In the last year Bitcoin has gone ‘viral’. As ConvergEx’s Nick Colas notes, a lot has happened in 2013: Price appreciation, yes, from $20 to +$800 – the result of this online “Currency” going from science project to mainstream topic. Volatility too – disruptive technologies seldom travel a level path. The story, Colas notes, is about to change, and there are three critical gates which bitcoin must navigate in the New Year. First is regulation, and we will get a good dose of that next Tuesday and Wednesday when the New York State Department of Financial Services holds hearings on bitcoin and potentially issuing a ‘Bitlicense’ to help regulate business which transact in the currency. Second is adoption – how will existing businesses incorporate bitcoin into their sales, marketing and payment channels. Lastly will be volatility, which will have to come down in 2014 to encourage broader use.
Via ConvergEx’s Nick Colas,
If the ratio of dog-to-human years is something like 7:1, then a bitcoin year is something like 500 years to one regular 365 day turn of the modern currency calendar. Money as we know it today – a physical representation of stored economic value that supplants simple barter – goes back to about 600 B.C.. That’s when the Lydians – in modern day Turkey – started minting coins. It’s a lot easier to buy a sheep or a goat with a coin than working out a barter with the seller, and every advanced civilization since then has used currency in some form to make economic transaction easier. In 2008, an enigmatic programmer (or programmers) unknown released a paper describing an online payment system called bitcoin. At first it was basically a puzzle contest for cryptographic hobbyists, with a prize for solving an endless battery of puzzles. Bitcoins were code-breaking bragging rights that could be exchanged with others.
Then, in 2011, bitcoin began to find an actual following. Its anonymous nature – the core of the system does not hold name, address and other information typical of a standard banking system – made it ideal for illicit transactions. Individuals concerned over online privacy – ahead of their time, it now turns out – also appreciated the anonymity as well as the algorithmically controlled nature of the issuance of bitcoin. No open-ended checkbook (as the Federal Reserve enjoys) in the bitcoin world – every 10 minutes another 25 bitcoin appear. And that’s it. For all this adoption, bitcoin remained largely under the radar.
Last year, bitcoin had its debutante coming out party, and its price went from $20 to $230 to $80 to $1000 and closed the year at $800. We started writing about it in February, mostly because we thought it was interesting that society – a portion of it, at least – had sufficient faith in technology to hand over their heard earned shekels to distributed network of computers running a program written by person or persons unknown. Worshipping in front of a golden calf is one thing – making offerings to a virtual calf seemed to merit our attention. Over the course of the year plenty of other market observers tossed their two cents in the hat, mostly in hater mode.
Well, its 2014 and the value of all bitcoin outstanding sits at roughly $10 billion. Does that mean the future of the currency is assured? Of course not – there’s still plenty to go wrong. But what that hefty amount does demand is a reasoned approach to the fundamentals driving bitcoin’s future. There are headlines aplenty about bitcoin now – still, I think, with a distinctly skeptical eye. Which is fine. But to paraphrase a chant heard at many a street rally, ‘Bitcoin is here; get used to it.’
In thinking through a framework to interpret what will be an eventful 2014 for bitcoin, here are the three points – we’ll call them Bitcoin Buckets for a touch of alliterative flair – to guide the discussion.
Bitcoin Bucket #1 – Regulation. Since those little Lydian coins in 600 BC, issuing currency has largely been the domain of governments. Granted, the U.S. itself only followed that guideline after the formation of the modern Federal Reserve 100 years ago. But in general to issue currency you need some bureaucrats, a standing army, a bank, and some borders on a map. Bitcoin has none of that, which makes it the currency equivalent of a “Stateless person” at the end of World War II or a White Russian after the 1917 revolution.
Initially, there was concern that governments – especially in America – would choose to squash bitcoin for fears over money laundering and illicit activity. That was, after all, an early use case for the currency and one that continues to this day. Then in the back half of 2013 two regional Federal Reserve banks published papers commending bitcoin for its low-cost facility of moving money, and it became clear that the U.S. central bank saw some value in the online currency.
We’ll have another data point on government’s take on bitcoin at a hearing next week in New York City, courtesy of the New York State Department of Financial Services. The early buzz, from an interview on CNBC with Superintendent Benjamin Lawsky, looks promising. He seems to see the potential for bitcoin and related services to provide much-needed competition to the U.S banking system. Should merchants have to fork over 3-4% for credit card transactions? Should credit card holders have to wait a day (or more, in the case of a weekend) for payments to post to their accounts? Bitcoin-based competition – within the confines of modern anti-money laundering and “know-your-customer” laws – could help drive those charges lower.
In the end, bitcoin really isn’t competition for national currencies – at least not for quite a while. It can be competition here-and-now for national banking systems. It is a disruptive technology for transferring money cheaply, by virtue of the online system’s dual mandate of solving those puzzle and keeping track of all transactions as a requisite for a seat at that table.
Bitcoin Bucket #2 – Adoption. One of the side benefits of getting on the bitcoin story early last year was that I had a lot of very entertaining conversations with computer nerds who had been early bitcoin adopters. By virtue of their early “Mining” efforts – solving those puzzles in the core algorithm for bitcoins – many of them found themselves quite wealthy. Not a few hundreds thousand dollars well off, mind you, but serious seven and eight figure wealthy.
At least on paper, that is… But they were reluctant – and still are – to sell those bitcoins on a still illiquid open market. And that’s where capitalism comes in. Bitcoin millionaires are a ready-made customer base for a wide range of luxury and near-luxury goods and services. If you want to peruse a list, look here: https://spendbitcoins.com/places/.
The bottom line is that bitcoin adoption by merchants is just going to accelerate. There’s a reason why Rodeo Drive and Madison Avenue have all the chic shops; that’s where the money is. And now the money is in bitcoin as well.
Bitcoin Bucket #3 – Volatility. You can’t make an omelet without breaking some eggs, so it should be no surprise that bitcoin was both a big winner in 2013 and extremely volatile. April saw the largest exchange melt down on huge volume. Later in the year we had a similar selloff as the Chinese government sought to crack down on asset laundering. None of this prevented bitcoin from ending the year near enough to $1000 to prove there is some level of organic global demand.
To succeed as a method of wealth transfer – which we believe to be the cornerstone of bitcoin’s long term success – price volatility will have to decline. Yes, that is a tall order for asset with very little issuance and no convenient way to short it. We have no doubt that merchants will adopt bitcoin simply to access newly minted high net worth individuals. But to keep them in the fold and increase the usage of bitcoin in other parts of their business, they will need to see some greater stability in the price.
To end on a cautiously optimistic note, this appears to be happening already. The decision by the Chinese government to curtail bitcoin exchange activity could have sent the currency into free fall – the growth in demand inside that country was a big part of the bullish case for bitcoin. And drop it did – to $600. But not $100. Or $10. Since then it has bounced back to $800-900. Baby steps on the road to lower volatility. But steps nonetheless.
It is tempting to conclude these notes with ‘Bitcoin is going to $5,000!’, but I don’t think anyone can reliably predict where it will trade over the next year. What does seem more certain is that bitcoin is a very important disruptive technology in financial circles. If it were a private, venture backed enterprise, it would certainly be worth more than the latest mobile picture app or video game platform. Which puts that $10 billion total valuation in some context. But our three buckets put some context around the challenges ahead – regulation, adoption, and volatility. We think that bitcoin will grow in relevance over 2014; we know it will be fascinating to watch.