The obvious elephant in the room, “Should I invest in Bitcoin?”. Should you? Well, as the saying goes, the information is free but the decision is yours. Most human value is invested in money, and Bitcoin is money. It is the perfect combination of both commodity & currency and is a phenomenal breakthrough in FinTech (financial technology) innovation. Money serves three basic functions in an economy, though not all “monies” are created equal. Contrary to critics’ claims, Bitcoin fulfills the three basic properties of money:

 

  • A medium of exchange
  • A unit of account
  • A store of value

 

Money

Money is the actualization of a protocol governing the communication of financial transactions between individuals. It is merely an invention of early man to enable him to store his value (labour) in an inanimate portable un-perishable divisible fungible unit of account that originates in the free market and is sought after by other individuals due to its scarcity, so that he may be able to exchange it at a later time for something of his needs or wants. Precious metals, namely gold and silver, along with tally sticks and cowry shells were all used to denote money in the early days. Interestingly enough, gold & silver are still established as sound money till this very day.

However, the only setback was that both gold & silver are heavy and troublesome to carry around and trade in/with therefore man, being a creature of convenience, innovated and thus began the migration to the paper money system that we are a little more used to in modern times. These paper notes (currency) were initially issued in lieu of gold or silver as a redeemable promise (IOU’s) by private individuals (bankers) who vaulted the metals allowing for ease of travel and trade by other individuals (depositors). And thus, one of the pillars of modern banking was born.

Eventually, with the progression of Statism, national governments coercively monopolized the issuance and distribution process, thereby de-linking paper notes from gold/silver; as it was and still is much easier to merely print than to go look for gold or silver. This was the beginning of the national fiat currency system that we use today; the more common ones being the USD and the EUR. It is important to note that these fiat currencies are not money, they are merely “tokens” imposed upon the masses (individual) by the use of legal tender laws (decree). They do not fulfill the properties of money.

With the coming of the digital information age, fiat currency then continued its natural journey to become virtual currencies on computers – these days more and more people in the developed world access their funds online via a banks’ website or an app and all we see are a bunch of numbers (bits) on a screen that is stored on a central server (the banks’ private ledger) that denotes the value (mans’ labour) stored in them. This natural progression has entered into the next phase, the phase in which money has yet again emerged from the free market in the form of Bitcoin; adhering to both Menger’s explanation of the origin of money and the regression theorem.

Bitcoin is accepted as payment for goods and services, is traded for various currencies/monies and treated as a fungible unit of account globally. It is also the most appreciating asset class in 2013. Bitcoin is gaining significant traction worldwide, is one of the most competitive forms of money, network based, economically liberating and open to anyone and everyone who wishes to partake in it.

 

Virtual Money

Virtual currencies have existed for a long time (iBanking, Paypal, e-Gold etc), as a means of payment in the form of digital units of value. They are usually intended for use in payments within specific virtual communities online (internet), such as in e-commerce payment settlements (Amazon, e-Bay etc), MMOGs (Massively Multiplayer Games) like World of Warcraft or the Xbox Live network to name a few.

These ecosystems and user communities use specialised software to manage their virtual currencies, to execute payments and trade. This is comparable to simple agreements using specific items as a mode of payment. In the non-virtual world, these may be commodities like gold, silver or cigarettes.

Virtual currencies are all digital in nature and operate under three different schemes, according to the European Central Bank. These schemes function in different ways and come in three categories:

 

Closed virtual currency schemes:

Usually intended for buying virtual goods and services within an actual virtual community, users obtain currency through some form of activity. Some of these are earned and used in on-line games, such as World-of-Warcraft Gold. Other closed virtual currency schemes are linked to the real world economy and common examples are the bonus systems that airlines (air-miles) or some credit cards offer.

 

Virtual currency schemes with unidirectional flow:

Under this scheme, virtual currency is purchased for fiat currency but cannot be converted back. Exchange rates are determined by the system owner. One example is Amazon Coins, which Kindle users can purchase and use to buy applications. Another example is the discontinued Facebook Credits, which were formerly used to buy virtual goods and services within Facebook itself.

 

Virtual currency schemes with bidirectional flow:

Under this scheme,virtual currencies may be purchased and converted back into the original currency at special exchange websites and/or directly from the issuer. These rates may be both market-based exchange rates and/or predetermined fixed exchange rates. Examples of currency schemes with bidirectional flows include Bitcoin, Paypal and Linden Dollar.

 

Commodity Money

Bitcoin is a virtual currency with a bi-directional flow, meaning that fiat currency (USD,EUR,JPY etc) can be traded for Bitcoin and back on exchange sites, using the free market-based exchange rates.

It is best defined as commodity money. Commodity money is that which has intrinsic value, due to its application and perceived value. Gold is an ideal analog comparison to Bitcoin’s digital nature, having intrinsic value because of its industrial, technological and cosmetic applications, combined with its scarcity due to finite supply.

Commodity-backed money is a variant of commodity money. Commodity money uses the commodity itself as direct currency, while commodity-backed money can be exchanged on demand for specific amounts of different commodities (e.g. precious metals). The gold standard exemplified commodity-backed money, under the Bretton-Woods accord. Under it, currency holders could trade their currencies for fixed amounts of gold, but was terminated by the US in August 1971 because it’s much easier to print without “backing”.

Fiat currency has no intrinsic value except by legal decree. Legislation enforced by coercive governments with monopolies on violence & law allows fiat money to somewhat “work”, as it satisfies some functions of money, combined with the fact that a critical mass of people in society acknowledge its validity as currency and trust in the perception of its value.

This situation resembles how Bitcoin is perceived to be valuable by a critical mass of people – globally – as valid money. For all intents and purposes, Bitcoin is a digital commodity traded and transacted within the free market.

 

Investment

What makes Bitcoin a potential investment vehicle? It shares the advantages associated with most digital currency platforms/digital commodities: ease of use, speed of transaction, cutting edge security and use in global transactions. Fiat currencies, on the other hand, which are subject to fraud and used extensively in criminal activities and illicit transactions (e.g. extensive use of USD in narcotics black market) are an alternative investment, if preferred.

 

Bitcoin does have clear benefits. Björn Segendorf of Sveriges Riksbank commented in his report that:

It can contribute to meeting new payment needs and to making payments cheaper and more secure. Those who choose to use a particular payment service can be expected to do so because it gives them an added value in relation to other payment services. This also applies to virtual currencies, which can, for instance, make some cross-border payments simpler, faster and cheaper. Another advantage is if the payer does not need to share sensitive information, such as card number or bank account number, with the payee”.

 

Bitcoins’ finite supply, with a hard limit of 21 million bitcoins (note the “small” b – that represents the units of account), replicates essentially the same supply situation as gold: finite, scarce and valuable. There is a finite supply available for circulation at any point in time, with production void beyond a specific threshold.

Bitcoin supply is predictable, grows at a stable rate and is resistant to the manipulation by political pressure and inflationary monetary policies (Keynesian) that fiat currencies face, due to their centralised control. Bitcoin’s value is deflationary in nature, increasing as time progresses and market capitalisation increases.

In essence, people can buy more goods with the same amount of bitcoins over time. Unlike investments in fiat currency in banks (yes investments NOT “savings”), it maintains value. However, this is without the same “government surety” that fiat currency enjoys from crony monopolies on laws and/or other institutions – albeit temporarily.

Bitcoin is fundamentally resistant to manipulation by any centralised authority, meaning it is driven purely by market mechanics and the consensus engine of its user base. While still in its infant stages pertaining to investment infrastructure as opposed to fiat money investments, at the very least it’s not vulnerable to the inflationary government monetary policies, which makes it a perfect hedge against inflation.

Bitcoin is, in the end, a long-term and high-risk investment. It is not perfect, and in fact does need to be improved in certain aspects (the “ease of use” aspect mainly, which will be addressed by the amazing devs working on the thousands of projects worldwide). For now, it is best suited for sophisticated investors or investors who can afford the risk, and who adopt a horizon of at least 5 years when considering ROI.

It remains to be seen whether it will grow with time, be supplanted by something better or consigned to history as a failure. However, given it’s record of surviving multiple market and regulatory shocks in a short time frame, its resilience as money is proven, with a use case that grows year-on-year.This is why i invested.

 

*Special thanks to Shiwen Yap, for authoring the original draft and initiating this article*