Will Bitcoin Remain The Gold Standard For Cryptocurrencies?

With Bitcoin gaining popularity and then some semblance of stability in its real-world value, will the cryptocurrency remain in the lead amongst other digital tender?

Virtual currencies are not exactly new. While purely digital currencies like Bitcoin are often the subject of news today, technology startups have explored virtual currencies as early as the 1990s. Take for example, which launched a currency called “Beenz” meant for earning loyalty points and paying online. After raising $100 million in VC funding, the startup failed to gain traction and eventually folded in 2001. Even virtual currencies used in multi-player online games do hold real-world value in terms of their purchasing power for both virtual and even physical goods.

For the longest time, however, digital payment services that rely on real-world or fiat currencies have dominated. PayPal was already on the rise in 2001 when eBay acquired the payment service and integrated it as the payment method for auctions. PayPal now processes at least US$ 55.05 billion in transactions per quarter, mostly involving credit card transactions and money drawn from bank accounts.

There is another trend on the rise, which involves cryptocurrencies. Currencies like Bitcoin and Litecoin differ from more traditional payment services in the method of recording and validating transactions. Unlike payment gateways that process transactions through a central exchange, cryptocurrencies rely on a distributed blockchain where everyone can essentially track transactions, but with parties having a certain level of anonymity. The peer-to-peer nature reduces the cost of transactions, which are supposedly faster. This also ensures verifiability of the transaction, although not necessarily traceable to the identity of the parties involved.

Currency vs. commodity

One big question today is whether cryptocurrencies are to be considered as currencies or whether it is more proper to value these as tradeable assets or commodities. Bitcoin, for example, may be considered good as cash because of its anonymity and the direct peer-to-peer nature of transactions. This makes it akin to paying with money, but without the involvement of central banks. However, some would argue that cryptocurrencies are more of commodity rather than money, in that it can be traded for its value, but not as cash equivalents. This has been a contention among regulators, tax authorities, entrepreneurs and users. Such arguments will shape the sentiment on currencies like Bitcoin and Litecoin in the foreseeable future.

In fact, value — or speculation thereof — has been one big factor that as led to increased cryptocurrency use. Since its launch in 2009, the value of Bitcoin has risen from a low of almost nil to a high of US$1,135:BTC, although the value has seen several crashes, which would usually correspond to major events such as the seizure of deep web service Silk Road’s assets and bitcoins, as well as China’s ban on exchanging bitcoins for fiat money.

Will Bitcoin remain in the lead?

To date, Bitcoin is the most popular cryptocurrency, and it has spawned a big industry around it, both among hardware companies and software-based startups. Because bitcoins can essentially be created through algorithm, chipmakers like Nvidia, Intel and AMD have launched product lines specifically meant for mining coins, which will usually involve high-powered calculations that rely on both CPU and GPU power. And given the need to facilitate transactions and exchange of funds, digital wallet startups have opened shop to keep users’ coins safe through online and mobile-based wallets. We now also see the trend among brick-and-mortar stores accepting bitcoins. Some startups have partnered with banks to launch Bitcoin ATMs.

The real test in determining whether cryptocurrencies will remain relevant is, of course time. Analysts have actually plotted the value of several popular cryptocurrencies against each other and against a fiat currency standard (the US dollar) using regression analysis to determine whether Bitcoin, as the leader in the field, will remain to be the dominant digital currency, with respect to value against the US dollar and value against other similar digital currencies.

The result is quite interesting in that being a first mover, Bitcoin is seen as enjoying a winner-take-all effect early in the market. However, as the market for cryptocurrencies matures, other currencies — called “altcoins” — gain an advantage in value over Bitcoin. The dynamics that play a big part here involve a so-called substitution effect, in which the introduction of alternative cryptocurrencies is made mainly as a balancing force to counter the rise of the first-mover, the value of which is seen as quite volatile. In short, the market deems Bitcoin not necessarily as a cash equivalent, but rather a financial instrument whose value is tied deeply with supply and demand, or the perception thereof.

Given this fundamental concern over Bitcoin’s long-term value, does it mean that it is not a good investment, per se? Perhaps for early adopters, the gamble may have paid off. Seeing the value of one Bitcoin rise up from a dollar to $476 in five years (even breaching $1,000 in mid 2013) is not bad at all. While the value has plateaued and somewhat stabilized in the $400-$500 range for a considerable time now, it may not make for sound long-term investment. Even Citibank says that the high volume of transactions and increasing merchant support is pushing the value of Bitcoin down. Perhaps the longer-term effect is that Bitcoin will turn out to become closer to a fiat currency rather than commodity, after all.