Bitcoin - bubble, bubble toil and trouble.

To misquote Shakespeare... It seems bitcoin is flavour of the month.

Lots of articles about bitcoin are appearing and our clients are asking about it. Not yet the topic of taxi-driver conversations but that won't be too far away.

A bit of history - bitcoin was first used commercially to buy two pizzas in Florida for 10,000 bitcoins in 2010. This is the equivalent of about NZ$165 million at today's exchange rate. Just imagine, if he had not bought those pizzas and had kept his bitcoin he would be NZ$165 million richer today.

No-one knows who invented bitcoin. There is a name attached to its inventor, Satoshi Nakamoto, but no-one has ever seen him/her, and it is likely to be a nom de plume. The software was released to the public in 2009.

But what exactly is bitcoin? Bitcoin is a worldwide payment system that transcends borders. We are familiar with New Zealand dollars, Australian dollars, US dollars, Euro. These currencies are controlled by the central banks in each country and that is where bitcoin is different. Bitcoin is outside the control of any country or central bank. It is hosted on a large number of computers on the world wide web without any governmental oversight.

If I want to pay for some books I've bought over the internet from Book Depository in the UK, they want to be paid in Pounds whereas I have NZ dollars. I must go to a New Zealand bank and exchange NZ dollars for pounds and accept the exchange rate they give me on the day and pay in pounds. If I had bitcoin, I could deal with Book Depository directly, what they call, peer to peer, and not have to deal with any bank or intermediary to exchange my New Zealand dollars.

As well as legitimate uses of bitcoin, there is a dark side. Bitcoin can be used for evading taxes or by criminals for keeping their ill-gotten gains private and out of the reach of 'prying eyes'. All transactions are encrypted, that is, turned into a code that only the two sides making the transaction can understand. This makes bitcoin a favourite of the criminal world.

How is the value of a bitcoin established? You may have heard of the huge gains in value of a bitcoin recently. What is driving its price upwards?

It is true that there is very little behind a bitcoin; just software, lists of who owns the bitcoins, lots of computers and smart people driving them. What they might call intellectual capital. So that is not the source of the upward pressure on bitcoin prices. The value of a bitcoin on any day is actually determined by its scarcity (how many there are available) and the desire of people to own it. That is all. Just supply and demand. Today, the demand for bitcoins is greater than the ability of the market to supply them, so the price is going up.

I see bitcoin quoted at NZ$16,526 as of yesterday. At the beginning of the year it was trading at around NZ$1,000. What does that tell us other that it is a rocket ship!

People are buying bitcoin for speculative reasons, not as a currency they expect to use for buying things. It is the same as buying US dollars in the expectation of the US dollar rising in the future and making a currency gain. That too would be speculative, but no where as risky as buying bitcoin.

For some people, there is a real fear of missing out on the bitcoin craze. Beware the hype. Bitcoin is in classic bubble territory the like we haven't seen for many years. For a bit of fun, maybe, but not with your hard-earned nest egg set aside for your retirement.

Keep asking great questions ...