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The last six months have seen a lot of interest being generated in Bitcoins across the globe, for good reasons and bad. From price explosions and crashes to international controversies, corruption charges, and new regulations – Bitcoins have been at the centre of it all. Despite volatility in prices, security concerns, and clampdown by regulators, popularity of virtual currencies have soared in recent months and an increasing number of investors and speculators have started to consider it as an alternative investment. Likewise, they are also increasingly being used to pay for goods and services, with more and more online retailers, entertainment venues, and even restaurants starting to accept it.
As the Bitcoin market slowly and cautiously makes its way into the Indian financial system, here are a few things that you absolutely must know about it before you decide to invest in it.
What is a Bitcoin?
A Bitcoin is a form of digital currency that is created and stored electronically. While it is not the only vitual currency in the digital market (there are at least more than 100), it is by far the most popular one and accounts for more than two-third of the virtual currency market volume.
Bitcoin is managed by a peer-to-peer network of users spread across the globe, and in that sense, it is decentralised and not regulated by any central bank. Also, unlike other currencies, the schedule and amount by which the Bitcoin ‘money supply’ increases is actually predetermined by a defined mathematical protocol of the network, two key features of which are as follows:
- The rate at which Bitcoins are annually generated is fixed – the amount of new Bitcoins coming in circulation each year is equal to half the amount produced in the previous year.
- There is an upper limit of 21 million Bitcoins that can ever be created, about 12.4 million of which is presently in circulation.
This is one question that puzzles a lot of people – after all, why is it that some intangible and obscure currency is presently worth more than $600? To solve this enigma, let’s first understand why a commodity like gold has value.
The reason gold is expensive is because a lot people across the globe find value in it – they know that it is a scarce commodity and they hoard it. True, gold has many excellent properties as a metal, but almost all the gold mined in the world is used for ornamental and storage purposes. People like to collect gold and store it. That’s pretty much it. As more and more people start finding gold valuable, the worth of gold increases – and since the supply of gold is limited, as its demand increases, so does its price. And once anything gains in value, it can easily be used as a form of currency.
Similarly, a lot of people have started to find Bitcoins valuable for a variety of reasons. Most of the initial users of Bitcoin found it as an efficient and convenient form of payment. Now, with its increasing popularity, a lot of people are simply buying and keeping it in hopes that its value will increase in the future. Similar to how people buy gold or collect art. And the more people start buying Bitcoin, the wider the network will grow, and the more it will gain in value.
Fame and Fall
While Bitcoin had been steadily gaining popularity over the past year, it really turned heads when its value skyrocketed to more than $1,200 in November 2013, making it almost as valuable as an ounce of gold and certainly the most expensive currency. Early supporters cheered, and even the world’s first ‘Bitcoin ATM’, that exchanged Bitcoin for dollars, opened up in Vancouver in Canada, However, this spike in its price also caused financial regulators across the world to start evaluating it seriously, which until then most had not. Then the ‘Silk Road’ drug-racket got busted in late 2013 and the role of Bitcoin in the scandal severely damaged its reputation. Its value crashed across the world, and many people and regulators became wary of its role as a virtual currency. The huge volatility in its price also scared off many investors who were earlier eyeing it as an investment opportunity.
Bitcoins in India
Although Bitcoin has managed to come somewhat clean since then, its potential for misuse and unstable nature has resulted in many Governments remaining sceptical of it. While a few developed economies like Sweden and Finland have warmed up to it, some like China and Indonesia have imposed outright bans on financial transaction conducted in Bitcoins. Most regulators, however, have decided to remain cautious, and India falls in this category.
In December 2013, the RBI issued a warning that explained the downsides of virtual currencies like Bitcoins and the Enforcement Directorate had raided the office of a Bitcoin trader in Ahmedabad. Following these events, many leading Bitcoin exchanges in India shut down temporarily although most are now back in business. Even as its legal status hangs in the balance, new trading platforms are coming up and many investors are expressing interest in it. While most platforms require users to upload images of Government issued IDs, proof of address documents, and online banking account details (just like brokerage houses), the black market is packed with illegal operators that do not ask for such identification.
Since a clear standpoint is lacking from the Indian officials on this issue, Bitcoins remain a speculative and high-risk investment from an Indian’s perspective. Despite gaining in popularity, Bitcoin (like most virtual currencies) is still in a nascent stage and faces many challenges ahead. This makes it a high-risk-high-return investment. In days to come, the RBI might decide to prohibit financial transactions in Bitcoins, in which case the digital currency will lose its appeal and many investors will start selling it. Considering the amount of black money already in the Indian financial system, this seems like a very plausible scenario.
However, in the off chance that the RBI comes out with a clear guideline that supports (or even regulates) transactions in Bitcoins, investor interest in the virtual currency will certainly spike – and the price tag of $600 will seem quite attractive then.
