Dec 12, 2013

There has been continuing press coverage and heightened interest in the currency alternative known as “Bitcoins”. A Bitcoin is a virtual currency – there are no actual notes or coins. They can only be created by specialist computer operators known as “miners” and the difficulty in mining for them grows as they are mined. The actual mining is a mathematical process relating to very large prime numbers.

The crucial element is that there is a (clunky) form of online exchange and limited supply which make Bitcoins attractive for those concerned about the impact of most developed nations printing money and potentially devaluing their currencies. They also have a certain cachet amongst those who wish to conduct business transaction out of sight of regulatory authorities; suspected use in criminal exchanges has led to close and ongoing investigations by the FBI and CIA.

However before one can form a view as to Bitcoins it is worth considering exactly what it is. Is it a currency? A store of value? An investment? What?

For currencies to be effective there has to be ease of transfer/conversion (which there isn’t — it involves complicated online wallets) and the huge fluctuations in its value limit its ability to function.

As a store of value it is flawed. It is entirely virtual and has no intrinsic value. As such it has been compared to gold which has little commercial utility but again the comparison is deficient; Bitcoins are not readily transferable and there are only limited counterparties who accept them.

It is also not an investment. It produces no income and its “value” derives entirely from what someone else is willing to pay for it. There have also been instances where a broken computer “lost” Bitcoins, there has been online theft and even the very legal basis of them is under question.

Bitcoins are most akin to gambling, buying them is fundamentally a bet that the value will increase over time. However at least in Las Vegas the odds are known or knowable; not so with Bitcoins. We would classify them as an interesting fad, Bitcoins are structurally flawed but an online non-governmental currency may well endure.

It will surprise probably no-one to hear that as the interest and press coverage in Bitcoins has risen banks have tried to get in on the act. In the first analyst report produced by Bank of America Merrill Lynch they forecast the price to rise from $1,052 to $1,300.

Within two days the price had halved.

Have a Happy Christmas and a prosperous New Year.