By Indraneel Pinnamshetty
While on the one hand, we are observing wide cautionary stance by governments across the world over bitcoins, on the other, we are witnessing bitcoin prices soar to new highs without any regard to government warnings and financial experts.
Bitcoins have rallied far this year, climbing past $17,000. As they move faster towards the $20,000 mark, we seek to explore the factors that justify the skyrocketing prices and what these sharp gains mean for banks, investors, miners, governments and other financial institutions.
Fundamental genesis
In a pursuit of complicated analytical reasons that explain the rise in bitcoins, one should not lose sight over the immediate and straightforward explanations for the prices rise.
The supply of total bitcoins is limited and is capped at 21 million units. Application of a straightforward law of supply and demand dictates that with limited supply, an increase in demand for bitcoins causes a rise in its prices. This surge in demand for bitcoins is effected through various institutional changes and external factors. For instance, Japan recently made bitcoin a legal payment method throughout the nation. A considerate move for merchants and consumers alike, this decision subsequently drove the prices high.
Hedging against financial risks
As far as parking their money goes for seasoned investors, bitcoin investment is seen as a haven for many people. If we look at bitcoins in the context of other investment assets, it becomes harder to argue that bitcoin’s price movement is unique. Equities, bonds, and real estate (especially in some regions) are all quite expensive. Private equities and alternative investments have also historically observed an upward trend in both domestic and international markets. Similarly, there is an increase in prices for real estate. According to Zillow, the median home value is up to $201,900 which marks the convergence with pre-2008 nominal prices. This surge is not exclusive to the USA since many developing countries are also experiencing the same trend.
At a time when economies of the world are tanking through loose monetary policies resulting in inflated asset prices, bitcoin is seen as an alternative asset class with its novel features such as its decentralized nature of the operation.
Banking blockades
An array of incidents such as the blocking of Wikileaks and backpage.com by leading banking and financial services agencies suggest the monopoly of the banking sector and the lack of alternative currency transfer media. It is at such conjunctures that Bitcoin eliminates the problems of the monopoly of various mainstream banking services.
Similarly, conventional money transfer networks like the Western Union and MoneyGram are slow and expensive. Bitcoin-based companies have emerged as competent competitors to facilitate various transfers and remittance in a cheaper and efficient manner.
Fiat currency crises
Fiat currencies are increasingly being perceived as volatile, unsustainable and faulty exchanges. Cypriots learnt this the hard way when their savings were confiscated in early 2013. This event had led to a price surge, as savers reconsidered the relative risks of banks versus bitcoins.
The next to be affected by the domino effect was Greece, where strict capital controls were imposed in 2015. Greeks were subjected to a daily withdrawal limit of 60. Bitcoin again demonstrated its value as money without central control and hence money without inherent traditional risks of central currency.
Soon after the Greek crisis, China began to devalue the Yuan, and Chinese savers turned to bitcoin to protect their accumulated wealth. It is these unstable and shifty fiat currencies that are helping to make bitcoin all the more an attractive currency option.
Risks and downturns
With bitcoin still in a premature stage, there are various infrastructural deficiencies that risk the further development of bitcoin. Bitfinex, the worlds largest bitcoin exchange by trading volume, said it was under a massive denial-of-service (DDoS) attack, meaning its servers had been intentionally flooded with online junk requests, taking its website down and crippling its services. Similarly, a lot of bitcoin exchanges are ill-equipped to handle sudden shifts in demand and supply scenarios.
There are many negative influencers of price, notable among them being the legislative risk of a major government banning or strictly regulating Bitcoin businesses. The risk of the bitcoin network forking along different development paths is also something which could undermine its price. Finally, the emergence of a credible competitor, perhaps with the backing of major (central) banks, could see bitcoin lose market share in future.
And as for every other technological revolution accompanied by bubbles, only time will tell what lies ahead in the future.
Featured Image Source: Pixabay