The Beginning

Created in 2009, following the banking crisis of 2008, cryptocurrency was developed as an electronic means of settling transactions without a middle man, meaning no banks!  Cryptocurrencies are operated by those creating the currency, located anywhere in the world, unlike government-issued currencies, allowing for virtual peer-to-peer trading without a centralized governing authority.  Instead, so-called “miners”—think of miners as a sort of accountant— verify the currency transactions by recording them on a transparent ledger of trades, and the miners collect a payment of newly issued bitcoins for their verifications.  Much of the world’s bitcoin is mined, created through powerful algorithms, in China.  As recently as this past January, before new rules dampened trading in the country, more than 80 of global bitcoin activity took place in yuan.  An estimated 5.8 million unique users use bitcoin, and over 100,000 merchants accept the cryptocurrency, including Microsoft and Time, Inc.  Merchants also benefit from bitcoins’ efficiencies, as fees range from 0-2, much less than the 2-3 traditionally charged by credit card companies.

The Concerns

Because of the anonymity of trading bitcoin, bitcoin has historically been used for illegal transactions and money laundering—leading to multiple F.B.I. investigations.  Additionally, lack of consumer protection, potential fraud, artificially inflated prices, and high volatility lead many to express concerns about the decentralized currency.  According to studies, bitcoin is seven times more volatile than gold, eight times more volatile than the S&P 500 Index, and eighteen times more volatile than the U.S. dollar.  China recently shut down the country’s bitcoin exchanges, reflecting a growing unease with the virtual currency and its recent surge in value.

The Takeaway

The longevity of bitcoin is in question, as is its intrinsic value.  As a recent Wall Street Journal questions, should it be valued as a commodity or a means for quick transactions?  Warren Buffet has suggested that it’s more than an efficient way of transmitting money—essentially an updated way of writing a check, he contends.  Regardless of your view of bitcoin, recent adoptions of its legitimacy by entities such as the Japanese government and its soaring value make it something to watch.

Disclaimer: Tarbox does not invest in bitcoin and has written this educational article as a part of our “Tarbox Outside-the-Box” series, meant solely to inform our clients on outside the box ideas.