For the first time since the mysterious Satoshi Nakamoto created Bitcoin in 2009, a major Wall Street bank has issued an opinion on the cryptocurrency--Bank of America is betting on Bitcoin's legitimacy, according to a report released today.
Bank of America Merrill Lynch claims Bitcoin may "emerge as a serious competitor" to cash in e-commerce and digital money transfers.
The decentralized, peer-to-peer network, does not require a central clearinghouse or financial institution to clear transactions. All Bitcoin users need is an Internet connection and Bitcoin software to make payments to another public account.
But will it become an internationally-recognized currency? In order to so, Bank of America says Bitcoin needs to become a "major player" in both e-commerce transactions and money transfers, and maintain an exchange value "close to silver." Bank of America says their analysis estimates Bitcoin's worth to be a maximum of $1,300.
But, considering it flew up to $1,242 the day after Thanksgiving (passing the value of an ounce of gold and hitting a peak of 9,000 percent gain for the year), it is at a risk of "running ahead of its fundamentals," Bank of America reports.
Below, read the report's findings on Bitcoin's advantages and disadvantages.
Low transaction costs.
As Bitcoin is a peer-to-peer network, where transactions are verified by independent "miners" (who are rewarded with newly minted Bitcoins for their work), there is no need for a central clearinghouse or financial institution to act as a third-party to financial transactions. This means Bitcoin carries a very low transaction cost. By bypassing financial institutions, Bitcoin offers users a new and theoretically cheaper electronic payment method.
Transparency and security.
Although Bitcoin has a close anonymity to cash, every transaction is recorded on a public ledger. This makes Bitcoin easier to track than cash, the report says, since each digital coin contains an electronic record of every transaction it has gone through since it was mined. The public ledger and each Bitcoin activity record offers "a level of transparency that is not available with cash," the report says. "Having a full history publicly available guarantees that a buyer actually owns the number of Bitcoins he or she wants to spend, preventing fraud," the report says.
Bitcoin supply mimics gold.
Bitcoin was designed to have a finite supply in the world, like that of gold. This protects its value from governments and banks. As it was designed, the smallest unit of Bitcoin--1 Bitcoin--contains 100 million Satoshi. As of right now, the current supply is 12 million Bitcoins. The market cap for Bitcoin is 21 million Bitcoins--which Bank of America measures as just 57 percent of its eventual total. As more people "mine" Bitcoins, or solve the mathematical equations, more will become unlocked and flow into the market.
Limited anonymity in the black market.
Although sites like Silk Road--which sells anything from heroin to guns on an eBay-like platform that only accepts Bitcoin--have helped tarnish its already murky reputation, BOA says it is not a perfect currency for criminals. "[The] fact that all Bitcoin transactions are publicly available and that every Bitcoin has a unique transaction history that cannot be altered may ultimately limit its use in the black market/underworld," the report states.
Bitcoin's volatility is one of its main disadvantages--making people believe it's just another Tulip Mania of technological proportions. "Bitcoin's role as a store of value can compromise its viability as a medium of exchange. Its high volatility, a result of speculative activities, is hindering its general acceptance as a means of payments for online commerce," the report says.
A big downside for businesses is the fact that its value fluctuates every day, which means your business is "effectively internalizing the costs of its volatility" if you do not give change in Bitcoin, the report says. In August, it was at $100. Today it is just above $900. If your business accepts Bitcoin, you can lose or gain money depending on the day. When online illicit drug marketplace Silk Road's first version was shut down by the FBI in October 2013, Bitcoin's price plummeted 15 percent. But after the positive Senate hearing, it rose 50 percent. But, Bank of America says it should get more stable after it is more widely accepted.
Hackers steal Bitcoins.
Bitcoin exchanges, like BTC China, OkCoin, and Mt. Gox are required for converting traditional money into Bitcoin. This does pose a risk, for users are transferring their money from their bank accounts to third-party accounts, which are not protected by the FDIC. Users' Bitcoin wallets are in "start-up exchanges" in China and elsewhere, which are often targeted by hackers, Bank of America says. There is also risk of the exchanges just stealing the money before it is converted into Bitcoin. The risks are great, especially if your business is heavily involved in the trading of Bitcoins. Your wallet could get hacked, or even worse the exchange you use. The Bitcoinica exchange's and BIPS exchange's systems were both hacked recently and lost $16,230,000 and $1,135,000, respectively.
Bitcoin is not a legal tender.
Another big obstacle to Bitcoin's international acceptance is the fact that it is not a legal tender. "Unlike fiat money, nobody is under any obligation to accept Bitcoins as a means of payment," Bank of America says. "Therefore, its value is only as good as the perception of its worth by its users." Just like in the 1600s, when all of a sudden the price of tulips crashed, Bitcoin could suffer the same scenario. Concurrent with repeated cyber attacks and volatility that make users lose money, a perception that Bitcoin is worthless could pop the bubble.
The risk of government regulation.
Bank of America says it is unlikely that the government will promote a new currency, especially one as suspect as Bitcoin. As the U.S. government is trying to figure out where Bitcoin fits into its tax and payment system, regulation of any kind would increase its transaction costs--offsetting one of its major benefits.