The reality behind the bitcoin bubble

Bitcoin is not issued or controlled by the government, making it attractive to some consumers. Photo / 123RF

David Larkin pays all of his bills in bitcoin.

The 32-year-old Melbourne IT worker is a true believer in the cryptocurrency and its potential to revolutionise the world of banking and finance.

But unlike buy-and-hold speculators and early adopters, many of whom have become astronomically wealthy holding onto their stash as the price skyrockets, Mr Larkin prefers to use bitcoin for its intended purpose.

"I don't have to," he said. "I choose to make a point that bitcoin has real-world application — you can do things with it."

Melbourne IT worker David Larkin is a bitcoin believer. Photo / Supplied

According to Mr Larkin, who also used bitcoin to purchase a computer which he now uses to "mine" cryptocurrency Ethereum, there are two types of bitcoin enthusiasts: the "get-rich-quick" crowd who "hold on for dear life" and just want to make a profit, and the "true bitcoiners" who see its future value.

"I'm more into the technology behind it and the way it works," he said. "People like us believe in the technology going forward. If people want to get rich off bitcoin they can, that's their choice. [But] it's not intended for that. That's why the creator [Satoshi Nakamoto] is still a mystery."

The price of bitcoin has increased by more than 700 per cent since the start of the year, hitting a fresh record high of $US8200 on Monday. Bitcoin's market capitalisation — the price multiplied by the number of bitcoins in circulation — now sits at more than US$135 billion, according to Coinmarketcap.

That has led to increasing warnings of a bitcoin "bubble", with many commentators likening the craze to the dotcom boom of the late '90s.

AMP Capital chief economist Dr Shane Oliver this week warned that "every generation gets sucked in" to an investing craze like bitcoin, which Japan Post Bank chief investment officer Katsunori Sago has described as "worse than the IT bubble".

Mr Sago based that assessment on the fact that he "hardly [knows] anyone in person who is trading crypto-currencies" and he hasn't "seen anyone using them in real life".

Mr Larkin said he found that reasoning "offensive". "The problem bitcoin users have with the stuff coming out is that all the people that doubt it — people who are saying that this growth isn't sustainable, it's a Ponzi scheme — are bankers, financiers, traders," he said.

"I've witnessed over the last couple of months houses being sold for bitcoin, cars being sold, Microsoft is accepting bitcoin as payment for its products. These things are becoming real-world applications very, very fast."

Mr Larkin pays his bills in bitcoin through a website called Living Room of Satoshi, a Brisbane-based start-up founded in 2014 which allows people to easily make BPAY, credit card or direct bank account payments using 11 different cryptocurrencies.

Its chief executive, Daniel Alexiuc, said the site was now processing about $1 million a week in small bills for things like rent payments and electricity. "A lot of the media attention has focused on bitcoin's increasing value because it just had to happen," he said.

"It's different to other currencies in that there's a fixed amount of it, not like gold or fiat currency ... so it's always going to have that inflationary aspect, rather than the deflationary aspect."

So is bitcoin a currency for buying your coffee, a payment system to beat the banks, or something to hoard in the hope of a massive payout?

As Jeffrey Tucker from the Foundation for Economic Education explains, "bitcoin is both a payment system and a money". "The payment system is the source of value, while the accounting unit merely expresses that value in terms of price," he writes.

"The unity of money and payment is its most unusual feature, and the one that most commentators have had trouble wrapping their heads around.

"[The] value proposition of bitcoin is bound up with its attached payment network ... It is not embedded in the currency unit but rather in the brilliant and innovative payment system on which bitcoin lives.

"If it were possible for the blockchain to be somehow separated from bitcoin (and, really, this is not possible), the value of the currency would instantly fall to zero."

Mr Alexiuc said it was "impossible to tell" where it would end up. "It is useful as a payment system, also as a currency, and also as a store of value," he said.

"It's a better form of currency, in my opinion, because it's not issued or controlled by the government. It can't be shut down, it can be sent cross-border without anyone's permission. A lot of people are attracted to that."

But he admitted that "when it comes to day-to-day usage, it's still very early". "I pay my employees in it," he said. "We're still trying to demonstrate its usefulness. $1 million sounds like a lot but compared to how many bills get paid in Australia every day it's a drop in the bucket."

According to Jordan Eliseo, chief economist with precious metals investment firm ABC Bullion, many bitcoin enthusiasts were "mistaking the pipeline for the oil". "Yes, you can use bitcoin to pay for things in a small and limited set of circumstances, but there are a couple of points to make," he said.

"The first is that unquestionably the vast majority of users of bitcoin today are not really purchasing it in the hope of using it in day-to-day commerce — they're purchasing it in the hope of making a profit in denominated fiat currency.

"There's nothing wrong with that. People who buy shares or gold are looking to make a profit as well, but we should be very clear that the vast majority of use of bitcoin today is speculation on rising prices."

Mr Eliseo said he had "some sympathy" with bitcoin's supporters. "They are right to say there are some flaws in the monetary and banking system, people are right to be concerned," he said. "I see bitcoin as the wrong answer to the right question."

He added that "just because more and more merchants are using bitcoin as a means of payment, it doesn't mean it's becoming money in itself".

"The vast majority of those merchants are not taking payment in bitcoin," he said. "They are using a payment facilitator to convert bitcoin to the currency the merchant wants. It's not any more exciting than being able to use a credit card or Apple Pay."

Mr Eliseo said while bitcoin was an exciting technology, it "falls very short" of the characteristics of what is required for money to work.

"First and foremost is the issue of consistency," he said. "The reason we're all happy taking dollars in wages, or a merchant is happy taking dollars when we go and buy our coffee and groceries, is a $20 note is a $20 note is a $20 note.

"Whereas with bitcoin, there are already three different versions [including Bitcoin Cash and Bitcoin Gold], all of which display different performance and development characteristics. If you were to apply that to a monetary system used in day-to-day commerce it would create chaos.

"There is a big difference between your local barista saying you can tap with your bitcoin card to buy a coffee, versus the barista actually having to price the coffee they sell in one of the three bitcoin currencies."

That issue of consistency — and volatility — is really at the heart of the Catch-22 facing bitcoin at the moment. Its proponents point to the rapid price increase as validation of the technology and proof of its value as a payment system.

But what good is a currency that's too valuable to spend?

Say, for example, you paid a $400 electricity bill with bitcoin back in May 2014 when Living Room of Satoshi launched. Those same bitcoins today would be worth more than $7000 if you had simply held onto them and paid your bill in regular Aussie dollars.

"That doesn't bother me," said Mr Larkin. "Not in the slightest. For me it's a revolutionary thing. I spend regularly and I'm happy to, because in my opinion that's what keeps the market going."