BITCOIN

INTRODUCTION

Blockchain technologies and cryptocurrencies such as Bitcoin, Litecoin, and

Ethereum, have attracted significant attention in recent years. Some experts have expected
that cryptocurrencies would cast disruptive impacts on the financial systems. However the
data show different result. To date, bitcoin is the most successful and significant example of
blockchain-based cryptocurrencies. As Katsiampa (2017) notes, Bitcoin is the most popular
cryptocurrency with 41% of the estimated cryptocurrency capitalisation in Bitcoin.
According to the data from coindesk.com website, the market capitalization of Bitcoin has
dramatically reached $278 billion from $111 billion for the period from November 2017 to
December 2017.

Bitcoin were created software engineer under the pseudonym of Satoshi Nakamoto on
2008. It is an online communication protocol that facilitates the use of a virtual currency,
including electronic payments or can be exchanged for real-life goods and services on a
limited basis. Bitcoin has served approximately 62.5 million transactions between
109 million accounts. Bitcoin’s rules were designed by engineers with no apparent influence
from lawyers or regulators. Rather than store transactions on any single server or set of
servers, Bitcoin is built on a transaction log that is distributed across a network of
participating computers. It includes mechanisms to reward honest participation, to bootstrap
acceptance by early adopters, and to guard against concentrations of power.

HOW BITCOIN WORKS

As a virtual currency, bitcoin utilizes decentralized capabilities to promote secure

payment as well as store money that does not need the names of people or bank details.
Bitcoin utilizes a public ledger that is known as block chain. This ledger is used to hold
decentralized records of all performed transactions which are owned and updated regularly by
internet users.

For bitcoins to be created, users must have the capacity to create blocks on the
network. Every block is generated in a cryptographic manner by gathering the computer skills
of the user. These blocks are finally supplemented to the block chain and this enables users to
earn as the network keeps running. It is important to note that there is a limit to the amount of
bitcoins that can be generated and this has been wired into the system thus preventing the
devaluing of the currency

Bitcoin’s design allows for irreversible transactions, a prescribed path of money

creation over time, and a public transaction history. Anyone can create a Bitcoin account,
without charge and without any centralized vetting procedure or even a requirement to
provide a real name. Collectively, these rules yield a system that is understood to be more
flexible, more private, and less amenable to regulatory oversight than other forms of payment
though as we discuss in subsequent sections, all these benefits face important limits. Bitcoin
is of interest to economists as a virtual currency with potential to disrupt existing payment
systems and perhaps even monetary systems. Even at their current early stage, such virtual
currencies provide a variety of insights about market design and the behaviour of buyers and
sellers.

Bitcoins are created at a steady but diminishing rate until an arbitrary limit of 21
million has been reached (Grinberg 2011). To date, about 12.4 million bitcoins have been
“mined” (created using the prescribed algorithm). This limit to the creation of bitcoins is very
appealing to those wary of high inflation resulting from the extremely simulative monetary
policies of major western central banks, particularly the U.S. Federal Reserve, Bank of Japan,
the European Central Bank, and the Bank of England. For the same reason, bitcoin is also
appealing to proponents of a return to the gold standard. These individuals see bitcoin as
analogous to a naturally occurring mineral with a limited and exhaustible supply.

Bitcoins are completely virtual coins designed to be 'self-contained' for their value,
with no need for banks to move and store the money. Bitcoins are traded from one personal
'wallet' to another. A wallet is a small personal database that store on computer drive (i.e cold
storage), on smartphone, tablet, or somewhere in the cloud (hot storage). The most common
way to purchase bitcoins is through an account with a bitcoin exchange, such as
coinbase.com, cryptsy.com, bter.com, and coins-e.com. These exchanges also post current
exchange rates between one bitcoin and major currencies, including the U.S. dollar and the
euro.

After an account has been created, one can directly transfer money from a financial
intermediary, including banks and Paypal. Once the transfer has been cleared, one can use the
funds to purchase bitcoins from the exchange for a fee the prevailing rate and hold the asset
in the account holder’s bitcoin wallet. At this point, the bitcoins are ready to be sold back to
the exchange or used for purchases. To speed up this process, which can take several days
because of increasingly strict measures against money laundering, physical ATMs began to
appear in several locations in late 2013 that allow users to buy and sell bitcoins for cash in a
matter of seconds (Rick 2014).

SUPPLY AND DEMAND

Bitcoin is not pegged to any “real” currency and its value is determined by supply and
demand. The supply of bitcoins is limited by the amount of electricity and computer CPU
time needed to mine it. There is no central clearinghouse, nor are any financial institutions
such as banks involved in facilitating transactions, which are both faster and cheaper than
transactions involving traditional means of payment. The bitcoin user community performs
the function of maintaining the block chain, a public and distributed ledger, to keep track of
transactions between anonymous accounts on a peer-to-peer network. Without such a ledger,
the same bitcoin could be exchanged for cash, products, or services more than once. This is
known as the double spending problem.

Members of the bitcoin community, known as “miners,” solve increasingly

complicated mathematical problems that verify transactions in the block chain so bitcoins do
not suffer the double spending problem. In technical terms, verifying transactions involves
the generation of “blocks” for which “miners” are rewarded with bitcoins, and if the block is
used to verify a transaction, miners receive additional bitcoins. Finally, the number of
bitcoins generated per block is set to fall according to a rule that will result in a maximum of
21 million bitcoins in circulation by 2040, according to the European Central Bank. 

Thus, the supply of bitcoins is independent of any central bank policy. This is also the
most powerful reason why many of its backers and users prefer bitcoin to fiat currencies.

ADVANTAGES OF BITCOIN
1. Greater Liquidity Relative to Other Cryptocurrencies

As the most popular cryptocurrency by a significant margin, Bitcoin has far greater
liquidity than its peers. This allows users to retain most of its inherent value when
converting to fiat currencies, such as the U.S. dollar and euro. By contrast, most other
cryptocurrencies either can’t be exchanged directly for fiat currencies or lose
substantial value during such exchanges. In this regard, Bitcoin is more like fiat
currencies than most other cryptocurrencies – though it’s not yet possible to buy and
sell Bitcoin in virtually any quantity at any time, as is the case with the U.S. dollar
and other major world currencies.

2. Increasingly Wide Acceptance as a Payment Method

Hundreds of merchants accept Bitcoin payments. Thanks to heavyweights like

Overstock.com jumping on board, it’s possible to buy virtually any physical item
using Bitcoin units. If you’re serious about reducing your exposure to fiat currencies,
Bitcoin’s growing mainstream acceptance is likely to be a big help.

3. International Transactions Easier Than Regular Currencies

Bitcoin transactions that cross international borders are no different from Bitcoin
transactions that stay in-country. There aren’t any international transaction fees or red
tape to navigate, as is often the case with credit card payments, ATM cash
withdrawals, and international money transfers. International credit card and ATM
fees can range up to 3% of transaction value, and sometimes higher, while money
transfers fees can be as high as 15%. While most other crypto currencies lack
international red tape, cross-border Bitcoin transactions are easier simply because
Bitcoin is more popular around the world.

4. Generally Lower Transaction Fees

Compared to other digital payment methods, such as credit cards and PayPal, Bitcoin
comes with lower transaction fees. Though such fees are variable, it’s rare for a
Bitcoin transaction to cost more than 1% of its value. Compare that to 2% to 3% for
most other digital payments.

5. Anonymity and Privacy Relative to Traditional Currencies

 Holding U.S. dollars or other fiat currencies in an online bank account, or executing
online credit card and PayPal transactions, doesn’t protect your privacy any more than
physically handing cash or a credit card across the shop counter. Though your online
accounts are hopefully protected from all but the most sophisticated hack attacks,
they’re clearly associated with you – meaning private merchants and public
authorities can track how you spend and receive your electronic funds. By contrast,
Bitcoin’s built-in privacy protections allow users to completely separate their Bitcoin
accounts from their public personas, if they so choose. While it’s possible to track
Bitcoin flows between users, it’s very difficult to figure out who those users really
are.

6. Independence From Political Agents and Creators

Since Bitcoin isn’t created or controlled by any state entity, such as a central bank, it’s
not beholden to political influence. Since it exists outside any political system, it’s
also much harder for governments to freeze or seize Bitcoin units, whether in the
course of legitimate criminal investigations or as retribution for political acts, as is
often the case in repressive states like Russia and China. Due to its completely
decentralized nature, popularity, and liquidity, Bitcoin is also unbeholden to its
creators. Many less popular cryptocurrencies are characterized by concentrated
holdings – the majority of existing units are held in a handful of accounts. This allows
the currencies’ creators to manipulate supply and, to an extent, value relative to other
cryptocurrencies, negatively impacting other holders.

7. Built-In Scarcity

Bitcoin’s built-in scarcity feature only 21 million will ever exist. It is likely to support
its long-term value against traditional currencies, as well as non-scarce
cryptocurrencies. In a way, Bitcoin’s scarcity imbues the currency with intrinsic value
similar to gold and other precious metals. Most traditional (fiat) currencies controlled
by national governments are non-scarce. Central banks can create new units of
currency at will, and often do. For example, the U.S. Federal Reserve began a
program of quantitative easing that created trillions of dollars in the aftermath of the
late 2000s global financial crisis. Though the long-term effects of such policies are
unclear, they make many economists uneasy.

DISADVANTAGES OF BITCOIN
1. Exposure to Bitcoin-Specific Scams and Fraud

As the world’s most popular cryptocurrency, Bitcoin has seen more than its fair share
of medium-specific scams, fraud, and attacks. These range from small-time Ponzi
schemes, such as Bitcoin Savings & Trust, to massive hack attacks, such as the
breaches that felled Sheep Marketplace and Mt. Gox. Other cryptocurrencies don’t
have the critical mass of users necessary to make such malfeasance profitable to
criminals, and such activity is more likely to be prosecuted by law enforcement
agencies when traditional currencies and payment platforms are involved.

2. Black Market Activity May Damage Reputation and Usefulness

Despite high-visibility prosecutions of the most egregious offenders, Bitcoin remains

attractive to criminals and gray market participants. Obviously, dark web
marketplaces like Silk Road and Sheep expose rank-and-file users to fraud and the
threat of criminal prosecution. And it’s unclear that the international legal system is
properly equipped to tackle the problem. If shady uses for Bitcoin outweigh legitimate
ones over time, and the authorities can’t effectively put a stop to the shenanigans, the
entire system faces marginalization.

3. Susceptible to High Price Volatility

Although Bitcoin is the most liquid and easily exchanged cryptocurrency, it remains
susceptible to wild price swings over short periods of time. In the wake of the Mt.
Gox collapse, Bitcoin’s value fell by more than 50%. Following the FBI’s
announcement that it would treat Bitcoin and other virtual currencies as “legitimate
financial services,” Bitcoin’s value spiked by a similar amount. While Bitcoin’s
volatility sometimes offers short-term benefits for speculative traders, it renders the
currency unsuitable for longer-term investors. And since Bitcoin’s purchasing power
varies so widely from week to week, it’s difficult for consumers to use as a legitimate
means of exchange.

4. No Chargebacks or Refunds
 One of Bitcoin’s biggest drawbacks is a lack of standardized policy for chargebacks
or refunds, as all credit card companies and traditional online payment processors
have. Users affected by transaction fraud. For instance, they purchase goods that the
seller never delivers can’t request a refund through Bitcoin. In fact, Bitcoin’s
decentralized structure makes it impossible for any single party to arbitrate disputes
between users. While miners take responsibility for recording transactions, they’re not
qualified to assess their legitimacy. Some newer cryptocurrencies, such as Ripple,
have rudimentary chargeback and refund functions, but this feature has yet to be built
into Bitcoin.

5. Potential to Be Replaced by Superior Cryptocurrency

Bitcoin spawned a host of successor cryptocurrencies. Though many are structurally

quite similar to Bitcoin, others make notable improvements. Some newer
cryptocurrencies make it even harder to track money flows or identify users. Others
use “smart contract” systems that hold service providers accountable for their
promises. Some even have in-house exchanges that let users exchange cryptocurrency
units directly for fiat currency units, eliminating third-party exchanges and reducing
associated fraud risks. Over time, one or more of these alternatives could usurp
Bitcoin as the world’s dominant cryptocurrency. That could negatively impact
Bitcoin’s value, leaving committed, long-term users holding the bag.

LEGALITY

The majority of countries do not make the usage of bitcoin itself illegal, its status as
money (or a commodity) varies, with differing regulatory implications. While some countries
have explicitly allowed its use and trade, others have banned or restricted it. Likewise,
various government agencies, departments, and courts have classified bitcoins differently. In
a simple word, the legality of Bitcoin depends on where users located. Bitcoin was legalized
as a formal method of payment in some parts of Europe, Japan this year, and India might be
next. In most countries, however, it somewhat operates in a grey zone, with no official ban or
approval of Bitcoin

CONCLUSION
 In conclusion, the analysis reveals that, as a currency, bitcoins are in their infancy.
Currently, limited acceptability makes bitcoins a poor medium of exchange, while high
volatility makes this asset a poor store of value. This could change over time. However, even
now, bitcoins do provide the potential to enhance the performance of an investor’s portfolio.
Therefore, it can be useful to hold bitcoins as a component within a diversified investment
portfolio.

Trading and investing in a virtual currency, such as bitcoins, is readily accessible to

individual investors. Additionally, competing exchanges have brought down the costs of
trading bitcoins to a minimal level. Financial planners can open bitcoin trading accounts or
digital wallets for their clients at a number of digital currency exchanges, such as
coinbase.com, cryptsy.com, bter.com, and coins-e.com. Coinbase.com offers only a bitcoin
digital wallet while the others facilitate trading in multiple virtual currencies. While
recommending virtual currencies as an investment asset, it is important to underscore the risk
involved with investing in these assets. Bitcoins should only be held as a minor component of
a well-diversified portfolio, such as in a market-weighted basket of major asset classes.

APPENDIX
1. Katsiampa, P., 2017. Volatility estimation for Bitcoin: A comparison of GARCH
models. Econom. Lett. 158, 3–6
2. Grinberg R (2011) Bitcoin: an innovative alternative digital currency. Hastings Sci
Tech Law J 4:159–208
3. Chong and Wang 2017. The technology and economic determinants of
cryptocurrency exchange rates: The case of Bitcoin. Page 59-60
4. European Central Bank (ECB), 2012. Virtual Currency Schemes.
http://www.ecb.int/pub/pdf/other/virtualcurrencyschemes201210en.pdf
5. Urquhart A (2016). The inefficiency of Bitcoin. Econom. Lett., 148 (2016), pp. 80-82,
10.1016/j.econlet.2016.09.019