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BITCOIN: REAL CURRENCY OR SPECULATIVE INVESTMENT?
There's a lot of hype around Bitcoin as well as uncertainty about its viability as an investment. Find out what our currency managers think.
By Luc de la Durantaye, Managing Director, Asset Allocation and Currency Management, CIBC Asset Management
Bitcoin: A type of digital currency in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds, operating independently of a central bank.1
Bitcoin is a cryptocurrency that uses a blockchain to record and verify transactions.
Think of a blockchain as a database or a digital accounting ledger. The Bitcoin software was released in early 2009 by a mysterious creator who went by the name of Satoshi Nakamoto.
A blockchain is decentralized and works on a peer-to-peer framework, without central control or government authority. Once a transaction is recorded, it’s almost impossible to retroactively delete or change it.
Let’s put aside for the moment many of the practical questions that come up when Bitcoin is discussed such as:
- Where do new Bitcoins come from?
- Where do I buy Bitcoin?
- Can I lose Bitcoin or have it stolen?
- Can Bitcoin be counterfeited?
- What can I buy with Bitcoin?
This is a complicated but topical subject. As currency managers, here are some of our initial thoughts on Bitcoin.
When assessing Bitcoin’s potential as a currency, it’s useful to remember some of the traditional roles that currencies play:
Store of Value: Bitcoin has a very short history. This makes it difficult to assess the soundness of its architecture or its ability to act as a store of value in the longer term — it hasn’t really been tested. Although it has gained a lot of ground since inception and soared in the past few months, Bitcoin remains full of risks. Theoretically, anyone could launch a cryptocurrency or new technology that competes with Bitcoin and has the potential to make Bitcoin and/or blockchain obsolete. Other cryptocurrencies already exist (Ether, Monero and Bitcoin cash). However, Bitcoin remains the most popular choice for the moment. Sovereign states might try to prohibit the use of cryptocurrencies as a way to maintain their own monopoly on issuing fiat currencies2 and their privilege of seigniorage and the benefits that entails.
Means of Exchange: Bitcoin isn’t really being used as a means of exchange at this time. Unlike major currencies, the value of Bitcoin is extremely volatile (and therefore highly unpredictable). This makes it very risky to use as a store of value for the future purchase of goods and services. Although Bitcoin had an impressive rally in 2017, it also saw multiple 30%+ corrections. Bitcoin is so volatile that Fortune magazine recently published an article entitled “5 Big Bitcoin Crashes: What We Learned.” All 5 Bitcoin crashes discussed in the article have occurred since 2013! Until it’s more stable and its use is more convenient and widespread, Bitcoin won’t be seen as a reliable means of exchange. However, we have witnessed other disruptive technologies that have rapidly changed the landscape once they reach “critical mass” (e.g. the use of Uber as opposed to taking a taxi, streaming or downloading music versus the purchase of CDs).
Monetary Policy Instrument: Bitcoin isn’t issued by a government. It has no inflation or trade balance data or any other economic fundamentals associated with it on which to base a currency valuation. It’s difficult for anyone (including ourselves) to calculate a fair value and determine if the currency is cheap or expensive. Bitcoin holders do not receive interest payments and that makes it more expensive to hold relative to many currencies that do pay an interest rate. The difficulty in establishing a fair value for Bitcoin increases its pricing uncertainty and has led to the large price volatility observed since its creation. Because of its distinctiveness when compared to traditional currencies, Bitcoin doesn’t lend itself well to our investment process, which is fundamentally driven. However, the recent introduction by the Chicago Mercantile Exchange of a Bitcoin futures contract might help it gain more acceptance in the financial community. With a futures contract, banks can “bet” on the price of Bitcoin without holding the underlying Bitcoins. This may bring new or different players into the market who don’t want to deal with the complications of holding Bitcoins. But the futures contract will also allow investors to short Bitcoin (bet on the price going down); previously this was difficult to do. Some analysts think this could finally put downward pressure on the price. The biggest shortfall we can see with Bitcoin (or any of the other cryptocurrencies) is the lack of a large stable “guarantor.” Major fiat currencies, such as the U.S. or Canadian dollar, have a government behind them to back their use as the sole means of exchange for that country. Cryptocurrencies lack a major proponent that can be relied upon to sustain and expand their use as a means of exchange.
As currency managers, we’re staying on the sidelines for the moment, but will continue to assess the developments in the cryptocurrency world. At this point, Bitcoin seems to be more a speculative phenomenon than a real currency opportunity. However, we’re keeping an open mind. Disruptive forces continue to manifest in global politics, business, media and society as a whole. One year ago, the U.S. election proved that “the impossible” can happen. These are interesting times.
1 Oxford DictionariesOpens a new window in your browser
2 Fiat money is currency that a government has declared to be legal tender, but is not backed by a physical commodity. Examples of fiat currencies are the Canadian and U.S. dollars, euro, Japanese yen.