Digging Deeper Into Bitcoins

Digging Deeper Into Bitcoins
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Bitcoins have been all over the news the last few months, with the value of the anonymous digital currency fluctuating wildly. Richard X. Bove of Rafferty Capital put out a note today that digs a little deeper into bitcoins, bitcoin mania and the future of the virtual currency.

Bitcoin basics

Bitcoins are a virtual currency that are “mined” by solving complex math problems, and only 21 million will ever be mined. The fact that the value of bitcoins is truly based on supply and demand, and the value cannot be inflated or deflated by government intervention is a big part of their appeal to many people.

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Although bitcoins are used extensively in online “grey markets” such as Silk Road and others because they can’t be traced, bitcoins are gradually becoming more mainstream and a growing number of businesses are accepting bitcoins for payment.

Soaring value, extremely volatile

The value of bitcoins has soared over the last few months. However, speculation and a limited supply has led to extreme volatility in the value of the coins. Bitcoins were valued at $13 each in September 2010, then soared to more than $900 by mid-November of this year. By November 20th, the price had dropped back to $600, then climbed to an all-time high of over $1,200 on November 29th.

The future of bitcoins

While Bove is not bullish on the bitcoin per se, he does believe that “cryptocurrencies — anonymous digitally-driven payment mechanisms — are here to stay.” He says there is a demand for such a financial product from many quarters and is inevitable that something steps in to fill the demand.

Bitcoins could become the standard digital currency, according to Bove, but there are some difficulties to overcome before this can happen. First, and perhaps most importantly, the extreme volatility in bitcoin prices damages their value as a currency. If this volatility can be reigned in and a stable market established, bitcoins could well become the credit cards of the 21st century, except much easier to use and with — to date — no transaction fees. Second, bitcoins must be accepted by governmental financial institutions as well as the shadow banking industry, and Bove argues this process is already underway.

Bove also raises the specter of bitcoins being monopolized by a foreign power such as China, and argues this is a real possibility. According to Bove, if this happens, “…the Chinese will have gained control of an international transaction device that can be utilized outside of the dollar and the control of the United States government. This is strongly desired in multiple nations and would not be good for the United States.”

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