PLNU’s Fermanian Business and Economic Institute provides clarification about the strange world of Bitcoin and other cryptocurrencies, as well as sheds light on some of the opportunities available for business professionals and entrepreneurs.
What is Bitcoin?
Bitcoin was the first cryptocurrency created utilizing blockchain technology. Cryptocurrency is a completely digital form of money with no physical backing, such as gold. Further, unlike the dollar or other currencies, it is not backed by any government or central monetary authority. It is handled solely by those who use it rather than going through a middle man, like a bank or a payment processor. This allows for a quicker, less costly way for businesses, organizations, and individuals to electronically transfer money to and from each other.
What is Blockchain?
Blockchain is the structure of data in a decentralized, digital ledger that aids in tracking transactions in a computer network. Each transaction is represented by large “blocks” of data that are continually stored and saved across many different network computers. The transactions are secure since each block is timestamped and locked from altering. When a transaction occurs, a consensus of multiple network users must execute algorithms to validate the transaction and accept the new “block” of data to be added to the ledger. In regards to Bitcoin, blockchain technology ensures ledger authenticity and eliminates the possibility of “double spending,” or spending of a single coin more than once.
How did it get started?
An unknown person or group under the name Satoshi Nakamoto created the original rules of the Bitcoin network and released the software to the world in 2009. Not much else is known about the inception of Bitcoin. Many have come out in recent years claiming to be Satoshi Nakamoto, but none of the claims can be validated.
Not much else is known about the inception of Bitcoin. Many have come out in recent years claiming to be Satoshi Nakamoto, but none of the claims can be validated.
How does it work?
Anyone can download and use Bitcoin software which tracks transactions of bitcoin tokens using the blockchain technology. Just like a bank is responsible for tracking and verifying debit and credit card spending, “miners” make sure Bitcoin transactions are recorded and legitimate.
What is bitcoin “mining”?
Mining is a very important aspect of Bitcoin. Just like mining natural resources, mining requires a sizable amount of energy and there is only a finite amount of resources to be mined. Unlike typical currencies where governments issue new money, new bitcoins are introduced into the market when miners solve complex math problems to approve transactions. Miners who complete the computational puzzle the fastest are rewarded with a specified amount of bitcoins in exchange. There are roughly 17 million bitcoins in circulation now, but the maximum amount that can be mined is 21 million and most think this limit will be reached around the year 2140. Miners are also awarded the fees paid by users to send transactions, which will become a higher percentage of mining income as the number of new bitcoins released decreases.
How is a bitcoin valued?
A bitcoin’s price is determined by how much someone is willing to pay. At its peak on December 17th, 2017, each bitcoin was valued at $19,783.21, but as of mid-April, 2018, it was priced at roughly $8,000. The valuation of bitcoins is incredibly volatile. There are 1,000,000 bits in a bitcoin and the smallest unit of a bitcoin that can be transacted is 0.00000001 Bitcoin.
There are 1,000,000 bits in a bitcoin and the smallest unit of a bitcoin that can be transacted is 0.00000001 Bitcoin.
How can I use it?
Because the idea of cryptocurrency is such a foreign one to most of us, it may be hard to imagine how to use it. Paying with a dollar bill or with a credit card makes much more sense to us because we are using something physical. If more and more retailers begin allowing the use of bitcoins, they could essentially become an online form of cash. To buy and spend bitcoins, you need a bitcoin wallet and address (software that allows you to send and receive bitcoins) and some bitcoins. In addition to making purchases, you can also use them to repay or send money to others, invest and trade them, or simply hold on to them.
Are there opportunities for business professionals and entrepreneurs?
The easiest way for business professionals and entrepreneurs to reap the benefits of Bitcoin is to simply begin accepting them in their businesses. By accepting bitcoins, businesses can reach a new market of customers who want to pay with digital currency. Companies like Amazon, Tesla, and Microsoft have begun accepting bitcoins. Bitcoin can be especially appealing to smaller businesses since each transaction is quick, irreversible, and anonymous. Bitcoin payments hit a digital wallet almost instantaneously and can be transferred to fiat currency, such as the dollar, in minutes. The speed of authorized payments allows for products to ship sooner and eliminates time wasted disputing transactions. Credit card transaction and chargeback fees also eat away at profits, but Bitcoin offers low or no transaction fees. Business owners utilizing Bitcoin can also reach into international markets much more easily. Accepting bitcoins removes the costs of money transfers in the form of international fees and exchange rate conversion. The major current factor holding back the use of Bitcoin as a medium of exchange or payment is its extreme volatility. Buyers or sellers could see the prices of products or services swing up or down by thousands of dollars in just a few days or even minutes.
Are there opportunities for investors?
First, it must be clarified what it means to invest. Buying and holding bitcoins? Trading bitcoins? Mining bitcoins? Or participating in bitcoin high-yield investment programs (HYIP)?
- While buying and holding bitcoins can be very risky due to their volatility, there are success stories. Had you purchased $100 worth of bitcoins when it first traded in 2010 and sold at the peak in December 2017, you would’ve made more than $21 million. However, the current value of a bitcoin is over $11,000 less than its peak.
- The process of trading bitcoins to make a profit in a relatively short period of time is not for everyone. This is typically done by large players and requires significant knowledge and experience.
- Bitcoin mining has become profitable only if done on a large scale requiring expensive mining technology equipment and large volumes of electricity.
- Extreme caution is required when considering a HYIP that offers to double or triple a bitcoin investment since many are simply scams that initially pay some returns to generate a buzz and get others to join. Once they get enough investors, they cease to operate and simply keep all of the bitcoins.
What are the risks that come with Bitcoin?
Risks are inevitable since there is no centralized bank ensuring the value of each bitcoin. With the decentralized exchanges possibly recording transactions outside of the U.S. borders, the Securities and Exchange Commission (SEC) cannot fully utilize its power to get your money back should fraud occur. The price of a bitcoin is not the only unpredictable component to the cryptocurrency. Transaction fees have proved to be just as volatile. The average transaction fee was $55 in December of 2017 and is now back down to about $1. Other risks include:
- Cyberattack – A study done by the University of Tulsa found that about a third of all bitcoin exchanges were hacked between 2009 and 2015.
- Black markets – Bitcoins and cryptocurrencies are frequently used in black market or illegal activities, which have put a cloud or dampener on their use by many mainstream companies.
- Irreversibility of purchases – Once you release bitcoins from your wallet, they are instantly gone forever and cannot be reversed should you make an error or have a change of mind about your purchase.
- A “hard fork” split – Since the verification of bitcoin ledger transactions is entirely reliant on network users, should a major disagreement occur between users it is possible that a group of miners and developers could essentially create a fork in the blockchain from the previous version that invalidates users running previous versions. This happened in 2017 when Bitcoin Cash split from Bitcoin due to disagreements between miners and developers on Bitcoin’s ability to scale effectively.
- Technology advances – Blockchain is also a long way from becoming a widespread solution due to scalability. One of the main issues is that businesses will not sign on to blockchain until it proves itself as capable of handling large volumes of transactions.
- Taxes – Bitcoin is a taxable asset so capital gains and losses must be recorded for each transaction. The recently signed Tax Cuts and Jobs Act of 2017 eliminated cryptocurrencies as a “like-kind exchange” vehicle. This now means that any profits gained from selling one type of cryptocurrency and buying another is not considered a “like-kind exchange” of similar assets and is subject to capital gains tax.
- Regulation – Central banks and other financial regulators to this point have not generally restricted or regulated cryptocurrencies. Some notable exceptions include China and South Korea. In 2017 these countries banned initial coin offerings (ICOs), which are a popular way to raise funds for new cryptocurrencies through crowdsourcing. Should Bitcoin or similar substitutes begin to challenge the dollar or other currencies, they could face much greater regulatory oversight or rules.
What about the future of Bitcoin and other cryptocurrencies?
“Money” has historically had two primary functions: a means of exchange and an asset. At this juncture, bitcoins and other cryptocurrencies have been used primarily by traders hoping or speculating that they can earn high rates of return on rising prices on an asset. This trading has sparked enormous volatility that has both raised the risk to potential investors and prevented a widespread adoption of bitcoins and similar offerings as a general means of exchange in trade and commerce. Central banks are now exploring the space, with research into ways they could offer backing to their own cryptocurrencies.
In conclusion, cryptocurrencies are very likely to become more dominant in the future. At this point, they are more the vehicle for traders and could be the victim of a speculative bubble. This volatility also makes them impractical for most businesses. Caution is now advised for individuals, companies, and investors.
Answers were provided by members of PLNU’s Fermanian Business and Economic Institute: Lynn Reaser, Ph.D., CBE, Chief Economist; Thomas Hale, Senior Research Associate; and Ben Miller, Undergraduate Student Researcher.