The growing acceptance of the new electronic currency, Bitcoin, is threatening to disrupt and change the global financial system. Mark Thomas explains why investors and advisers need to understand this phenomenon.
The fierce opposition that the experimental digital currency Bitcoin has received since its introduction in 2009 is tantamount to the fear and skepticism that the internet encountered during the 1990s.
Of course the internet is now the technology network that links several billion private, public, business and government bodies every second of every day.
Bitcoin is the latest technology disruptor. It uses peer-to-peer payment technology with decentralised cryptography to facilitate anonymous virtual transactions.
It has been heralded as the way poorer, developing nations can get ahead in the financial sector because there are no middle men, meaning no banks and minimal transaction fees.
It’s a technology, currency and international network of exchange all in one.
Emerging economies have the most to gain from having a cost-effective and accessible foreign exchange system.
Bitcoin offers a peer-to-peer payment gateway which can facilitate transactions from anywhere to anywhere in parcels as small as $US1/100,000,000: that is, one hundred millionth of a dollar. Transactions as large as $150 million have also reportedly been made.
Recently China and the United States announced they were actively developing policy to manage behaviour in the Bitcoin market. This has added some clout to the previously dismissed new global currency.
In the US, Bitcoin is now categorised as property, making it obligatory for users to report on all capital gains.
Meanwhile, the Chinese government has suspended trading by several Bitcoin exchanges. These exchanges allow people to buy or sell Bitcoins using different currencies.
A key leader in the Bitcoin community, Andreas Antonopoulos, has criticised governments globally for following a pattern of behaviour when it comes to dealing with disruptive innovations.
“First they ignore you, then they laugh at you, then they fight you, and then you win,” he said in 2012 when Bitcoin was still being dismissed by regulators.
Like the internet, Bitcoin had a humble and slow start. However, the Bitcoin story has become infinitely more exciting, with Bitcoin trading volumes accelerating in the last six months.
At the time of writing, the value of one Bitcoin was approximately $US300. This was significantly lower than in November 2013 when Bitcoins were valued at $US1200.
To further illustrate the volatility of the currency, throughout 2011 the value of one Bitcoin fluctuated from $US0.32 to $US32 before crashing back down to US$2.
Not surprisingly, the currency is emerging as a high beta trade for speculative investors looking to make a quick profit.
The anonymous nature of Bitcoin, combined with the fact that there are no banks or third parties involved, also suits criminals and money launderers who are among its early adopters.
It also makes users and exchanges vulnerable to hackers and other cyber criminals.
In February, nearly half a billion dollars worth of Bitcoin disappeared from the vaults of the world’s largest Bitcoin exchange, Mt. Gox.
All this has contributed to Bitcoin’s bad reputation and the threat of regulatory restrictions on the currency.
Antonopoulos compares the way Bitcoin has been shunned by policymakers and pigeonholed as the domain of nerds and criminals with the early days of the internet, when “the internet was a den of thieves, pornographers, pirates and criminals but that doesn’t matter much now”.
It’s still early days for Bitcoin. There’s no polished interface, Bitcoins are difficult to use and exchange, and supply is capped at an arbitrary limit of 21 million by predefined protocol. This finite supply has been likened to gold.
Like all investments, Bitcoin is subject to price volatility or early-stage collapse, but it appears here to stay. Hopefully in time, it will lose its reputation as the currency of choice for speculators and money launderers.
As Antonopoulos puts it, Bitcoin “cannot be un-invented”.
Mark Thomas is chief executive and chief investment officer at van Eyk Research.
