When will the Bitcoin bubble burst?

bitcoin 2018

writer icon Leigh Chadbright     Werner Moser   |   Business     🕐 09. Jan. 2018

Anyone who has invested in Bitcoin these last few years has been in for an exciting ride. If you invested 10 000 dollars in January 2017, you would now be sitting on around 150 000 dollars’ worth of Bitcoin. If you had invested the 1st of December 2017, you could have turned 10 000 dollars into more than 15 000 dollars, a value that continues to climb.

To the untrained observer, it may seem like the crash is inevitable. Is the underlying technology and potential worth the risk? Is there still value in Bitcoin?

Bitcoin is the brainchild of Satoshi Nakamoto, the as yet unidentified individual or group who first gave us the idea of cryptocurrency. In a 2008 paper, Nakamoto described the potential of "an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party."

This will require some explanation, but it is essentially creating a unique piece of digital property that can be traded safely and securely between users of the system. Anything that you can trade safely can then become currency. In his book, Mastering Bitcoin, Andreas Antonopoulos points out that Bitcoin "isn’t money, it’s a decentralized trust network". But why would you want to trust random strangers on the internet, and why are people valuing this trust so highly?

Bitcoin’s security is based on blockchain technology. A convenient analogy is that a blockchain is Wikipedia without the ability to edit or change any information. It can only be added to and built on. Instead of edits, the blockchain is continually grown by ‘miners,’ people who have set their computers to compiling recent transactions into blocks and trying to solve a monstrous computational puzzle likened to a giant Sudoku.

It is the miners which form the backbone of Bitcoin security, a decentralised network of nodes that constantly monitor and verify the blockchain and keep it safe and secure. Like Wikipedia, anyone can view the blockchain at any times and check its authenticity. Unlike Wikipedia, it cannot be altered or corrupted. This is the genius Bitcoin - millions of miners incentivised by creating new currency that concurrently ensures the security and regulatory functions normally carried out by centralised banking systems.

This idea of mining new coins is what gives pause to anyone thinking of investing in Bitcoin - how can something that you can set your computer to unearth for free ever have any value? What is often misunderstood is that there is a limit to the total number of bitcoins that can be mined. The Bitcoin protocol contains an algorithmic system that regulates the mining function. It is constantly adjusted to ensure that a new bitcoin will only be mined every ten minutes. Every four years, the rate at which new bitcoins are mined is halved. And the maximum possible number of bitcoins is just below 21 million, a figure set to be reached by 2140.

So for the first time, we have this possibility to create a unique piece of digital property that can be transferred between users. The record of this transfer is then stored in the central blockchain. It is a decentralised store of information, a verifiable database, that ensures that all transfers are genuine. There is no possibility for theft or fraud.

Only the owner of a bitcoin can send it, and it can only be taken by its intended recipient. It cannot be duplicated, and the network of nodes act as a constant safeguard to validate transactions and ownership.

Once you can understand the security and legitimacy of cryptocurrency, it becomes easy to see why everyone has become so excited about the potential. The advantages are manifest.

Governments cannot print more of your currency and devalue it. There is no centralised bank taking a cut of your transactions. It has near zero transaction costs. Since Bitcoin is send-only, someone you buy from cannot reach back into your account and take more money from you.

We use banking systems because they offer safety and security, including the chance of having cash fraudulently taken from your account returned to you by your bank. This security comes at a cost - banking charges and transaction fees. Some online retailers have payment fees accounting for 2.5% of their profits. These fees could be eradicated at a stroke. Hacks of credit card databases would become a thing of the past; since Bitcoin is send-only, there is no need for companies to store your credit card information.

The system also works across international borders - you do not need to convert currencies. Someone in Sweden can buy something from New York or Hong Kong at the same cost in Bitcoin without worrying about exchange rates. It would also allow services to reach new territories - Netflix is currently only available in around forty countries due to the instability of payment systems in certain regions. Micropayments are also possible - something previously unworkable due to large transaction costs.

Bitcoin is already helping those in developing countries. An estimated 400 billion is sent home daily to families from people working away from home, and banks can take anywhere up to 10% of this. Bitcoin payment services are slashing these costs.

Emerging startups in the Asian market have been creating payment systems that enable immigrant workers to send money back to their families in the Philippines and China. The use of Bitcoin can offer much lower costs, even after the payment company has taken a cut. Such services have recorded five-fold growth in the last 18 months. If Bitcoin can become a trusted industry standard for money transfers, its growth becomes understandable.

As a result, there is a constant stream of tech developers and entrepreneurs intrigued by the potential of bitcoin looking at new ways to leverage its potential - exchanges (Payward, Buttercoin, Vaurum), Futures Markets (ICBIT), Hardware Wallets (BitCoinCard, Trezor, etc), Payment Processors (bitpay.com).

It is this potential that is driving the Bitcoin frenzy. The more it is used, the more valuable it has become. Microsoft, Expedia, Steam and Zynga already accept bitcoin payments on some items. There are Bitcoin cash machines around London willing to turn electronic currency into paper money - albeit at inflated margins.

And this is what you’re buying into when you purchase Bitcoin - you’re betting that there must be money to be made in any system that can strip out the costs usually forced on consumers by banking and payment systems.

Sounds too good to be true? Well, it might be. We should talk about the problems. Your bitcoins are stored in an electronic wallet and this can be hacked in the same way any hacker can get hold of your banking details. There are security processes that can be followed - spreading your currency over multiple wallets, keeping your computer up to date and safe from viruses, using only recognised trading platforms, keeping your information offline.

You can also store the private information that establishes ownership of your bitcoin (usually as a 64 character hexadecimal key) offline. If you are worried about a hack, you can print off the details and put them in a safe and rest safe in the knowledge that they cannot be touched. The Bitcoin becomes as physical and untouchable as a banknote, though one that will inevitably be more prone to massive swings in value.

There are also concerns about the anonymity of Bitcoin and its potential uses by criminals. The Silk Road, the dark web’s amazon for buyers and sellers of narcotics and other illegal products, were trading millions of dollars in Bitcoin. Users were trading under the mistaken belief that their transactions were anonymous and untraceable. In 2014, however, the husband-and-wife team of Philip and Diana Koshy managed to find a crack in the system. The explanation is complex, but in essence some computers would send out information about one transaction that would identify them as the owner of a certain Bitcoin address. For the first time people were able to track who was spending what.

Using tricks like this, in January 2016 the FBI and Interpol managed to identify 10 men converting bitcoins into Euros in a sting on an international drugs ring. Once agents had cracked the ring, they were able to track all the payments and transactions to prove illegal activities. The strength of Bitcoin’s security - the fact that every transaction is stored in the blockchain as a permanent record - means that if enforcement agencies know where to look, criminals have their dirty books always available. And as criminals have become more wary, investors have become more bold in buying into a system that can be used to purchase more than just drugs.

There is still a need for a regulatory future. Bitcoin and emerging cryptocurrencies are an existential threat to existing financial systems. Whilst the FBI may have the power to forensically track transactions in drugs cases, there is still the possibility for millions more of us to evade tax, to launder money and to hide profits by utilising a decentralised currency that does not offer governmental oversight.

The dream of Bitcoin - a move towards a single currency without the need for multiple global currencies that feed of exchanges and transaction funds - can also be seen as a nightmare for governments no longer able to track and tax their citizens’ spending. At the same time, Western governments understand the need to keep control of the emerging behemoth and not cede its potential, and any possible regulatory control, to Russia or China.

It is this potential which makes Bitcoin and other e-currencies an intriguing proposition. How high can Bitcoin go? No one knows. The threat to Bitcoin’s value comes not from the idea that it might become redundant. It is whether its value can be maintained in the face of emerging currencies and advances in other blockchain technology.

Bitcoin has seen 50% crashes before, notably after the Mt. Gox hacking scandal in 2015 (an online trading exchange was compromised, not the currency itself) and the ‘China Chill’ of 2015 when it was feared the Chinese government would ban trading in cryptocurrency. There was also a hit as recently as July this year when it was feared that there were underlying weaknesses in the underlying code. Each time Bitcoin has bounced back stronger.

Whether you invest depends on your tolerance for volatility. Many Bitcoin investors have diversified their portfolios by buying into other cryptocurrencies or investing in tech companies involved in blockchain technology. It is capable of more than just making currencies. The Australian Securities Exchange (ASX) will replace its current clearing system with blockchain technology by March 2018, cutting the cost of transactions and making them faster and more secure.

Bitcoin, cryptocurrency and blockchain tech is here to stay. Bitcoin is the frontrunner in the race to become the de facto international cryptocurrency of choice, which is why it’s price is still rising. Will it stay there? Or will it fall by the wayside to late challenges from new runners like Ethereum and Ripple? Only time will tell.

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