Is Bitcoin a currency, a technology-based product, or something else?

This article summary is part of my personal background research work.

Article Summary

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Keywords

• Bitcoin as a currency
• Technology diffusion
• Financial bubbles
• Asset class analysis
• Regulatory implications
• Technology-based product
• Cryptocurrency regulation
• Speculative investments
• Economic valuation models
• Blockchain technology

Short summary

The paper by White, Marinakis, Islam, and Walsh (2020) seeks to classify Bitcoin, examining whether it functions as a currency, a technology-based product, or something else. Through an exploratory analysis, the authors employ multiple methods to compare Bitcoin’s behavior to various instruments, including currencies, derivatives, technology-based products, and speculative financial bubbles. The study finds that Bitcoin’s behavior aligns more closely with a technology-based product or a speculative bubble rather than a currency. This classification has significant regulatory implications, as existing currency and security laws may not apply appropriately to Bitcoin.

Additionally, the research highlights Bitcoin’s volatility, speculative nature, and potential for being an emerging asset class, with comparisons drawn to historical financial bubbles. The diffusion patterns of Bitcoin are also analyzed using technology diffusion models, demonstrating that Bitcoin's growth follows a sigmoidal curve typical of technology adoption, rather than the diffusion patterns seen in traditional currencies. The paper concludes that Bitcoin, while sharing some characteristics with currencies and commodities, is fundamentally distinct and should be regulated as a unique financial and technological phenomenon.

Issues (Threats and Opportunities)

• Regulatory Uncertainty: The paper highlights the lack of consensus on how to regulate Bitcoin, posing a significant challenge for policymakers and investors. The unclear classification between currency, commodity, or security raises legal and compliance risks.
• Speculative Nature: The identification of Bitcoin as a speculative asset or bubble event suggests high volatility and potential for significant market corrections, which could lead to substantial financial losses for investors.
• Technology Diffusion: The study's comparison of Bitcoin's growth to technology-based products underscores its potential for widespread adoption, but also its susceptibility to rapid obsolescence or disruption by newer technologies.
• Market Volatility: Bitcoin’s correlation with derivative indices and its inverse relationship with major currencies indicate extreme market volatility, complicating its use as a stable investment vehicle or medium of exchange.
• Economic Valuation Challenges: The paper points to the difficulties in applying traditional economic valuation models to Bitcoin, which could undermine its perceived value and stability in the financial markets.
• Investment Opportunities: Despite the risks, the paper suggests that Bitcoin's unique risk-return profile makes it an attractive, though speculative, investment for certain portfolios, particularly those seeking high-risk, high-reward assets.
• Legal and Regulatory Gaps: The study implies that existing legal frameworks may be inadequate to address the unique characteristics of Bitcoin, necessitating new or revised regulations.
• Adoption Barriers: The paper discusses the significant hurdles to Bitcoin's adoption as a mainstream currency, particularly its failure as a unit of account and its limited use in everyday transactions.
• Technological Innovation: The classification of Bitcoin as a technology-based product opens up opportunities for innovation in related technologies, such as blockchain, but also highlights the need for continuous development to maintain relevance.
• Long-Term Viability: The comparison of Bitcoin to historical financial bubbles raises concerns about its long-term viability, with the potential for a dramatic price collapse if market enthusiasm wanes.

Methodology

The authors employ a multi-faceted methodology to analyze Bitcoin's classification. This includes correlating Bitcoin’s behavior with traditional currencies, asset classes, and technology diffusion patterns. They use statistical tools such as correlation matrices, Beta and Sharpe Ratios, and the Richards model to compare Bitcoin’s behavior to that of financial bubbles and technology-based products. The analysis draws on historical data from various financial instruments and employs diffusion models to understand Bitcoin’s growth patterns, ultimately aiming to determine its closest analog in the financial or technological spheres.

Results

The study reveals that Bitcoin does not behave like traditional currencies, as it fails to function effectively as a unit of account and exhibits a weak correlation with major currencies. Instead, Bitcoin's behavior is more akin to a technology-based product or an emerging speculative asset class, characterized by high volatility and significant market speculation. The correlation analysis shows that Bitcoin is strongly linked with derivative indices, suggesting that it is driven more by speculative investment behavior than by any intrinsic value as a currency.

Additionally, the study's application of the Richards model to Bitcoin's diffusion indicates that Bitcoin’s growth follows a sigmoidal curve typical of technology adoption, rather than the r-shaped curve seen in traditional currencies like the Euro. This finding supports the view that Bitcoin functions more like a technology product, with its adoption driven by innovation and speculative interest rather than by traditional economic factors.

Implications

Implications for Bitcoin Mining
The classification of Bitcoin as a technology-based product rather than a currency suggests that Bitcoin mining should be viewed not merely as a financial activity but as a technological process akin to resource extraction in the digital realm. This perspective could influence how regulations and policies surrounding Bitcoin mining are developed. For example, environmental concerns related to the energy-intensive nature of Bitcoin mining might be addressed through regulations similar to those applied to other technology-driven industries. Additionally, the speculative nature of Bitcoin highlighted in the paper could lead to increased scrutiny of mining operations, especially in regions where energy costs are subsidized, as these factors could contribute to market volatility.

Implications for Bitcoin Adoption
The study’s findings raise significant questions about Bitcoin's future adoption. As Bitcoin is more akin to a speculative asset or technology product, its widespread adoption as a stable currency remains uncertain. The high volatility and speculative behavior associated with Bitcoin could deter its use as a day-to-day medium of exchange, limiting its adoption to niche markets or specific use cases where volatility can be managed or mitigated. This could lead to Bitcoin being perceived more as an investment vehicle or a store of value, akin to commodities like gold, rather than a functional currency. The study also suggests that Bitcoin's adoption will likely continue to be driven by technology enthusiasts and speculators, rather than by mainstream consumers or businesses.

Implications for Bitcoin Use in Modern Society
The paper’s conclusions on Bitcoin’s classification have broader implications for its role in modern society. If Bitcoin is seen primarily as a speculative asset or a technology product, it may influence how it is integrated into financial systems and used by institutions. The potential for Bitcoin to disrupt traditional financial services is significant, but this disruption may be tempered by its speculative nature and the risks associated with its volatility. For policymakers and regulators, the challenge will be to develop frameworks that allow for innovation while protecting consumers and maintaining financial stability. Furthermore, the study's findings may lead to a more cautious approach to integrating Bitcoin into payment systems, as its reliability as a unit of account and medium of exchange remains questionable.

Research Questions

1. Regulatory Uncertainty
   • What specific legal frameworks would be most effective in regulating Bitcoin as a technology-based product rather than a currency?
   • How can policymakers create a flexible regulatory environment that adapts to the evolving nature of Bitcoin and other digital assets?
2. Speculative Nature
   • What are the key drivers of speculative behavior in Bitcoin markets, and how can they be mitigated?
   • How do speculative bubbles in Bitcoin compare to those in traditional financial markets, and what can be learned from these comparisons?
3. Technology Diffusion
   • What factors contribute to the rapid adoption of Bitcoin as a technology product, and how might these factors change over time?
   • How does the diffusion of Bitcoin compare to other historical technology adoptions, and what lessons can be drawn from these comparisons?
4. Market Volatility
   • What mechanisms can be implemented to reduce the volatility of Bitcoin in financial markets?
   • How does Bitcoin’s market volatility impact its potential as a stable investment vehicle or medium of exchange?
5. Economic Valuation Challenges
   • What new valuation models can be developed to better capture the unique characteristics of Bitcoin?
   • How can existing economic theories be adapted to account for the complexities of valuing digital assets like Bitcoin?
6. Investment Opportunities
   • What are the long-term investment prospects for Bitcoin, given its high-risk, high-reward profile?
   • How can investors better assess the risk and return potential of Bitcoin in a diversified portfolio?
7. Legal and Regulatory Gaps
   • What are the most significant gaps in current legal frameworks concerning Bitcoin, and how can they be addressed?
   • How can international cooperation be improved to create consistent regulations for Bitcoin across different jurisdictions?
8. Adoption Barriers
   • What are the primary barriers to widespread adoption of Bitcoin as a mainstream currency, and how can they be overcome?
   • How does the failure of Bitcoin to function as a unit of account impact its long-term adoption prospects?
9. Technological Innovation
   • What are the most promising areas for innovation in the Bitcoin ecosystem, and how can they be supported?
   • How can Bitcoin's classification as a technology-based product drive further advancements in blockchain technology?
10. Long-Term Viability
    • What factors could lead to a collapse in Bitcoin’s market value, and how can they be monitored?
    • How does the comparison of Bitcoin to historical financial bubbles inform our understanding of its long-term viability?
11. Volatility of Bitcoin:
    • How can central banks effectively manage the volatility of Bitcoin within their reserve portfolios?
    • What are the historical trends in Bitcoin volatility, and how do they compare to traditional reserve assets?
12. Potential Returns:
    • What are the long-term return prospects of including Bitcoin in central bank reserves?
    • How do the potential returns of Bitcoin compare to those of traditional reserve assets over different time horizons?
13. Regulatory Uncertainty:
    • What regulatory frameworks are most effective in integrating Bitcoin into central bank reserves?
    • How do different countries' regulatory approaches to Bitcoin impact their potential inclusion in international reserves?
14. Technological Risks:
    • What measures can central banks take to mitigate technological risks associated with Bitcointransactions?
    • How do cybersecurity threats impact the reliability of Bitcoin as reserve assets?
15. Adoption and Acceptance:
    • What factors influence the adoption of Bitcoinfor international transactions?
    • How does the increasing acceptance of Bitcoin in various sectors affect their suitability for reserve portfolios?
16. Liquidity Concerns:
    • How liquid is Bitcoin compared to traditional reserve assets?
    • What are the implications of Bitcoin liquidity issues for central bank reserve management?
17. Speculative Attacks:
    • How vulnerable are national currencies to speculative attacks if Bitcoin isincluded in reserves?
    • What strategies can central banks employ to defend against speculative attacks involving Bitcoin ?
18. Cost of Mining:
    • What are the cost-benefit implications of central banks engaging in Bitcoin mining?
    • How do the environmental and economic costs of mining Bitcoin compare to other methods of acquiring Bitcoin?
19. Blockchain Technology:
    • How can Blockchain technology improve the efficiency and security of central bank transactions?
    • What are the potential risks and benefits of using Blockchain for central bank operations?
20. Policy Implications:
    • What policy measures are necessary to support the inclusion of Bitcoin in central bank reserves?
    • How can central banks develop frameworks to balance the benefits and risks of Bitcoin investments?

Five Key Research Needs

1. What specific legal frameworks would be most effective in regulating Bitcoin as a technology-based product rather than a currency? Addressing the regulatory uncertainty surrounding Bitcoin is crucial for its long-term stability and integration into the global financial system. Developing clear and effective legal frameworks will help mitigate risks, protect investors, and encourage innovation in the digital asset space.
2. What are the key drivers of speculative behavior in Bitcoin markets, and how can they be mitigated? Given Bitcoin's high volatility and potential for speculative bubbles, it is important to understand the underlying factors driving speculative behavior. This knowledge could lead to the development of strategies and policies to stabilize the market and protect investors.
3. What new valuation models can be developed to better capture the unique characteristics of Bitcoin? Traditional valuation models are not well-suited to digital assets like Bitcoin. Developing new models that account for its unique characteristics will enhance the accuracy of market predictions, investment decisions, and risk assessments.
4. What mechanisms can be implemented to reduce the volatility of Bitcoin in financial markets? Reducing Bitcoin’s market volatility is essential for its adoption as a stable medium of exchange and a reliable investment vehicle. Understanding and implementing mechanisms to achieve this will increase Bitcoin's credibility and usability in financial markets.
5. What factors could lead to a collapse in Bitcoin’s market value, and how can they be monitored? Monitoring potential risks to Bitcoin's market value is vital for safeguarding investor interests and maintaining market stability. Learning from historical financial bubbles can help develop early warning systems and preventive measures to avert significant market disruptions.