Bitcoin’s Growing Pains

Bitcoin Growing Pains

Bitcoin, the world’s most popular cryptocurrency, and blockchain, its payment verification system, are two of the most pervasive buzzwords in economics today. Bitcoin was set up by an anonymous developer known only as Satoshi Nakamoto, with the objective of creating an open-source, digital and decentralized monetary system. Since its inception in 2008, the number of users has grown tremendously, and there are now between 3 and 6 million users called wallet-holders.

There are many issues surrounding this new currency, with the most obvious ones being its lack of oversight, price volatility and use as a tax-evasion tool. First, the system was set up in such a way that no central bank or authority would be able to manipulate or oversee it. This is in part because blockchain provides broad control and oversight of transactions, which are public and cannot be edited. This is both a valuable trait and an issue. The professed main purpose of this new currency is to escape oversight of governments and banks. Going forward, this lack of oversight makes it hard for Bitcoin to grow, since major financial institutions will continue to block its integration with mainstream finance.

Second, the value of Bitcoin is highly volatile, which makes it unlikely that it will be able to replace the existing vehicle currencies as a steady holder of value. Bitcoin has volatility seven times greater than gold and eighteen times greater than the U.S. dollar. In the last three months, price has fluctuated from $2300 USD to $5800 USD. A lack of liquidity might be to blame, which ties into its aforementioned lack of oversight. However, if major banks start trading Bitcoin as market makers, the increased volume might generate some stability.

Third, the currency has been criticized because it is allegedly used by criminals in order to evade tax and government oversight. For example, if a friend sends you Bitcoin for cash, there is currently no way for the government to know that this transaction occurred and subsequently impose a tax. This represents an opportunity for people who have illegal incomes to avoid detection, since these Bitcoins can then be cashed in, taxed, and used as real money. Also, the currency can be used to directly purchase illegal goods such as drugs and weapons. Governments are wary, and four countries – Bangladesh, Bolivia, Ecuador and Kyrgyzstan – have banned it outright.

The professed main purpose of this new currency is to escape oversight of governments and banks

More recently, China has also taken drastic measures to impose control over the Bitcoin market. In China, Bitcoin has been widely used to circumvent the central government’s capital controls and tax. The federal government has enacted plans for a comprehensive ban of all Bitcoin exchanges and initial coin offerings (creating new cryptocurrencies). The continued crackdown has made the price fall, since the Chinese market represents one of the largest and most active group of users. Bitcoin users can “mine” the currency by making computer hardware do mathematical calculations for the Bitcoin network to confirm transactions and increase security in exchange for transaction fees. An extension of the ban to mining would be disastrous globally, since . In October, the government has that they will now authorize transactions but keep records, issue licenses, and limit large transactions. Thus, the ban should only be temporary, until the central government is able to carry out their record-keeping, licensing and limits platforms.

In 2013, the Winklevoss brothers, famous for their lawsuit against Mark Zuckerberg for allegedly stealing the idea behind Facebook, took to the Securities and Exchange Commision (SEC) in a bid to create a Bitcoin ETF (exchange traded fund). For those who don’t know, the main purpose of an ETF is to track a basket of underlying assets that may be difficult to otherwise trade. Thus, a Bitcoin ETF would provide a much-needed link between traditional investors and the currency. However, their proposal was rejected, on the grounds that there was a “lack of regulation and surveillance-sharing agreements between exchanges.” On the other hand, the SEC recently announced that it will reconsider the proposal.

Though the future of Bitcoin is uncertain, if China lifts its ban and the ETF bid by the Winklevoss twins is successful, things will be looking up for the currency. In light of this optimism, the price of a single Bitcoin now wavers around 7000 Canadian dollars – not bad for a currency worth only cents 8 years ago.

The views and statements expressed in this article are the author’s own and do not necessarily represent those of The Bull & Bear.

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