With every passing day, bitcoin, the digital cryptocurrency, keeps reaching newer heights. On December 7, the price of bitcoin almost touched $20,000 before closing at $14,000 on December 8. At the time of writing, bitcoin was trading at around 16,600. In any other asset class, such extreme intraday price movements would create mayhem in the markets. But for the rollercoaster that is bitcoin, it is just another day in the office. Just a year back, bitcoin was trading at around the levels of $800 and way back in May 2010; Laszlo Hanyecz made the first real-world transaction using Bitcoin by buying two pizzas for 10,000 Bitcoins. Hypothetically, had he held on to those bitcoins instead of purchasing the pizzas, he would have been richer by $140 million. Quite an expensive pizza indeed!

So, what are bitcoins? It’s a valid question which must be arising in many people’s minds. Technically, it’s a decentralised payment system and digital currency which works through a peer-to-peer network without any intervention from central banks. The transactions are recorded in a publicly distributed ledger system called blockchain and the transactions are conducted using cryptography, hence the name cryptocurrency is given to such payment systems. The article “Bitcoin demystified in simple terms” explains the concept very lucidly so that both laymen and tech geeks can understand it. For a Wall Street type, who is ever hungry for potential opportunities, bitcoin smells of money. Speculators have taken to bitcoin like a duck to water. They may not understand the intricacies of bitcoin mining or network nodes in blockchain technology but that does not stop them from taking heavy positions in bitcoin.

One of the reasons for the price surge is the massive involvement of speculators. More and more observers, including RBI in India, are cautioning people to be careful as the previous instances of such frenzied speculation has led to disastrous consequences. Right from the ‘Tulip Mania’ in the 1630s to the dot-com bubble in the late 1990s, the madness of crowds has been well-documented. As the demand and price for bitcoin increases, the chorus call of a bubble brewing in bitcoin also keeps increasing. As can be seen in the chart below, the price movement of bitcoin is comparable to the surge in NASDAQ index just before the bubble burst in early 2000.

Price chart of NASDAQ Index from the 1970s to 2002.

Price chart of bitcoin since inception.

If indeed bitcoin is following the footsteps of the internet bubble, then we are due for a massive correction. In the case of the dotcom bubble, many participants had assumed that internet would take over the world overnight. Even though they were eventually proven right about the impact of internet, the timeline turned out to be way more gradual. Also, only a handful of internet companies have benefited from the internet revolution due to the inherent winner-take-all effect that is in-built in the internet ecosystem. In bitcoin’s case, the bursting of the bubble would have crippling and devastating consequences and the effects would linger on for years.

On the other hand, it is also possible that this time is different. This statement is quite often remarked at the time of peak frenzy just when a bubble is about to burst. Even an astute genius like Alan Greenspan became a victim to the “This time is different” syndrome by proclaiming that rising home prices in US seen in 2005 and 2006 were not in a speculative bubble and he later conceded that he did not see it coming.  Yet, this time could actually be different. If the widespread popularity materialises into a fundamental shift, bitcoin can scale even further heights.

In essence, bitcoin can be seen as a form of digital gold which provides a hedge to drastic reversals in central bank-backed currencies just like physical gold performs a hedge against inflation. Silver and platinum provide alternatives to gold in the precious metals basket while Ethereum and Litecoin among others provide alternatives to Bitcoin in the cryptocurrency segment. Also, cryptocurrencies are designed in such a way that supply always remains scarce just like gold. If indeed, bitcoin is looked at as a digital store of value then it opens up a whole new asset class to invest in. Currently, most investors grapple with choices like real estate, stocks, bonds, cash and gold. If cryptocurrencies are able to provide a stable platform to invest in, then it becomes a whole new ball game altogether. As a credible asset class, it can attract a humungous supply of investable funds looking for the right place to park their money in. If things do pan out as discussed, then all arguments against bitcoin sound hollow.

Price chart of gold since 1900.

The price chart of bitcoin also looks similar to chart patterns of gold. If bitcoin is able to gain mainstream acceptance, similar to gold, then bets against bitcoin are doomed to fail. It will keep on reaching stratospheric levels as the demand will far outstrip the supply. Of course, trading in bitcoin is not for the fainthearted. The prevailing air of fear, uncertainty and doubt can confuse even the most battle-hardened professional let alone an amateur. Markets tend to overshoot both while going up and while going down and many will not be able to withstand the volatility. But if bitcoin is not in a bubble zone, then any correction will not be crippling and participants will be able to shrug off any downturn. Hence, markets will be able to rebound quickly rather than linger downwards for years. In such a scenario, for which I personally ascribe a higher probability, the potential for bitcoin is massive.

Gold has been a stable store of value ever since the advent of civilisation. When humans collectively ascribe value to a thing it becomes a self-fulfilling prophecy. Such is human nature. Similar is the case with bitcoin. It has risen like a phoenix and can keep flying high if people continue to embrace it as a digital store of value. Ofcourse, there are many challenges ahead. For instance, CBOE launched the bitcoin futures on December 10. This will provide a platform for bitcoin bears to put their money where their mouth is.

So far, the only way to take a negative position on bitcoin was by avoiding it. Now with the arrival of bitcoin futures, traders can short bitcoin. The ability to short can change the force of the underlying market and the price can get hammered downwards if too many shorts float in the market. If bitcoin prices are able to withstand such a challenge then the upward trend will generate further momentum. On the first day of futures trading, the bulls continue to dominate with the January futures price rising from $15,000 to $18,000. Another challenge is the security issue. Just like there are attempts to steal gold vaults, hackers attempt to steal bitcoins digitally. On December 6, hackers managed to steal $70 million worth of Bitcoin from a major crypto mining firm. In February 2014, $450 million was stolen from a Tokyo-based bitcoin exchange. These are the risks participants have to contend with if they wish to convert money into bitcoin.

Bitcoin has managed to capture the imagination of the masses. Even central banks are fretting about the possible implications of its widespread usage. The situation is still in flux and all the cards are yet to be dealt. The battle between the believers and the sceptics is still raging intensely but one thing is for sure. For many people, bitcoin is the most exciting prospect of their lifetime. Everyone is invited as long as one is able to withstand the daily gyrations and the security issues. With the opening up of the futures markets, the naysayers also get the opportunity to participate. Indirect exposure to bitcoin can be built either through investing in bitcoin-related start-ups or by buying bitcoin-related domain names. In hindsight perhaps, the eventual outcome will seem crystal clear but currently no one really understands what is going on even if they pretend that they do. As a parting note, I would only like to suggest a new phrase for the future extremely tech savvy generation: “As good as a bitcoin.”