The bitcoin currency was created in the midst of the financial crisis of 2008-2009, as an experiment and political statement against the global government and central banks’ ability to manage monetary policy. Bitcoin is a digital currency based on an open-source, peer-to-peer internet communications protocol. The goal of the system was to create a private global traded currency without the need for third parties to guarantee transactions. The backbone of the bitcoin system is the decentralized blockchain, or the public register of all transactions that are verified by the network. The reason for the blockchain is to prevent the problem of “double spending” that past attempts at pure digital currencies failed. Additionally, the blockchain of the system controls the money supply of bitcoins, which are rewarded to “miners” or individuals who use their computers to verify transactions on the network, while they attempt to solve a time-extensive math algorithm that is hard to find a solution to, but once found is very easily verified (computer speak known as “hashing”). A mine who finds a solution to the algorithm creates the next block in the blockchain, which is verified by the network as a “true” solution to the algorithm. From then, that block records transactions for the time period until the next block is found, which at the current difficulty of the network is about 10 minutes. For finding a verified block, the miner is awarded a set amount of BTC or bitcoins (currently 25), which decreases over time, until all 22 million bitcoins are mined.
Figure 1. Expected total quantity of Bitcoins over time (2009-2033), measured in millions. Source: Blockchain.info
Another more economical characteristic of bitcoin is the ability to transfer large amounts of currency anonymously over the internet to anyone in the world instantaneously, and without fees from a middleman or third party such as Money Gram or Western Union.
Due to all the characteristics of bitcoins, investors and consumers have found value in this digital currency as store of value similar to gold or silver. The currency is traded worldwide 24/7 on various exchanges on the internet. The largest exchange with over 80% of all bitcoin trading, mtgox.com, allows investors to trade bitcoins in over 16 different currencies including USD, EUR, and JPY. Additionally, the currency has seen tremendous growth since it began trading on mtgox.com in July 2010. Bitcoin began trading at $.03 USD/BTC in early July 2010 and now (April 4th, 2013) currently trades around $143 USD/BTC. However, many financial advisors and economists’ criticize bitcoins as being in another “bubble” considering the currency adoption rate in commerce and trade has not justified the high price. During the summer of 2011, bitcoin’s price plummeted from a peak of $29.57 on 9th June 2011 to a price of under $4.
The underline purpose of this study is to use empirical analysis to find out if...