A Bit about Bitcoins

Posted by on December 23rd, 2013

Bitcoins were created in 2008 as an open-sourced peer-to-peer payment system. Since then, they have evolved into the world’s first  digital currency, traded by individuals and accepted by merchants across the globe. Unlike traditional currencies, the transfer of ownership for bitcoins is tax-free and completely unregulated.

The growing utilization and popularity of bitcoins as a currency and investment has sparked an interesting discussion about relative value, a fundamental concept for any investor relations professional. The market value of anything, whether it is an investment, currency, or product stems from demand for that item due to its relative scarcity. Nothing can be valuable unless there is a limited supply of it. People can want it; for example if a stock has high appreciation potential it will be in demand. But there is only a dollar amount assigned to each share because there is a finite amount of shares outstanding. In investor relations, we try to communicate the value of each of those shares to the investment community.

Interestingly, the value of bitcoins has appreciated only because there is a limited supply; with only approx. 12 million in circulation. It’s deregulated and decentralized — it’s not tied to anything — so its value is completely determined by the asker and the bidder within each transaction. It’s not as if they created a bunch of bitcoins, and one central body priced each one for a certain amount and negotiated with buyers, like a bank might do with an IPO.  Instead, they created the bitcoin peer-to-peer network, and during each transaction let the global market regulate itself. As the bitcoins became more widely used and legitimized, their value potential was realized.

Bitcoins have established a new model of creating currency. The old way was tying notes to or simply exchanging precious metals, such as gold. The currency’s value reflected how much an individual would be willing to pay for gold — a historically scarce item. Now, in our global economy, most countries’ currencies are only worth their comparative value to international currencies. That is in turn driven by each of these countries’ money supply and economic conditions. Bitcoin is novel because its value was established by artificial scarcity and realized through usability.

Alternative currencies are rapidly gaining acceptance in the mainstream economy. Companies like OKCupid and Overstock.com have begun to accept bitcoins, startups for digital wallets have flooded the Silicon Valley, and the Winklevoss twins of Facebook fame have filed with the SEC for approval to begin trading bitcoins through an exchange-traded fund.

Now, that’s not to say that developing a new currency wouldn’t have its share of hiccups. Recently, regulatory agencies in the People’s Republic of China action moved to ban the usage of bitcoins. In October, the FBI shutdown the black market website entitled “Silk Road,” which supposedly hosted nearly half of all bitcoin transactions. Well, as my favorite history professor in college once told me, “Human history shows that bad people are going to do bad things whenever the opportunity presents itself.”

A cap has been put in place that the mining of bitcoins will cease once 21 million are in circulation. Bitcoins are quickly becoming an artificially created tangible “future,” similar to oil, gold, and other precious metals, of which market price is determined by what an individual is willing to pay for it. Fascinating stuff.

Without question, the history of bitcoins up until now has unveiled a very intriguing perspective on how the markets, or human beings, perceive and apply relative value.