The Euro-zone sovereign debt crisis has ravaged European equity markets, ultimately forcing the European Central Bank to pledge the unlimited expansion of its balance sheet to prevent bond market turmoil. This has sent the Euro on wild swings against its major counterparts, the British Pound, the Japanese Yen, and the US Dollar.

The most recent chapter of the Euro-zone crisis, the “Ill-Constructed Bailout of Cyprus” (as I like to call it), has seen new measures taken in order to ensure bailout funds: capital controls. To prevent a full-on bank run resulting from the uninsured depositor tax levied on the country’s banks, the Cypriot government has implemented sweeping capital controls that effects transactions on an individual and international level:a €300/day cash withdrawal limit; a €1,000 limit on the amount travelers can take outside of the country; the use of checks worth up to €9,000/month; and a ceiling on transactions which do not require official central bank approval at €25,000.

With the Cypriot capital controls in place – a measure could very well be the beginning of a massive capital flight from the region, which would raise into question the viability of the Euro over the long-run – there has been a noted desire for an alternative investment vehicle to move money around the developed world. Usually, this role is filled by the precious metals, especially Gold and Silver; however, a new player has entered the ring – Bitcoin.

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What is Bitcoin? It is a decentralized, electronic currency (known as a “digital currency” or a “crypto-currency”) created in January 2009. Unlike fiat currencies such as the Euro or the US Dollar, Bitcoins are not backed by a governing central bank and accompanying sovereign; there is no ‘Bitcoin Central Bank,’ so to speak. This raises an interesting concern about the money supply – if there is no central bank, who prints the money? That job goes to “bitcoin miners,” or individuals who use computers to decrypt strings of code in order to “unlock” Bitcoins, which are stored in “virtual wallets.” (While the actual process is more complex than what I’ve described, this basic outline is enough to understand Bitcoins on a conceptual level.)

BTC/USD – Bitcoins in US Dollars – April 10, 2013

Chart created by Christopher Vecchio, Currency Analyst using Bitcoincharts.com

Bitcoins have been on a bit of a ride recently, swinging from the low-$30s in early-March to near $150 on Wednesday, April 3. When Bitcoin first started in January 2009, it was trading under one penny (<$0.01). From an outside point of view, this is one heck of a bullish market; for the sake of demonstrating a point, if we peg the value of 1 Bitcoin at $0.01 initially, then as of Tuesday’s closing price of $236, Bitcoin’s value (in USD-terms) has increased by 23,599% in just over four years! It’s not a jump to say that the past several years have benefited the original holders of Bitcoins. But, what if that volatility were reversed? Past performance is not an indication of future performance, and this rings truer than ever with Bitcoins.

Bitcoins have gained fame in recent weeks for its meteoric rise, and the connection to the Euro-zone crisis is apparent – it’s no coincidence that an unregulated, anonymous mechanism to transfer wealth has gained popularity in the wake of capital controls in the Euro-zone, which essentially limit means of transacting domestically or internationally if the individual or business is located in Cyprus. Another logical connection then exists: if the Euro-zone is about to endure further turmoil; and more capital controls are possible; then Bitcoin should increase in value. Does that mean Bitcoin is a savy investment to play the Euro-zone crisis?

The long and short of it is a resounding no. Bitcoins are unregulated and uninsured, so that means at any point in time, you could lose your investment on a whim without an insurance policy (i.e, if someone steals your credit card and purchases goods, you are not liable for said transactions; in the Bitcoin world, if your virtual wallet is hacked, there is no way to recover the lost funds). On regulation, the anonymous aspect of Bitcoin is an attractive selling point, but those who invest are willingly putting themselves at risk to see their activity blocked on the premise of anti-money laundering grounds – Bitcoin has become a popular medium of exchange in black markets across the globe.

Due to low volumes in the Bitcoin market – just over 10 million are in existence – volatility is extremely high. Just this week, we’ve seen prices swing around +/-20% on an intraday basis; comparatively, 1 week historical volatility for the EURUSD as of April 4 is +2.84%. A stable exchange rate is essential for a widely accepted and used currency. It’s also important for traders: the amount of volatility seen in Bitcoins over the past several weeks would cause massive swings in any number of currencies, including the EURUSD, and would likely result in a margin call for those on the wrong side of the trade. While short-term traders want volatility, the amount of volatility seen in Bitcoins is undesirable for risk neutral and risk averse investors.

In summation: Bitcoins are a very, very risky investment. If you’re trying to take advantage of the calamity in the Euro-zone, a simpler, safer, and easier method is to sell short the Euro, against the British Pound, the Japanese Yen, or the US Dollar, for example (short EURGBP, short EURJPY, short EURUSD).

--- Written by Christopher Vecchio, Currency Analyst

To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com

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