Bitcoin, blockchain and bubbles - what is all the hype about?

Cryptocurrency, and bitcoin in particular, has been a hot topic in the past few months, be it on the media, investors boasting about their profits, or curious parties wondering what the hype is all about.
Let’s have a look at what cryptocurrencies are, why bitcoin is making headlines, and what the regulatory environment’s response to this new trend is.

What is it?

A cryptocurrency is a digital asset designed to work as a medium of exchange that uses cryptography to secure its transactions, to control the creation of additional units, and to verify the transfer of assets.

Bitcoin has two key traits that define it: it is digital and it is seen as an alternative currency. Think of it as virtual tokens that largely exist online. It is created through a complex process known as “mining”, and is then monitored by a network of computers across the world. There is currently a steady stream of about 3,600 new bitcoins being mined every day, with a total of about 16.5 million now in circulation. It operates independently of any bank, and is seen as heralding a new age of global payments.

Bitcoin comprises just under half of the $100-billion cryptocurrency universe.

Blockchain is the technology behind bitcoin. Blockchain technology creates a decentralised digital public record of transactions that is secure, anonymous, tamper-proof and unchangeable. It makes all transactions public. This underlying technology is regarded by some major financial institutions as bullet-proof.

Its value is determined by how much people are willing to buy and sell it for. Models like relative purchasing power, inflation differentials or interest rate differentials cannot be used to determine an appropriate valuation, as values required to determine long-term fair value through these models are impossible to obtain. We can assess the value of the tradeable asset based on supply and demand. Simply put, its value is determined by how much people are willing to buy and sell it for. With no viable way to determine the price at which bitcoin, or any cryptocurrency, should be trading, based on usual valuation criteria, if demand were to slump, it could result in spectacular losses similar to those seen during previous bubbles (which is true even in bitcoin’s relatively short history).

Bitcoin’s high volatility negates the definition of a currency as a store of value, and makes it an unlikely means of long-term wealth preservation.

Why has the value gone up so much this year?

Bitcoin’s first recorded price was in 2010. Here is how the bitcoin price has changed (in USD) since then.

Bitcoin, blockchain and bubbles - what is all the hype about?

In 2017 alone, there has been massive growth in price. As at 15 January 2018, you can buy one bitcoin for R168,790.

Bitcoin, blockchain and bubbles - what is all the hype about?

Some say the reason for this growth is a classic economic bubble – frenzied investors paying far more for an asset than it is worth for fear of missing out.

It has been placed in the same bracket as the mania for Dutch tulip bulbs in the 1630s – a kind of tulip fever for the hi-tech era.

Others point to the growing prospect of bitcoin crossing over into the financial mainstream, as there has been an increase in institutions accepting payment in bitcoin across the globe, including Takealot, Microsoft, Wikipedia and Shopify.

What about regulatory concerns?

At the moment bitcoin is largely unregulated. Since the environment is still relatively new, regulators around the world are struggling to formulate a plan to deal with it.

The anonymity of digital currency has attracted people wanting to make illegal purchases on the internet, as it makes it difficult to trace transactions back to individuals.

On a local scale, the exponential rise in the price of bitcoin poses a threat to the South African Revenue Services’ (SARS) revenue collection efforts, as it is largely dependent on traders’ own truthful declaration of profits. Financial institutions like banks are required to provide SARS with information on the investments of their clients for verification purposes, but in a crypto environment where such information is lacking, SARS may have to trust that a taxpayer made honest declarations with regard to crypto gains.

According to Dr Randall Carolissen, SARS group executive for research, SARS is having discussions with its counterparts on how to track cryptocurrency trades. They are also strengthening their relationship with the South African Reserve Bank (SARB) to look more critically at matching the flow of funds in and out of the country with the actual movement of goods.

SARS has said that it has plans to provide clarity on the tax implications of transacting in cryptocurrencies like bitcoin in either an interpretation or practice note early this year.

At the moment, cryptocurrency is treated in the same way as capital realisation. If you buy it at a particular point and then sell it, there will be capital appreciation on which Capital Gains Tax is payable.

In a paper issued by the South African Reserve Bank (SARB) in 2014, the bank noted that it did not oversee, supervise or regulate the virtual currency landscape, systems or intermediaries for effectiveness, soundness, integrity or robustness. Consequently, any and all activities related to the acquisition, trading or use of virtual currencies are performed at the user’s sole and independent risk and have no recourse to the bank.

As these currencies become more sophisticated, we can expect to see more stringent regulation being developed and enforced.

Will the bubble burst?

Bitcoin has doubled in value in the space of a month at the end of 2017. Some argue that it is too volatile to be seen as a currency, and warn that a crash is inevitable.

However, bitcoin has been “declared dead” a few times, and has shown some resilience and bounced back from some near-death experiences.

There have been plenty of occasions where Bitcoin has seemed to be in trouble – splits in the community over how it should be governed, robberies at exchanges, warnings from regulators. But every time that a warning has been heard that the bubble is about to burst, the currency has stuttered for a few days and then gone charging higher.

The biggest shadow over the future of Bitcoin is the growing evidence that it is hugely wasteful in terms of energy use. By one estimate, the process of mining new coins and recording new bitcoin transactions now consumes more electricity each year than is used by Ireland.

The continued rise in the value of bitcoin looks unsustainable in both economic and environmental terms, but with the future of this currency being so uncertain, there is no telling what might happen.

There is an old saying that, when the last naysayer changes their mind and gives in to an investment craze, is when a bubble bursts. Until then, as long as investors are willing to buy, there will be a market.

Sources: Wikipedia, BBC, Moneyweb

29 Jan 2018 16:51


About Ilanie Brits

Audit and Accounting Manager at Meredith Harington