Speculators’ liking for Bitcoin means the virtual currency is unlikely to become a serious alternative to traditional mediums of exchange - or a threat to financial stability - any time soon, a new study concludes.
“A minority of users, both in number and Bitcoin balances, appear to use Bitcoin as a medium of exchange,” the researchers say. “Bitcoin is mainly used as a speculative investment.”
With the size of Bitcoin investments and transactions still small relative to other assets, the virtual currency poses no immediate risk for financial or monetary stability, they say.
Essentially, blockchain technology is a method of recording and confirming transactions where participants each hold the complete record of transactions. This peer-to-peer verification means no central recording system exists and payments do not have to go through a central financial institution.
There is no physical coinage, making Bitcoin a “virtual” currency as opposed to a government-issued “fiat” currency like the Australian dollar.
“We wanted to answer the question of whether Bitcoin is a currency or an asset,” says Dr Adrian Lee of UTS Business School Lee says. “Are Bitcoins mainly used as an alternative currency to pay for goods and services or are they used as an investment?
“What we found is that Bitcoin is mainly used as a speculative investment.”
The study by Dr Lee, Professor Dirk Baur of UWA Business School and Assistant Professor Kihoon [Jimmy] Hong of Hongik University in South Korea identified six main types of bitcoin user: active investors, passive investors, currency users, testers, miners and 'hybrid' users. Passive investors held one-third of all Bitcoin.
Rather than a virtual currency like Bitcoin “crowding out” fiat currencies, if anything fiat currencies crowd out virtual currencies, Dr Lee says. “The very design of a virtual currency like Bitcoin makes it less likely to be used for its original purpose as a medium of exchange.”
For a start, Bitcoin is deliberately scarce – the supply is perfectly predictable, increasing in ever smaller steps until 2040, at which point the supply will be fixed. “What happens is that the demand for virtual currencies by potential users increases the price, attracting speculators, who drive the price even higher –reducing the virtual currency’s property as a medium of exchange.”
The researchers do note that if acceptance of Bitcoin or other virtual currencies were to increase significantly, on a global level, there could be issues for monetary policy. “Given Bitcoin’s global, decentralised nature and independence from any central bank, regulatory oversight might be challenging,” Dr Lee says.
In the meantime, how does Bitcoin behave as an asset? “Bitcoin is different from all the traditional assets we investigated in comparison,” Dr Lee says.
Bitcoin returns are uncorrelated with traditional asset classes such as stocks, bonds and commodities, he says, both in normal market conditions and in periods of financial turmoil. The fact it behaves so differently to other assets means it offers large diversification benefits, the researchers say.
This low correlation also implies low risk from a macro perspective – if a “bubble” developed in Bitcoins and it burst this could be an isolated event. However, if Bitcoin investments were debt-financed a significant fall in value could lead to margin calls and flow-on effects as investors sold other assets to fund the calls.
Bitcoin is highly volatile. The value of a Bitcoin rose from $5.28 in mid-2010 to $388.55 by mid-2015 but with steep rises and falls in between. In November 2013, for instance, Bitcoin’s value hit $1150, only to plunge to $548 just over two weeks later.
The Bitcoin research was conducted with funding from the SWIFT Institute. SWIFT is the Society for Worldwide Interbank Financial Telecommunications, a member-owned cooperative through which the financial world conducts its business operations. The Institute supports independent, academic research into important topics affecting the industry and its customers worldwide.