Investments

Bitcoin explainer: what you need to know

16 February 2018

Cryptocurrency bitcoin has exploded in value: but can it be trusted? Mark Rider explains what’s going on.

Most finance news can be a bit dull. Bitcoin, however, seems to have caught everyone’s imagination. But what do we know about this volatile new entry?

What is bitcoin?

Bitcoin is a type of digital cryptocurrency. It operates on a decentralised peer-to-peer networked program on your computer, removing the middle man of banks and financial institutions. It allows online payments to be sent directly from one party to another without going through a financial institution.

So think of bitcoin as software, or a bit of code, that could be copied and reused and sent to multiple people. The blockchain technology that sits behind it stops copying and reusing from happening, because computers on the network reach a consensus that that coin has changed to a new owner when a transition is made.

The bitcoin buzz                                                                 

Bitcoin peaked near $US20,000 in mid-December 2017, lost close to 40 per cent of its value within a month as it dipped below $US12,000 by mid-January. Since then it continued to fall to around $US6900 early in February, erasing more than 60 per cent of its mid-December high. It's slowly recovered since and at time of writing, February 15 in the US, a bitcoin was valued near $US10,200.

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But how can I use it?

Don’t expect to use bitcoin to buy your morning coffee, the purpose and functions of bitcoin are still being discovered. So far it appears that bitcoin’s value is made in holding the asset rather than spending it. In addition to this, as bitcoin has risen in price, so have transaction fees.

Bitcoin can process a maximum of around seven transactions a second. As demand approached that limit, transaction fees crept in. After peaking at up to $30 a transaction, transaction costs settled at around $10 to $15.

What does the future look like?

Bitcoin pays no dividend and is difficult to use in transactions. In addition, the hype surrounding it certainly has all of the hallmarks of a ‘speculative bubble’. Speaking on Bloomberg Television in early February, US economist Nouriel Roubini described bitcoin as the “mother of all bubbles” which he said is crashing.

People have been buying it and holding onto it in the hope that bitcoin will continue to rise in value, much like the US housing bubble. As pricing spirals higher, and as Roubini pointed out, the more likely it is that it will crash.

One major risk for cryptocurrencies is regulation. China banned bitcoin in 2017 and other cryptocurrencies may not have come onto regulators’ radars yet, but some are becoming the preferred medium of exchange for criminals due to anonymity. If governments can find a way to crack down, they surely will.

All up it’s hard to say what will happen next. Bitcoin and other cryptocurrencies are so new that historical examples may not apply. While the technology is exciting, we have a healthy level of scepticism to its long-term benefits.