BITCOINS: For Online Payment and Speculative Trading

One of these days, I
was trying to purchase a book from Sapna
Book House, a famous brick & mortar book store in Bangalore, and now
they were selling books online. During the online purchase transaction, I saw
that Sapna Online was allowing the payment mode through Bitcoins.
This was the first time I was exposed to Bitcoins as a payment mode. Bitcoin that was fairly a foreign word
to most Indians and was largely being associated with disguised transactions,
to my surprise was active here in a legal transaction, standing as an alternate
to other payment modes like traditional payments, cards, PayTM and the likes. Bitcoins
are alternate currencies, held digitally and usable for online purchase and
sale transactions. Accepted by more than 100000 online stores around the world, bitcoins are
making their way into the market places for retail products, alternative
investment products, and many other purposes. In fact, one of the initiatives
by a group of volunteers during Chennai floods recently, included accepting
donations through bitcoins (later converting them to Indian rupees and sending
it to NGOs working on relief). Despite being
unorganised, unregulated and opaque to a large extent, bitcoins are finding
their arena for operations even in markets like India.

Before proceeding
further, it may be important to mention here one of the major arguments against
bitcoins. And that is, that Bitcoins are profusely used for illicit activities,
as it has come to light through various criminal investigations around the
world. The case of Ross Ulbricht, a convict of money laundering and other
crimes, has been running Silk Road,
an online black market that was selling illegal drugs providing anonymity to
the buyers and sellers. And when he was caught, approximately $ 3.6 million
worth of bitcoins were seized from him. Incidents such as these have led to
slowing down the pace of permeation of bitcoins across markets. Add to the
chaos, the basic tenet of bitcoin structure, that there is no centrally
controlling entity to assure the error free transaction. While that is also the
advantage of bitcoins over existing payment options, it cannot be denied that
manipulation is still possible. The red flag keeps waving when we hear news
like the recent theft of roughly USD 60 million bitcoins from BITFINEX (one of
the very active bitcoin exchange from HongKong).

Few of the major
Bitcoin exchanges in the world are Bitfinex,
Bitstamp, and OKCoin. In India, there are few online self-regulated
exchanges that are operating, Unocoin,
CoinSecure, BTCXIndia, ZebPay, Bitcoin India and many other local agencies.
It is said that there are more than 30000 bitcoin owners in India to count the
least. Most of the above exchanges are payment gateway providers rather than
the real bitcoin miners/creators. Their operational procedure is simple. They
network with online retailers like Sapna Book House, Highkart.com etc., and
provide payment gateway service, wherein the retailer allows the user to pay
for his purchases by depositing bitcoins. When the buyer chooses to pay by
bitcoins, the sites are redirected to these exchanges. They buy the bitcoins
and pay the equivalent rupee value to the retailers.

Trading
in Bitcoins

Any asset or variable
whose price fluctuates welcomes traders and a secondary market gets created.
Bitcoins are no different. The secondary market for bitcoins, that is, those
buying and selling transactions executed only to make a gain out of price
change, has also gained traction in the recent past. What leads to such
opportunities is the volatile movement of price of bitcoins. Below graph
presents the monthly price movement of bitcoins (in US$) from Mar-2014 to
Oct-2016.

Investment products are
expected to satisfy three criteria – safety,
liquidity and profitability –
extent of satisfaction depending on individual investor’s risk tolerance, source of
capital and greed. If bitcoins
were to be analysed as investments, we may discuss the same in their ability to
deliver above three criterions.

Safety

As can be seen,
sufficient volatility is present to create trading opportunities for those who
could reasonably estimate the price movement in advance. The standard deviation
as a measure of volatility is 16.4%. The lowest price during the period was
213.99 and the maximum has been 662.31, with a range bounding 448.32. With an
average standard deviation of gold in the last three years being 15%, equity
market world over at approximately 12% and realty being untraceable, we can say
that bitcoins will rank the lowest in terms of safety. In addition, lack of
transparency, literacy and regulations, bitcoins pose higher risk on the face
of it.

Liquidity

With the increasing
number of self-regulating exchanges and the payment gateway service providers
(including the online retailers) the liquidity of bitcoins is increasing. Yet,
the usefulness of the bitcoins is not established. They are still not inevitable. The liquidity can be said to be
increasing, but, a guaranteed counterparty tracing is not assured.

Profitability

In the last 25-26
months, average monthly return of bitcoins has been 1.9%. Not a great return
per se. But the maximum intra-month change in price has been close to 40% and a minimum of -32%. What this signifies is that bitcoins, when seen
as long term investment option, may still be not sophisticated yet, whereas, as
a clear speculative instrument, it does prove to be worth a shot.

Bitcoins, like gold or
oil, are supposed to be scarce commodity and thus, theoretically their price is
supposed to be increasing with the passing of time. Bitcoins are generated by miners during
the process of using their computing power to verify and record other bitcoin
transactions.  The supply of such
bitcoins is restricted by the monetary policy created by the inventor of
bitcoin (supposed to be anonymous Satoshi
Nakamoto), at the introduction of the concept itself, that, there can be a
maximum of only 21 million bitcoins. And
this is expected to be reached by 2140 (as the speed at which bitcoins are created and
release is roughly one in ten minutes currently and speed will decline linearly
at 50% velocity). Such being the scarcity defined already, bitcoins continue to
derive price like other commodities, with a difference of holding no physical
entity.

As a whole, we can say
bitcoins are strengthening their niche and percolating around. As alternate
payment options, they are already in the marketplace and they will only be
getting standardised as time progresses. As far as the trading is concerned,
considering bitcoins as a saving or investment option may happen in a far
distant future, but, right now they are a great gambler’s
product to play with.

By the way, in India,
currently one bitcoin is priced at Rs. 45637 (as
quoted on 24-Oct-2016 by UnoCoin).