3 reasons why a falling Bitcoin price is good news for virtual currencies

 

In the context of the dramatic price changes faced by Bitcoin in recent weeks, Dr. Neeraj Oak explains why it isn’t all bad news for the supporters of virtual currencies.

With the price of Bitcoin continuing to fall from the dizzying peak of over $1100 in December 2013 to a current value of around $300, it is easy to assume that this is a very bad thing for the virtual currency community. In reality, it might actually be a blessing in disguise. Here are three reasons why:

 

Reason #1: High prices dissuade new users

The operating model of any virtual currency is to grow its user base to become as widely accepted as possible. However, if the price of the currency is too high, this can become a psychological barrier to new adopters, who may feel that they do not get a good deal when they exchange fiat money for Bitcoin. This is especially true when one considers that the price of Bitcoin in September 2014 was around 100 times greater than its price in January 2012. New users may find it unsatisfying to pay such a high price for a commodity that was so recently considerably cheaper.

A lower price for Bitcoin is helpful in this respect, but what is even more important is that the price becomes stable. This does not mean a stagnant price, but rather one that has a relatively predictable trend. Volatility and uncertainty are not attractive features for new adopters.

 

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Figure 1: Bitcoin prices (USD) since December 2012

 

Reason #2: Reducing the dominance of Bitcoin encourages the growth of newer virtual currencies

The price of Bitcoin towers above all the major alternative virtual currencies in the market today. A high price often brings the added advantage of greater visibility and prestige for the currency, making potential investors and adopters sit up and take notice. One of the problems of the dominance of Bitcoin is that many of the newer, smaller virtual currencies have struggled to find the limelight. With the price of Bitcoin falling, opportunities may appear for these currencies to garner more attention. Ultimately, this is beneficial for the virtual currency community; these alternative virtual currencies tend to be at the forefront of innovation in the field, and increasing their profile will help to spread ideas that could improve the prospects of all virtual currencies.

 

Reason #3: Deflation encourages speculation

Throughout the meteoric rise of Bitcoin stories have spread of the enormous fortunes made by early adopters. So long as the price of Bitcoin continued to increase, the idea that such price rises were somehow systemic became almost credible. When investors believe that the price of a commodity is bound to rise, they will often pay over the odds to acquire it, raising the price further. On the other hand, people using Bitcoin as a transaction method would be at a disadvantage, since the prices of goods and services that can be bought using Bitcoin often lag behind the headline Bitcoin price.

The result of sustained increases in Bitcoin prices is that it becomes a speculative vehicle rather than a transaction vehicle. This crowds out the true value makers in the currency: the consumers and merchants. Without these two groups of Bitcoin users, it is hard to conceive of a sustainable business model for Bitcoin- it would merely be a speculative bubble.

The recent fall in Bitcoin prices will do a lot to dispel the myth that short-term investments in Bitcoin are bound to pay off because it is a deflationary currency. With luck, this will help to drive away the types of speculators who drive the notorious volatility of Bitcoin prices.

To summarise, the recent fall in Bitcoin prices may have been painful for many of its users, but may help to create a healthier, more sustainable virtual currency. The Altcoin community too should take note; this could be their chance to assume the leadership position in the rapidly changing virtual currency domain.

 

Dr. Neeraj Oak, Chief Analyst, Shift Thought 

Author of Virtual Currencies – From Secrecy  to Safety, co-author The Digital Money Game

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Security is not safety

Dr Neeraj Oak explains the first of the three themes of the new book: “Virtual Currencies- From Secrecy to Safety”. In this post, he covers the ideas of secrecy and safety, and considers why they may not be able to coexist.

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It’s often said by proponents of cryptocurrencies that the design of such systems makes them safe to use. Is this really true?

It’s easy to confuse the idea of a secure system with that of a safe one. In reality, these terms mean very different things. A secure system is one that is locally resilient to errors or malicious attack. A safe system is a much more all-encompassing idea, describing an environment in which users can make payments with confidence, knowing that their money and personal information cannot be stolen, leaked or lost.

To illustrate the difference between security and safety, I like to use the example of putting a padlock on a live bomb. A padlock is a security device; it stops people from tampering with whatever object it is attached to, protecting it from potential attackers. But does it make the bomb any safer? Perhaps a little, since someone trying to set off the bomb may have a little more trouble doing so. However, the bomb still remains as dangerous as it was before; if it were to go off, it would cause no less damage.

How does this analogy fit with the cryptocurrencies on today’s markets? I’d agree that the security features are impressive, indeed many of the methods they use are ahead of their time. But safety has still eluded many cryptocurrencies, as several incidents ([1],[2],[3]) in the past years have shown. The problem is that while the security provided by cryptography and the blockchain is strong, attackers find it easy to bypass these by targeting individual users.

Attacks on users include phishing, communications exploits, keylogging and mining clipboards and computer data. These types of attack predate cryptocurrencies and are often used against services like online banking. The difference is that centralised organisations banks will often take responsibility for flaws in their security systems and go to a great deal of effort to ensure customers are kept safe. This could include providing memorable information, tying online banking to email or telephone banking to force attackers to break two levels of security or using physical devices such as card readers to verify transactions. In a decentralised system like Bitcoin, there is currently no provision of such features, nor is there likely to be one in the near future.

Beyond the means of attacking users, the consequences of attacks are also reduced in cryptocurrencies. Anonymity means that attackers find it easier to hide their true identity, giving them safe havens to store stolen funds. Further, transactions cannot be reversed without the explicit consent of both parties, so once a user has lost money to a thief or scammer, there really is no way of getting it back. In the case of online banking, there may be some means of halting transactions or compensating users. This is not the case in many of today’s generation of decentralised virtual currencies.

While there is certainly a vulnerability in the safety aspect of virtual currencies at the moment, this need not always be the case. Allowing anonymity or secrecy is a choice that many of these virtual currencies make, and is not intrinsic to their operation. Anonymity has been one of the most attractive features to the early adopters of cryptocurrencies such as Bitcoin, but it is not the only reason to use such technologies. Decentralised cryptocurrencies could potentially be faster, cheaper, more accessible and more convenient than centralised payment services. Abandoning anonymity could be a drastic step in the eyes of many current users of cryptocurrencies, but if it has a positive effect on the safety of the system, then it is a step that both current and future cryptocurrencies should consider.

Join me for the next post, in which I look at the consequences of trading secrecy for safety and the importance of attracting mainstream users to cryptocurrencies, which are still considered by many to be a fringe movement.

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Why we wrote “Virtual Currencies- from Secrecy to Safety”

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Virtual currencies have been grabbing headlines since the release of Bitcoin in 2008/9, and not always for the right reasons. Like any new technology, virtual currencies offer an equal share of promise and danger, creating opportunities for those locked out of today’s financial services and threatening to bypass incumbents.

In my role as Chief Analyst at UK-based consultancy Shift Thought, I have often been faced with questions from our clients about virtual currencies, such as: “How do they work?”, “What do they mean for my business?” and “How will they change the economy of my country?”, “Should I be worried”, “Where are virtual currencies headed” and “What are the regulatory implications”.

As a mathematician, scientist and engineer, I have come to depend on the availability of reliable books as a means of quickly getting a grasp of a new field. However, in the field of virtual currencies, I struggled to find reliable resources and this led to our efforts into building such a resource ourselves. There is a lot of raw information out there, but it is often hidden away in white papers and government studies. Some of the information also seems biased. Virtual currencies seem to have a way of encouraging fanatical loyalty or extreme loathing. Considering the disruptive potential of virtual currencies, it is critical to have some form of unbiased, comprehensive guide in order to rapidly understand the opportunities and challenges they represent.

At Shift Thought we research how people pay in each part of the world, and how this is changing. Utilising the architectures and proprietary technologies created by our founder Dr. Raju Oak, we have been able to create a constantly updated picture to inform the Digital Money Game described in the first book in the Digital Money Series.

In this second book, we wanted to create a guide for readers who are interested in understanding the multiple facets of virtual currencies, and a vision of where the virtual currency market is going, and how best to profit from its trajectory. If you work in financial services, telecoms or retail, this book will help to inform strategy with respect to virtual currencies. If you are a merchant or consumer, we hope that you will discover any potential advantages virtual currencies now offer. More importantly you should be able to understand the How and Why and also see potential risks from dealing with them.

We address questions from a wide cross-section of interest groups and perspectives. Dealing with the opportunities and challenges that virtual currencies represent will be crucial to the world economy. Providing a clear picture to those outside the virtual currencies community is vital in informing balanced decisions in the years to come. We wanted to create an easily accessible resource for young entrepreneurs and innovators around the world to explore this exciting space.

Our book Virtual Currencies - From Secrecy to Safety is available at Amazon sites across the world. You do not need to buy a kindle device as Amazon provides a free Kindle app for the PC as well as tablets and mobile devices. Do register at our Shift Thought portal to get access to more content and join us in The Digital Money Group on LinkedIn.

Join me for the next three posts, where I plan to cover some of the major themes of our book: The move from secrecy to safety, the importance of the mainstream user and the implications of decentralisation.

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