Should you be investing in Bitcoin? Will it sustain its massive gains? Is it safe to invest in it?

A lot of people have become curious about Bitcoin again since its perceived value is near historic highs the past month.

What is Bitcoin?

Bitcoin is a cryptocurrency. Other popular cryptocurrencies include Bitcoin Cash, Litecoin, Ethereum, Binance Coin, Tron, and many others. They have their own exchange rates and places where they can be traded or purchased.

The controversial cryptocurrency mysteriously came into being as an invention or “gift” from Satoshi Nakamoto, who released white papers detailing the rules of Bitcoin. However, the individual or institution known by that presumed alias has not come forward to claim credit and to this day remains anonymous.

To put the origin of cryptocurrencies into context, the 2008 global financial crisis revealed the ugly truth about our imperfect banking system – oppressive and inaccessible to the poor. Many noted that only the rich benefit from the banking system.

The average person receives cents when they make deposits into the bank, and the only people who have the ability to access those funds are the rich. Traditional banking system is intrinsically capitalistic — favors profit that benefit the top 1% of society.

This gave rise to cryptocurrencies that attempt to challenge the current banking system. They were established to address inequities in favor of a secure, democratic and efficient financial system.

Crypto versus fiat

When we refer to cryptocurrency, this is only one type of money. Currencies like coins and paper money, also called fiat currencies, are printed by the central bank of each country. These central banks create the rules for using their currency.

For the Philippines, the central bank is the Bangko Sentral ng Pilipinas (BSP).  Other countries have their own versions and rules, such as the Federal Reserve in the United States; Reserve Bank of India; and the European Central Bank among others.

How does money gain value?

For example, the PhP100 bill costs about PhP3 to print, so why is it worth PhP100? That value is what we as a society have agreed on and trust to hold its value. We further trust that value because it was issued by the government and serves as its legal tender. It guarantees that the value of bills and coins are its face value rather than the amount spent to print it.

Role of central banks

Central banks determine how much money is in circulation and decides when to print and how many. All global currencies are guaranteed by their government as legal tender.

Because money issued by the government is guaranteed by the government, typically countries with stronger economies have more trusted central banks and have stronger currency value. Countries like Japan, Korea, U.S.A, as well as the United Kingdom, which are more developed, have “hard currencies.” In comparison, the Philippine Peso is not as strong (“soft currency”).

Central banks seek to stabilize the value of their currency. BSP doesn’t want the value of the Philippine Peso to be too volatile in either direction.

During the Asian financial crisis, the value of the peso devalued. The peso lost 45% and was devalued against the US dollar. It fell from PhP24.5 to PhP35.61 in a matter of two months. The worth of the money was essentially halved.

To avoid such volatility, central banks intervene in the market. They buy or sell currency in order to adjust the supply of money, which stabilizes exchange rates.

No central bank regulates Bitcoin

On the other hand, cryptocurrencies are decentralized. There is no governing body that regulates its prices and enforces its rules.

Cryptocurrencies are bought in peer-to-peer networks or exchanged. Theoretically, anybody could establish a digital currency so long as they have a peer-to-peer network. But whether or not the currency is trusted is another issue. The value of cryptocurrencies is agreed upon by those participating in the market.

The peer-to-peer network of cryptocurrencies is very similar to the Philippine Stock Exchange, or the stock market. There is a network specific to facilitating the exchange and purchase of each cryptocurrency.

Need for stability in Bitcoin

Rapid devaluation of currencies are avoided to establish trust and integrity among market players in the economy. Gradual increase and decrease in the value of a currency is preferred over wild swings which is a typical characteristic of cryptocurrencies.

Until Bitcoin reaches the trust level that would make it stable and immune to wild swings, its commercial use will be very limited. This will make it stuck as a speculative asset class that would go against its aim create a secure, democratic and efficient alternative financial system.