Craig Krupski

FIN 320 Spring

Bitcoin Paper

Over the past decade we have seen the explosive advancement of technology
in our culture. Cell phones, tablets, and computers are becoming more and more
sophisticated as consumers continue to spend countless hours in front of a screen.
As these technologies advance, we begin to see that new products and services
begin to develop. What else began to develop as of recently due to technology was
digital currency. Digital currency such as M-Pesa, and bitcoin are used for
purchasing products, portfolio investment, and exchanges such as Mt. Gox in Tokyo
where you can swap the digital currency for a fiat currency of your choice. For the
majority of this paper I am going to be focusing on the digital currency of bitcoin and
explain how an online currency can be created and the effects it has for investors
and consumers worldwide.
As a future investor one would ask how is a digital currency such as bitcoin
created? Creating a bitcoin, also known as mining is a process where volunteers
with appropriate mining software and computer gadgets gather up all the
transactions and verify their legitimacy then they add them to bitcoins block
chain which is basically the ledger account for all of bitcoins transactions. Once the
miner adds the transactions to bitcoins block chain, they then receive newly created
bitcoins as a reward for their work and contribution to the block chain. The
commission these minors get is in the form of bitcoins that are completely new. This
is how bitcoins are initially produced. Miners then check to make sure that all the
transactions in the block chain are valid and then can begin to add more
transactions to the block chain in order to get more bitcoins. Basically miners are
given the incentive of new bitcoins for their work. Every four years the commission
the miners received is halved. Because the commission miners receive is lower and
lower each block they add to the block chain means it also limits the number of
bitcoin outstanding to 21 million (Velde).
This digital currency is becoming larger in popularity every day but one
should ask how is an online currency exchanged from person to person? There is
numerous ways to exchange or purchase a bitcoin. First, one can store their bitcoins
in virtual wallets. People who store their bitcoins in virtual wallets can trade or
make purchases with another person with a virtual wallet. The transaction process
consists of an input code of a virtual wallet of one person along with the output code
of the persons virtual wallet who is receiving the bitcoin. These virtual wallets
possess codes consisting of numerous characters just like a bank account with the
routing number and account number at the bottom of a check. The miners who
maintain the block chain essentially initiate these transactions by verifying codes
and ensuring double transactions arent apparent. This is relatively similar to the
electronic money companies such as M-Pesa and PayPal. M-Pesa is a money transfer
service in Kenya where citizens use it to transfer money from their wallets to the
destination they choose. This service provides Kenyans the ability to transfer money
nationwide for those people who dont have access to banks. Although this is very
similar to the fundamentals of bitcoin, the difference is that M-Pesa is recognized by
their government as a service for transferring fiat money unlike bitcoin. Also, bitcoin
is an all-digital currency as compared to M-Pesa who has workers that pool all the
transactions and transferring cash from bank to bank.
People started to question whether bitcoin can really be valuable? Why
would one person want to use bitcoin as an asset or a source of currency? There are
many advantages and disadvantages for businesses and consumers alike. One
advantage for both merchants and consumers is the ease of transfer to which a
customer can transfer bitcoin funds to a business. One consumer can transfer X
amount of bitcoins to a business for goods or services via an app on their phone.
This ease of transfer makes it simple for a consumer to send funds with just a push
of a button. But one disadvantage for a consumer is that not all businesses accept
bitcoins as a means of payment. Using a currency that is limited to only a few
businesses makes it hard to buy goods and services that a consumer needs as
compared to a generally accepted currency such as dollar bills and coins. A
disadvantage of bitcoin for a business is that the price is very volatile. One amount
of bitcoins can be worth more today as compared to tomorrow. This high volatility
makes it hard for businesses to price things on a bitcoin basis. This means that
businesses would have to have a price adjustment almost every day for one good if
they wish to purchase it via bitcoin. In regards to investors who wish to hold bitcoin,
one advantage that can also be a disadvantage is its volatility. On January 1
st
2013
an investor could have bought a bitcoin for $13.50 and on November 23 its price
was about $730 a bitcoin. This high volatility in price swings can also be a
disadvantage too. One can make little amount of profit off bitcoin but can loose even
more. Some analysts at the Wall Street Journal are recommending some investors to
invest 1% or 2% of their portfolio into bitcoin. This could potentially be enough to
produce a substantial amount of profit but if it were to drop in value, 1% or 2% of
your portfolio isnt much to loose. A disadvantage for an investor holding bitcoins
could be the possibility of loosing your digital wallet. Once this happens, an investor
would loose their bitcoins forever. There is no way to get these lost bitcoins back.
What if one looses their phone, or if their computer crashes or gets stolen? Then
those bitcoins held in that digital wallet on that form of technology is lost forever,
along with your computer or phone.
As this digital currency begins to rise in popularity government regulators
began to show skepticism with the online currency. One of those concerns is the
ability for criminals to send money to others with ease. According to the Federal
Reserve Bank of Chicago online currency like bitcoin is the preferred method of
payment for criminals who use websites such as the Silk Road to buy drugs,
weapons, and other illegal activities because of bitcoins anonymous ease of
transaction. Ross Ulbricht, the founder of the Silk Road was eventually arrested and
the FBI seized around 600,000 bitcoins valued at around $80 million dollars. The
ease at which bitcoin can be transferred is appealing to those who want to launder
money illegally. Recently, Charles Shrem, a board member for bitcoin, was
criminally charged in January 2014 for swapping dollars for bitcoins and illegally
helping the Silk Road launder their money (Sidel, Casey, and Matthews). Another
concern government regulators have with bitcoin is ease at which bitcoins can be
lost. Mt. Gox is an exchange center for bitcoin that recently collapsed. Numerous
customers held millions of dollars worth of bitcoins in Mt. Gox and lost it all. As of
April 2014, the CEO of Mt. Gox, Mark Karpeles, refuses to come to the United States
to testify about the collapse of Mt. Gox, the worlds largest bitcoin exchange (Stech).
His refusal to testify seems like something fishy is going on. What is risky about
bitcoin is the ability for it to be lost and gone forever. If one were to accidentally
delete or loose their digital wallet file they then loose their bitcoins associated with
that digital wallet. Just as happened with Mt. Gox, numerous customers lost their
digital wallets and the exchange center collapsed. How can a currency just disappear
from a customer forever? Unlike our dollars, a fiat currency, this is unable to
happen. Say we loose a dollar on the sidewalk, one person can pick it up and use it
but it isnt gone forever. Our dollars are also FDIC insured with our banks so if we
happen to loose our bank account number this money will not disappear unlike a
bitcoin.
After doing my research and learning the ins and outs about bitcoin, I would
have to say I do not believe that bitcoin will play a significant role in the future of
our currency. I say this because I see a lot of skepticism and a lot of problems arising
from an all-digital currency. In an age where technology continues to advance I
believe that the paper fiat and coin money we have right now is suitable for our
needs now and even in the future. There seems like there is too much risk to hold
assets in a digital currency with value changes day by day. I believe that bitcoin
could be effectively used for portfolio management and diversification for those
who are willing to risk a certain amount on a completely volatile high risk and high
reward asset but using it as a currency is something I do not see happening in the
future. Its volatility shows its instability to hold value in certain markets might scare
off some investors. With the collapse of the largest bitcoin exchange, Mt. Gox, and
the questionable choices of some board members make it seem rather like a scheme
to rip people off rather than a profit-producing asset. I dont understand how
owners of a bitcoin can accidently loose their wallet and their consequences for that
is loosing all their bitcoins forever. Also, being an all-online digital currency makes
me suspicious of fraudulent attacks and hacks that can happen. If we indeed did turn
to bitcoin as our choice of currency I can picture someone generating a computer
that can hack peoples digital wallets and steal from them if we did turn to this form
of currency. What one tool is for one can be a weapon for another. Bitcoin has a unit
of account, and has a store of value, but in regards to medium of exchange it lacks
the acceptance from a numerous amount of people and companies as a form of
payment that prevents it from being considered money today.










Works Cited

Stech, Katy. "Mt. Gox CEO Won't Attend Bankruptcy Case Questioning." Wall Street
Journal. Wall Street Journal, n.d. Web. 21 Apr. 2014.
<http://online.wsj.com/news/articles/SB100014240527023038878045795021606
85266006>.


Velde, Francois R. "Bitcoin: A Primer." The Federal Reserve Bank of Chicago. Federal
Reserve Bank of Chicago, Dec. 2013. Web. 16 Apr. 2014.
<http://www.chicagofed.org/digital_assets/publications/chicago_fed_letter/2013/c
fldecember2013_317.pdf>.


Hobson, Dominic. "What Is Bitcoin?" The ACM Magazine. ACM Magazine, Fall 2013.
Web. 16 Apr. 2014. <http://internet.jroepeumw.net/wp-
content/uploads/2014/01/p40-hobson.pdf>.


Light, Joe. "Should You Invest in Bitcoin?" Wall Street Jorunal. Wall Street Journal, 23
Nov. 2013. Web. 16 Apr. 2014.
<http://online.wsj.com/news/articles/SB100014240527023046071045792121013
56897382>.


Sidel, Robin, Michael J. Casey, and Christopher M. Matthews. "Bitcoin's Boosters
Struggle to Shore Up Confidence." Wall Street Journal. Wall Street Journal, 3
Apr. 2014. Web. 16 Apr. 2014.
<http://online.wsj.com/news/articles/SB100014240527023046881045794653441
99752538>.