Bridge over ocean
1 June 2014 CFA Institute Journal Review

Money from Nothing (Digest Summary)

  1. Imrith Ramtohul, CFA

The use of bitcoin has certainly evolved in the past year, but many still question whether it could qualify as money because it suffers from certain weaknesses that might not allow it to become widely accepted as a hard currency.

What’s Inside?

Bitcoin suffers from weaknesses that could prevent it from becoming a widely accepted hard currency. It has a finite supply, it is not always a good store of value, and it is rather inflexible as a medium of account.

How Is This Article Useful to Practitioners?

Bitcoin registered exponential growth in value over the past year, rising from a total valuation of $490 million to $7.9 billion. In addition, daily transaction volume increased by around 60% over that same time period. Given this trend, the question remains whether bitcoin could eventually qualify as currency.

Economists typically agree that money is anything that serves three functions: (1) be a medium of exchange, (2) be a stable store of value, and (3) function as a unit of account. Bitcoin seems to be accepted as a medium of exchange given the growth in transaction volume. The use of bitcoin also involves low transaction costs. But bitcoin has not proved to be a stable store of value. Its value has been influenced by speculation, unregulated exchange platforms, and the finite supply of bitcoins. For example, around 6% of outstanding bitcoins recently disappeared from an exchange, causing a large drop in value. This volatility could contribute to bitcoin not being widely accepted as a store of account.

In addition to the volatility, the “supply” of bitcoins will be limited to 21 million units, although it will take a number of years to reach that limit. New bitcoins could be minted until 2030. The finite supply, though, could contribute to the deflation that bitcoin has already experienced. The author believes that bitcoin transactions have flourished mainly because merchants still use other currencies as the principal accounting unit. The author concludes that bitcoin may not be widely accepted as a currency because of these weaknesses and potential problems.

Abstractor’s Viewpoint

The author offers a compelling argument that bitcoin may not be widely accepted as a hard currency. It would seem, however, that the growth in bitcoin transaction volume could persist for some time. It could be useful to further investigate the reasons behind the recent popularity of bitcoin. It is equally important for authorities to raise public and investor awareness of the potential risks of using bitcoin as a virtual currency.

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