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Bitcoin as a Currency: The Risks and Rewards

Michael Hudson
16 September 2015

Bitcoin presents a paradigm shift. Both in terms of a technological breakthrough akin to the Internet, and as a currency. As with most great innovations of our time, the introductory stage is rich with excitement at the massive potential, as well as caution to the uncertainties it presents. So let’s have a look at bitcoin, as a currency, and the various risks and benefits we see highlighted on a regular basis.

The Risks of bitcoin as a Currency

Bitcoin is a Nascent Innovation

Traditional currencies have been around in their various forms for centuries. Bitcoin, by comparison, is in its infancy, being a mere 6 years old at most, and it still has a long way to go in ‘proving’ its worth as a viable currency. People have become accustomed to the nuances of traditional currencies, and despite how they may feel about government issued and controlled funds, are comfortable with dealing and transacting with them. Bitcoin requires significant mainstream adoption to establish itself and earn the same reputation and level of confidence, and that may take some time as early reservations keep people cautious. 

Lost or Stolen bitcoins are Irretrievable 

The Bitcoin network, due to its decentralised nature, is one of the most secure on the planet. Bitcoin wallets, on the other hand, are easily penetrable when people aren’t vigilant with security. Dealing with bitcoin wallet details on the Internet requires a level of security that most ‘laymen’ aren’t adept with, and as such poses a risk to the general end user. The overarching issue here is that bitcoin transactions aren’t reversible (while this has benefits to merchants who deal with

The Price Remains Volatile

Bitcoin’s price fluctuation is undoubtedly one of the chief concerns for those who wish to adopt it as a currency. Its frequent swings make using bitcoin to buy a loaf of bread or a gallon of milk difficult to budget, and potentially incredibly expensive. Compared to established currencies and commodities, Bitcoin has a relatively small market cap making the value vulnerable even marginal movements. However, this is a factor that will ease as the currency matures. In fact, if we look at the extended view, as provided by Mercatus Center researcher Eli Dourado, a clear pattern of diminishing volatility can already be seen. 

Bitcoin as a Currency: The Rewards

Bitcoin Has a Limited Supply

Governments, through quantitative easing, periodically introduce more money into the market, which leads to inflation. Inflation negatively impacts the purchasing power, and thus value, of the currency. With bitcoin, this measure is eliminated by the pre-programmed supply of bitcoin. The mathematical algorithms that ‘rule’ the Bitcoin network introduce new bitcoin at a steady and predictable rate, giving a total finite supply of 21 million coins. This established amount means that bitcoin is, in fact, deflationary by design and won’t ever be subject to inflation. 

Hyperinflation is Impossible

While fortunately not a frequent occurrence, governments can and do fail. Considering regular currencies are controlled and regulated by governments, it leaves the local currency exposed to hyperinflation, or in the worst case scenario, a complete collapse. When this happens, the sky-high inflation rate makes general purchases exorbitant and has the potential to wipe out an individual’s entire store of wealth almost instantly. Imagine what it was like in Germany in the 1920s when the local currency at the time - the mark - went into freefall and inflation hit in excess of 10,000% per month! You weren’t able to carry enough money to pay for essential goods. Even if you pushed piles of cash in a wheelbarrow, you’d arrive at the store only to be told that your money was now worth 50% less than what it was when you left home. The fact that no government controls bitcoin it’s free from political and economic controls or influences, making hyperinflation impossible.

Reduces Transactional Costs

When transacting with fiat currency electronically, payments are subject to the verification and clearance of several intermediaries. Each of these movements attracts processing fees that are tacked onto monthly maintenance fees, or charged to one of the parties involved in the transaction (normally the payee). Additionally, certain transactions, depending on the payment processor involved, are restricted to minimum or maximum values. Bitcoin payments, on the other hand, are processed and verified by the computational peer-to-peer network (miners). They complete the transactions and add them to the blockchain, incentivised with bitcoin for doing so. Irrespective of the amount being transferred, bitcoin transactions currently attract a fee of around a 3rd of a penny, if at all. 

It’s a Borderless, Universal Currency

Again coming back to the fact that bitcoin is not controlled any single government or authority gives it a unique ability to be used as an international, unified currency. The Bitcoin network isn’t concerned where in the world the parties in a transaction are located, enabling streamlined cross-border payments. I’ve already spoken about the miniscule transaction fees, and this is just another use case where lowered costs result in a tremendous advantage to those either wanting to pay for international goods or make remittance payments. These types of transactions are not only cheaper but almost instantaneous too, being processed and cleared in under 10 minutes.

Bitcoin still has some way to go in terms of being accepted as a viable currency and indeed faces various challenges in doing so. The advantageous qualities, however, are undeniable and pose an exciting and ground-breaking revolution in the financial ecosystem.

Photo credit: The money is better on the top layers... via photopin (license)

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