoin Exchange’s Demise is Another’s Birth”, Takashi Mochizuki, WSJ, Feb 26, 2014.
2. “Bitcoin ATMs Open in Singapore”, Newley Purnell and Lorraine Luk, Digits WSJ, Feb 28, 2014.
3. “Bitcoin Oversights Falls Outside Central Bank’s Purview”, Ryan Tracy and Scott Patterson, WSJ, Feb 27, 2014.
4. “Almost Half a Billion Worth of Bitcoins Vanish”, Robin Sidel, Eleanor Warnock, and Takashi Mochizuki, WSJ, Feb 28, 2014.
5. “Mt. Gox Resigns from Bitcoin Foundation”, Robin Sidel, WSJ, Feb 24, 2014.
6. “A Primer on Bitcoin and Its Rise”, Andrew R. Johnson, WSJ, Feb 25, 2014.

Dr. Subramanian “Subbu” Rama Iyer is an assistant professor of Finance at UNM Anderson School of Management.  Click here to contact Dr. Iyer.

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