Bitcoin: Real Currency or

Speculative Investment Luc de La Durantaye, CFA

Managing Director, Head of Asset Allocation and

Currency Management of CIBC Asset Management

Bitcoin is a 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 bank¹.

Bitcoin software was released in early 2009 by a mysterious creator who went by the name of Satoshi Nakamoto. There are other cryptocurrencies (Ether, Monero, Bitcoin Cash), but Bitcoin remains the most popular.

Bitcoin uses a blockchain (a digital accounting ledger) to record and verify transactions. The advantage of a blockchain is that it 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.

There are also many practical questions that come up when Bitcoin is discussed:

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. Here are our thoughts on Bitcoin.

Is Bitcoin here to stay?

When assessing Bitcoin’s potential as a currency, it’s useful to remember the traditional roles that currencies play:

Store of value: Although it has gained a lot of ground since inception, and soared late in 2017, Bitcoin remains full of risks. It has a very short history, so it’s difficult to assess the soundness of its architecture or its ability to act as a store of value in the longer term. Theoretically, anyone can launch a competing cryptocurrency, or even a new technology that could make blockchain obsolete.

Sovereign states could also try to prohibit the use of cryptocurrencies as a way to maintain their own monopoly on issuing fiat currencies*.

Means of exchange: Bitcoin is not 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), making it very risky to use as a store of value for the future purchase of goods and services. Although Bitcoin rallied impressively in 2017, it has also seen multiple corrections of 30% and more. Bitcoin is so volatile that in September 2017, Fortune magazine published an article entitled “5 Big Bitcoin Crashes: What We Learned.” All five Bitcoin crashes discussed in the article have occurred since 2013!

Until Bitcoin is more stable and its use is more convenient and widespread, it won’t be seen as a reliable means of exchange. However, we have witnessed other disruptive technologies rapidly change the landscape once they reach “critical mass” — the use of Uber instead of taxis, and streaming or downloading music instead of buying CDs are examples.

At this point, Bitcoin seems more a speculative phenomenon than a real currency opportunity.

Monetary policy instrument: Bitcoin is not 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 don’t receive interest payments and that makes it more expensive to hold compared 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 does not lend itself well to our investment process, which is based on fundamentals. 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 should bring new and different players into the market who don’t want to deal with the complications of holding Bitcoins. However, 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 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 its use as a means of exchange.

Our current opinion

As currency managers, we are staying on the sidelines for the moment, but will continue to assess the developments in the cryptocurrency world. At this point, Bitcoin seems more a speculative phenomenon than a real currency opportunity. However, we are 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 https://en.oxforddictionaries.com/definition/bitcoin

*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 dollar, U.S. dollar, euro and Japanese yen.)