Differences between Bitcoin and Traditional Money, Potential for Bitcoin to Compete with Fiat Money - Coursework Example

Name Institution Instructor Course Class Date Bitcoin Money is anything that is acceptable as a medium of exchange. Bitcoin is a form of digital currency that was designed to allow direct pseudonym transactions between two willing parties in a decentralised system, without the need of a third party such as a clearinghouse or bank. The currency is one of the most prominent forms of digital currency as indicated by growing consumer acceptance. Money must satisfy four basic functions. First, it is a medium of payment; it can be used to make payments for goods and services (Lannoye 24-25). Money also serves as standard of deferred payment thus enabling delayed payments or payments in the future (Lannoye 24-25). It is on this premise that capital markets and other financial intermediaries are founded. It also serves as a store of value; store of today’s purchasing power (Lannoye 24-25). It is however not the only store of wealth. Other assets, which serve the same role, include stocks and bonds. Nevertheless, money has an unmatched advantage, which is liquidity. It must also serve as a unit of account for it to serve as a medium of payment. Characteristics of Bitcoin make it a form of money. It is currently being used as medium of exchange especially in online transactions and gaining acceptance in brick and mortar enterprises as well mainly due to ease of transaction, safety and low cost of transactions (Bitcoin). Bitcoin is also used as a store of value. It is however vulnerable to fluctuations but so are other assets such as stocks, which serve the same role. Its reliability as a store of value and medium of exchange has however been debatable given that it has no central issuance, no regulation, and unpredictable volatility (CNN Money). Bitcoin also qualifies as a type of money by virtue of the fact that it is divisible, portable, and durable and has recognisable value (Lannoye 24-25). Differences between Bitcoin and Traditional Money Bitcoin is decentralised. Unlike traditional money where a central authority is solely responsible for the issuing and regulation of currency, Bitcoin is created through a mining process (CNN Money). The process entails use of a combination of hardware and software tools to solve mathematical problems of a complex nature and in return the gets rewarded with bitcoins (CNN Money). Therefore, Bitcoin neither derives its worth from a government authority nor an underlying commodity but rather on the market principles of supply and demand (Bitcoin). On the contrary, a government authority, mainly central bank, determines the value of traditional money although market forces also play a part. Bitcoin offers privacy and security. Users only require an address containing no link to any personal information. A private key accompanies each address, and only the owner of the latter knows the key (CNN Money). In making a transfer of bitcoins, the sender just needs an address of the recipient. The sender sends his public key to the recipient and verifies it using his private key (CNN Money). Payments using traditional currencies, on the other hand, involve debit and credit cards and bank accounts that contain personal information. Electronic money transfer platforms also require personal information of the sender and receiver. Bitcoin has an equivalent of a general ledger known as the block chain. It stores all Bitcoin transactions and shows the bitcoins held by a particular address but does not reveal the personal information of the owner of that particular address. Block chain clearly makes Bitcoin very transparent unlike other traditional currencies (Swan 1-9). Transactions involving Bitcoin are irreversible: that once a person sends bitcoins to their recipient, there is no way of getting them back. The anonymity involved in these transactions makes them irreversible (CNN Money). The cost of transacting using bitcoins is significantly less than that of traditional money. There is no set fee in receiving of bitcoins. Bitcoins can be transferred worldwide without the constraints of exchange and bank rates. There are no qualifications needed for one to hold bitcoins and no limits as well on the amount of bitcoins that a particular address can hold (CNN Money). On the other hand, transfer of traditional money usually involves transfer fees and has numerous regulations, which make it hard to carry out inter-boarder money transactions. Potential for Bitcoin to Compete with Fiat Money For Bitcoin to be able to compete with fiat money in the future, the currency must overcome some obstacles. One of these obstacles is the incumbent monies problem. Money is already in use practically all over the world; therefore, the decision is not whether to use money or not but rather why change from the incumbent money to Bitcoin. This transition in itself poses two major problems: switching costs and network effects (Guttmann 18). The switching costs involved in this transition range from redesigning the structure of the current ATMs and vendor machines to learning how to use Bitcoins as a unit of account. This implies that Bitcoin must be extremely be better than the incumbent monies to warrant the switching costs. The network effect arises where the value of a commodity is directly hinged on the number of people using the commodity. The incumbent money already has a wide acceptance as a medium of exchange. Multiple monies require coordination, which is already in place in reference to the incumbent money. Its potential benefits must not only justify the switching costs but also the extra costs of coordination. Fiat money also enjoys a legal tender status and acceptance. Government makes payments and all tax receipts are in the form of fiat money. Bitcoin is to an extent in conflict with government policies including monetary policies. The government might naturally respond to this by imposing regulations on the use of Bitcoin. Bitcoin, as a cryptocurrency, enjoys the first mover advantages. There is however the problem of other competing cryptocurrencies. The switching costs may be in favour of Bitcon but that does not mean that cryptocurrencies will not polish on Bitcoin’s weakness and prove a superior cryptocurrency. An example is Litecoin, which is founded on similar technology but the maximum circulation is 84 million unlike Bitcoin’s 24 million (CNN Money). Technological advances are difficult to predict but electronic and online transactions will certainly increase. Block chain technology used in cryptocurrencies will be adopted for its superiority. The potential of Bitcoins and other cryptocurrencies competing with fiat money is however limited. They will most likely end up as niche monies that serve on particular transactions such as illegal payments that require pseudonyms or in the case of hyperinflation where they would serve as a better substitute (CNN Money). Most people are content with the current systems. Risks and Benefits of using Bitcoins Bitcoins offer the freedom of making payments anywhere in the world anonymously without the constraints of exchange rates or bank rates. The cost of transacting using Bitcoin is also significantly lower than that of transacting traditional money (Guttmann 18). The user gets to choose their own fee with their being no relationship between fees charged and the amount of bitcoins received (CNN Money). Bitcoins are also convertible to fiat currency (Guttmann 18). Bitcoins transactions also expose businesses and clients to fewer risks mainly because they are irreversible and do not contain the user’s information hence fraudulent chargebacks associated with credit card payments are minimised. Bitcoins enable businesses to venture into new markets where credits cards may be non-existent or the levels of fraud are very high hence discouraging credit card payments. The block chain technology results in transparency where All Bitcoin transactions are readily available and can be viewed in real time for verification (Swan 8). Bitcoin has downsides too. The degree of acceptance of Bitcoin is still very limited and in most places, people are not familiar with the currency. This imposes a restriction on places that bitcoin can be used. Bitcoin is also subject to volatility because of limited usage and speculation. The price of bitcoins is therefore vulnerable to events. The currency is a technological startup still in its formative stage. It is therefore prone to many changes before maturity. The lack of regulation makes it ambiguous and there is potential setup for exploitation of users. Taxation and Legislation Bitcoin remains largely a grey area in most countries, and Australia is no exception. There are no explicit regulations and restrictions regarding the currency (CNN Money). Australia does not recognise it as a form of money but a form of barter arrangement; therefore, the taxation and treatment of bitcoin is governed by laws regarding barter trade. The ambiguity of whether bitcoin is a form of money is one of the reasons that have held it back from gaining a wider public acceptance (CNN Money). Trend During its inception, Bitcoin was mainly exchanged for pennies. It experienced fluctuation in the next four years settling on an average of $8.16 from Feb 2011 to 2012. In 2013, the highest value for a bitcoin was $ 1242 (). In January 2015, it had a low price of 199.63 before settling at an average value of $290. In the course of the year, the currency mainly fluctuated between $200 and $300. It however shot up to $400 in November (). The following chart indicates the price trend of biotin in the last three years. Source: Coindesk Conclusion High volatility makes it a less desirable as a store of value and since its value is clearly not derived from an underlying asset, it is difficult to hedge a bitcoin. Scalability is crucial in deciding whether it is viable as a form of investment. Ten percent of the current businesses would have to adopt it if Bitcoin is to achieve a critical mass needed. Venture capitalist financing did however increase by 36% in the first part of the year but slowly declined in the later part of the year. The use of Bitcoin has increased in the dark web due to the pseudonym nature of transaction but mainstream adoption in the recent past has been quite slow due to lack of justifiable cause to adopt Bitcoin. The block chain technology on the hand continues to receive growing attention and some analysts predicts that it is a likely possibility that some governments may introduce their own form of digital currency in the future. Investors are reluctant to invest in Bitcoin due to its unregulated nature with speculators on the other hand rushing in to invest in it. Digital currencies present a huge potential for global payments, it could be Bitcoin or other cryptocurrencies. The current unregulated nature and unclear legal status however makes it a risky investment. Works Cited Bitcoin. Bitcoin is an innovative payment network and a new kind of money. 2016. Web. April 25, 2016. CNN Money. What is bitcoin? 2016. Web. April 25, 2016. Coindesk. Price and data. 2016. Web. April 25, 2016. Guttmann, Benjamin. The bitcoin bible: All you need to know about bitcoins. Books on Demand. 2013, Print. Lannoye, Vincent. The history of money for understanding economics, 2nd edn. Vincent Lannoye. 2015, Print. Swan, Melanie. Blockchain: Blueprint for a new economy. O’Reilly Media, Inc. 2015, Print. Read More