Bitcoin is a relatively new form of virtual currency with a uniquely designed decentralized platform. The bitcoin system could potentially disrupt existing payment systems, but first it must address outstanding issues, such as market risk, counterparty risk, transaction risk, operational risk, privacy risk, and regulatory risk.
Since its inception in 2009, the bitcoin system has facilitated more than 60 million transactions between 109 million accounts. Today, there are 14 million minted bitcoins equating to $3.5 billion. The authors detail the growth of the virtual currency as well as the functionality of its ecosystem, including the roles of currency exchanges, mixers, and mining pools. Looking to the future, this virtual currency could potentially be broadly used to transfer digital property, including financial assets, such as stocks and bonds.
How Is This Research Useful to Practitioners?
The evolution of bitcoin, as well as that of other virtual currencies, provides researchers with a unique environment to study the design of financial markets, user behavior, and the impact of regulation. Bitcoin is unique because it has a publicly available record of transactions, a predefined set of rules, and readily available historical price and volume data. As new rules, regulations, risk deterrents, and technologies are introduced into the bitcoin environment, researchers will be able to observe the impact of these changes to learn how to improve on their design in the future.
More broadly speaking, bitcoin provides a way to transfer digital property from one internet user to another. This method of transferring assets could, potentially, be used to buy and sell financial assets, such as stocks and bonds. If online currencies, such as bitcoin, continue to develop and can address concerns pertaining to counterparty risk and regulatory risk, then financial market participants may need to consider investing in assets denominated in a virtual currency as part of their overall investment strategy. This potential is evidenced by the fact that of all bitcoins minted in 2009–2010, more than 60% remain unspent or took more than one year to be spent, suggesting that some users may already be using bitcoins as an investment.
How Did the Authors Conduct This Research?
Even though bitcoin was just created in 2009, a significant amount of press coverage, publications, and data exists. When two users enter into a bitcoin transaction, the transaction is not complete until it is entered into the blockchain and verified by other users. This blockchain, which is a historical record of all transactions, is publicly available for download and recently surpassed 30 gigabytes in size. Using this historical data, the authors are able to determine the total number of bitcoins, the total number of transactions, and the required computational power, among other things. They are also able to gather bitcoin data by observing currency exchange bankruptcy filings.
For example, the Japan-based Mt. Gox exchange served more than 80% of all bitcoin transactions until it collapsed in 2014, losing 754,000 of its customers’ bitcoins valued at $450 million. The authors also research how bitcoins are being used, such as to purchase illegal goods anonymously via the online marketplace known as Silk Road or, more recently, to purchase home goods from online retailers, such as Overstock.com. Using these data, the authors are able to observe how buyers and sellers have benefited from this new form of exchange.
This research provides a detailed background on the creation, governance, and risks of the bitcoin currency. It is important for investment professionals to be aware of emerging opportunities and how these may align with an overall investment strategy. Ultimately, I would like to see future research highlight the continuing evolution of this virtual currency as well as make recommendations for future enhancements.