Bitcoin hits $11,000

The old saying applies: If it looks like a duck, walks like a duck, and quacks like a duck, it's probably a duck. Charting Bitcoin's price trajectory over the past year, it looks, walks, and quacks like a speculative bubble. Before getting caught up in the frenzy, it's worth looking at what exactly Bitcoins are. 

Are Bitcoins useful for anything beyond financial speculation? Its promoters call Bitcoin an electronic currency — but are Bitcoins really suitable for everyday market transactions, like grocery shopping? Are they a good long-term store of value, a sensible choice of financial instrument for people who want to save for retirement, for example?

Nicholas Perrin is a strategist and systems designer on the leadership team at Holochain, a group of software experts designing a rival to the 'Blockchain' technology underlying Bitcoin. According to Perrin, the answer to these questions is: "No." Because of the way it was designed, he told DW, the Bitcoin system isn't particularly useful for anything other than financial speculation.

Bitcoins are limited-supply electronic tokens

Bitcoin is the best-known of dozens of cryptocurrencies that in recent years have been springing up like mushroom caps in a foggy autumn forest. Bitcoins are encrypted digital tokens, created gradually and decentrally by thousands of computers running complicated encryption programs that require enormous amounts of computer processing capacity and electricity.

The process of creating Bitcoins was deliberately designed to be difficult, expensive, and slow, so much so that it will take more than a century before the final Bitcoin has been generated, around the year 2140. In order to make Bitcoins scarce, and hence potentially valuable, the Bitcoin software system's designers have imposed a hard limit on the total number of Bitcoins that will ever be created: 21 million.

Conceptually, then, Bitcoins are analogous to gold coins. Just as gold is a rare metal that must be obtained in difficult and expensive mining processes, the difficult and expensive computational process used for generating Bitcoin tokens is called 'Bitcoin mining.'

Why are Bitcoins valuable?

The 'value' of Bitcoins is entirely driven by a narrative proposing that these limited-supply digital tokens can be used as 'money' because they can be traded between digital 'wallets' protected by very long numerical passwords.

But since the value of Bitcoin is so volatile from moment to moment, Nicholas Perrin argues, Bitcoin isn't suitable for ordinary transactions. Would you buy a box of apples with a special currency you had bought hoping its value would soon double? Or invest your retirement savings in a token whose value is vulnerable to wild swings in popularity and hence in price?

Read more:Bitcoin slides on stern warning from JPMorgan CEO

"Bitcoin will always remain vulnerable to pump-and-dump schemes that make it unusable as everyday money for ordinary people," he said. "Its value is basically arbitrary, driven by a fear of missing out."

The underlying Blockchain software

Bitcoin transactions are recorded in a continuously updated, giant electronic database, or ledger, called the 'blockchain,' which records every transaction made, and never deletes any of the system's transaction history. At any given time, many thousands of identical copies of the blockchain are distributed on internet-linked computers. The underlying software provides a means of ensuring all the copies of the blockchain remain identical.

A key feature of the blockchain is that the Bitcoin transactions recorded on it are peer-to-peer, rather than mediated through a central authority like a bank. If people are able to obtain Bitcoin wallets anonymously, this improves transaction privacy — but also the potential for illegal transactions.

Who designed the blockchain? No-one knows. The project appears to have been motivated by libertarian ideology. Anonymous software developers released Bitcoin and the underlying Blockchain system as Open-Source software in 2009.

No help to the poor

One of the biggest problems with the world's existing financial system is its failure to achieve 'financial inclusion' — i.e. its failure to provide the world's poorest people access to money, credit, secure savings accounts, insurance, and other financial products. According to a 2016 study from the World Bank, around 39 percent of the world's population, including two billion adults, are 'unbanked' — they don't even have a bank account. 

Bitcoin doesn't help the poor, Perrin says, because both of the main ways to obtain bitcoins are unaffordable to the poor. One way is to buy bitcoins through online 'bitcoin exchanges,' using real money. The other way is bitcoin mining, which involves running large numbers of specialized computers.

Risks to Bitcoin

Will Bitcoin continue to rise in perceived value? Will it cost more and more real money to buy a single Bitcoin in future?

There's no reliable way to predict short-term Bitcoin price movements. But there are reasons to suspect that in the long term, Bitcoin may lose most or all of its value. One reason is competition. There is a growing number of rival cryptocurrencies, some of which may be better-designed than Bitcoin.

If and when a different and better cryptocurrency system grabs the public imagination, it could  rapidly take market share away from Bitcoin, reducing demand and driving down the e-coin's price.

Another risk to Bitcoin is regulation. Some countries have been trying to kill cryptocurrencies. China, for example, recently banned ICOs (initial coin offerings) — i.e. the sale of newly minted Bitcoins or other digital tokens.

Read more: Bitcoin takes flight again after overcoming roadblocks

Japan, by contrast, recently set up regulations for Bitcoin exchanges, which must apply for licenses to operate. The new rules have recognized Bitcoin as a payment system. However, they have not been recognized as legal tender - i.e. merchants do not have to accept Bitcoins in payment for goods and services if they don't want to, and the e-coins will not be accepted in payment for taxes.

Nevertheless, the imprimatur of legality generated by Japan's regulation of Bitcoin appears to have caused many more people, especially in Japan, to view Bitcoin as a legitimate form of financial instrument, and to 'invest' in Bitcoins. This has arguably been a key factor in causing the recent rapid rise in Bitcoin's price.

But future regulatory changes could just as easily cause a rapid fall in Bitcoin's price.

So, the market price of a Bitcoin has hit $11,000. But it doesn't really matter. Bitcoin doesn't contribute to value creation in the real economy, and it doesn't solve any of the main problems of the existing financial system.