Rise of Bitcoin causing a reexamination of basic questions about finance and currency

Posted on : 2017-12-30 12:51 KST Modified on : 2019-10-19 20:29 KST
The price of the virtual currency has risen 1,500% in 2017
Citizens examine a sign displaying the values of virtual currency in front of the Bithumb customer center in the Jung District of Seoul on Dec. 12. (by Park Jong-shik
Citizens examine a sign displaying the values of virtual currency in front of the Bithumb customer center in the Jung District of Seoul on Dec. 12. (by Park Jong-shik

The still pseudonymous Satoshi Nakamoto published the first paper about Bitcoin (“Bitcoin: A Peer-to-Peer Electronic Cash System”) in October 2008. For several years after that, the virtual currency remained on the margins of the vast financial market, little more than a low buzz on the fringe. But now Bitcoin is gaining respectability in global financial circles—so much so, in fact, that it’s causing central banks and major governments to ask basic questions about the definition of finance and currency.

■ Is it a bubble?

The main reason that Bitcoin has gotten so much attention so quickly this year is because its price has risen more than ever before. This year alone, it has jumped by 1,500%. The foreign press compares Bitcoin’s soaring price to a rocket shooting into the sky. In the twentieth century, at least, no financial asset has risen in value as rapidly as Bitcoin. Naturally enough, financial experts have been quick to call it a bubble. That’s what 51 of 53 respondents said in a recent survey by the Wall Street Journal that asked economic experts about the Bitcoin craze.

Generally speaking, the bubble argument is based on the belief that there is an appropriate price for the asset in question that would reflect its actual value. When an asset’s asking price shoots high above this appropriate price, a bubble is said to form. The appropriate price is estimated on the assumption that the asset in question is connected to economic fundamentals. The price of stock in Samsung Electronics, for example, is linked to the company’s performance and to industry projections. The work of analysts at brokerages is estimating the appropriate price of stocks, bonds and other financial instruments.

But since Bitcoin is not connected with any economic fundamentals, its appropriate price is hard to estimate using the usual methods. This is leading some to argue that “bubble” is not the appropriate term. That’s also why there are still no bitcoin analysts, even though Bitcoin’s market capitalization had expanded to US$280 billion (as of Dec. 14).

“Bitcoin’s price can’t be predicted,” said Brian Schaitkin, a senior economist with the Conference Board, an American economic analysis firm. “It could keep multiplying, or it could collapse to zero.” If anything, psychologists and socialists may be better suited as Bitcoin analysts, given their training in analyzing human behavior.

■ Will it become a currency?

Bitcoin emerged from distrust of “legal currencies” that are issued by central banks and whose value is guaranteed by governments. Central banks released a flood of currency in an attempt to escape the financial crisis, which raised doubts about whether the value of that currency could be maintained. Seething rage at the governments, central banks and investment banks that failed to contain the crisis also provided momentum for the birth of Bitcoin. Even Nakamoto’s paper was published shortly after the financial crisis.

A large number of experts are dubious about whether Bitcoin can attain the status of an alternative currency that can replace legal currencies. Its greatest weakness is the tremendous volatility in its price, which derives from the fact that its fair value cannot be estimated. If the price assigned to a given product can zigzag from 1 bitcoin down to 0.5 and then up to 2 in a single morning, it can hardly function as a currency, these experts point out.

There are also concerns that Bitcoin would have a major negative impact on economic activity overall. Since Bitcoin’s supply is limited to 21 million, it could be toxic for the economy, which requires regular infusions of currency. In a report published at the end of October, the Chicago Mercantile Exchange wrote that people with money that has a limited supply like Bitcoin tend to hoard it instead of spending it. Such behavior, the exchange said, can lead to an economic recession or fiscal uncertainty. Given Bitcoin’s tendency to stay in accounts instead of being circulated, the report said, it’s likely to cause problems for the economy.

■ What’s in store for the future?

Such concerns have influenced the South Korean government’s refusal to recognize Bitcoin and other virtual currencies as being currencies or even financial instruments. Paradoxically, this refusal prevented Seoul from resorting to its most powerful tool, financial regulations, even while it was announcing various regulatory plans to cool the overheated market on Dec. 13. Applying financial regulations would mean bringing virtual currencies and their market into the mainstream.

But it’s probably too early to conclude that Bitcoin is doomed to remain outside the mainstream. The virtual currency has only been around for eight years, and it’s too young to gauge its potential. The reason countries around the world have such conflicting views about virtual currencies—some view them as currencies or financial products and others prohibit their sale altogether—is because Bitcoin’s future remains unclear.

For the moment, it remains the object of speculation, but at some point, when the conditions are ripe for virtual currencies, it could begin to function as a payment method. The initial coin offerings (ICO, the act of raising capital through virtual currencies) that are permitted in countries like the US illustrate the potential of virtual currencies as a new method of raising capital.

On the same day the South Korean government showed that it means to take stern action against Bitcoin, US Securities and Exchange Commission Chairman Jay Clayton said in a statement that he intended to remain in dialogue with actors in the virtual currency market. Clayton offered various perspective on virtual currency but delayed offering a definite conclusion.

 

By Kim Kyung-rak, staff reporter

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