Bitcoin’s origins in cryptography have created a $215bn currency market, and treasurers and investors need look no further than a booming ecosystem of emergent trading platforms. But buyer beware – bitcoin’s volatility offers potential for boom and bust.
Who is Satoshi Nakamoto? The unknown individual (or individuals) behind the name penned a white paper on Halloween 10 years ago. Since then, the mystery has only heightened. At the time, secretive transactions over the internet required enormous trust between buyers and sellers, or financial institutions to mediate. The white paper suggested a new approach to peer-to-peer transactions, which eliminated the requisite role of a bank to verify and process exchanges. Premised on existing market participants, the cryptography proposed took advantage of the random distribution of communication ‘nodes’.
These nodes served to verify and build on an encrypted public ledger, creating a long chain of trusted transactions. Importantly, these ledgers discouraged fraudsters intent on spending the same money twice.
Released in 2009, the open-source code for creating the blockchains associated with these transactions culminated with the appearance of bitcoins. The technology behind bitcoin went public, allowing nodes to multiply at scale. The new market of cryptocurrencies was born.
Cryptography and blockchain build trust, but real value is hard to quantify
A minefield of opportunities and perils have been highlighted on cryptocurrencies. Looking for quick profits, mainstream investors tuned into the price volatility of bitcoin over the past two years. Predicated on anonymity, attention shifted not only to bitcoin, the most well-known cryptocurrency, but to ‘alt-currencies’ in general – Ethereum, XRP, Steller, IOTA and Tether – have all become commonplace.
Investors looking to capitalize on price have been through boom and bust times, with many reputable sources claiming that the bubble has burst. According to CoinMarketCap, the leading cryptocurrency tracker, bitcoin currency has plunged to around $6,400 from a high of around $17,400 this year. While the price of bitcoin has made headlines, many established institutions dispute its real value. In fact, experienced financial players, whether motivated by self-interest or market sentiment, have dismissed the value of bitcoin altogether. Despite defining bitcoin as a commodity, currency or up-and-coming technology, the price seems to be driven by fools betting that an ever-greater fool will purchase bitcoins for more.
Pricing cryptocurrencies, whether over different exchanges, countries, or anywhere else, is problematic. The pricing of typical currencies (foreign exchange) depends on central bank policy and national enforcement – with no centralized mint or regulator, cryptocurrency pricing is based on however much people are willing to pay.
Risk and reward for corporate treasury
The hype surrounding bitcoin and cryptocurrencies has invigorated corporate treasury interest. The rewards around using bitcoins for treasury purposes are obvious: hedging. In an ideal scenario for corporate treasurers, bitcoins could be used to hedge every foreign currency exposure. A single transaction could net-off an entire book of exposures. The potential of blockchain technology also warrants faster payments, reduced transaction fees, and could, in some cases, offer protection against volatile currencies. Payments made by bitcoin could eliminate the need to make SWIFT payments, since treasuries could pay suppliers directly, without correspondent banks or SWIFT subscriptions.
Doing business in countries where economic crises and regular currency shocks occur is risky. National governments often restrict foreign currency transactions and impose export limitations, making it difficult to extract profits. Bitcoin’s peer-to-peer transaction protocol could offer treasury departments freedom from currency import and export regulations.
While many hard currency exchange rates vary less than 2% in a day, some, like the Venezuelan bolivar and Zimbabwe’s dollar, have fluctuated many times over. The bolivar has lost some 90% of its value; in Zimbabwe, inflation has been so out of control that the currency is near worthless. Desperate to stymie hyperinflation and capital flight, Venezuelan President Nicolas Maduro has pegged the country’s new currency to the ‘petro’, an oil-linked cryptocurrency. For treasurers, downside protection from radical price decreases and the unconventional approach to hedging underscores the new relationship between digital and fiat currency.
In the EU and UK, trading of cryptocurrencies is legal – and while they are considered a digital currency, they trade more like a commodity. Other countries, such as Morocco, have an outright ban on the trading of bitcoin. While legally permissible, many banking institutions would consider bitcoin trading against AML policies.
The difficulty in figuring out the true identity of a bitcoin owner means that proceeds of crime could go undetected. For treasury departments, the risk of falling afoul of regulators may outweigh the potential to be on the forefront of digital currency profits.
The power-play between government regulation over currency and the freedom to transact in cryptocurrency is fraught with challenges. Bitcoin concerns bankers since its very existence purposefully destabilises the banking system of payments.
Investors flock to exchanges
Exposure to bitcoin’s upside has entered mainstream consciousness. Bitcoin and other blockchain currencies are exchanged like any other commodity and vary in transaction fees, transparency and liquidity. Some of the most popular Bitcoin exchanges operating in the UK include Bittylicious, CoinBase, CEX.IO, BitBargain and QuickBitcoin.
The Bitcoin rollercoaster
Harking back to the Dutch Republic in the 1700s, speculation in novel tulip flowers developed into a full-blown futures market. Tulips were in such high demand that bulb contracts changed hands 10 times over before the product anchored in Dutch ports. The bubble then crashed seemingly overnight. An outbreak of the bubonic plague – or in economic terms, an external shock – tanked the tulip market. Prices bottomed out, and the tulip index fell from a high of 200 in February 1637 to barely above zero in May the same year.
Economists have been quick to point out similarities with Bitcoin. Clearly the intense interest in cryptocurrencies has taken hold of the market, driving up prices – the pump-and-dump strategies seen in other bubbles have also been witnessed. Other parallels have been made, including the impact of the burst bubble. The Dutch economy, while shocked by the tulip crisis, did not collapse. Thankfully, while bitcoin and alt currencies have created investor mania the market is still small. The market cap of all cryptocurrencies stands at around $215bn – less than one-thousandth of the S&P 500 share index.
A kernel of truth from Bittylicious CEO Marc Warne seems most appropriate on bitcoin trading and exchange. “Why not give it a try? If you have £20 to spare, for instance, buy a tiny amount and track its price. If something goes hideously wrong the £20 can be written off and it can be considered a learning experience. If you can, spend it somewhere like at a few pubs that accept it.”
Note
‘Bitcoin’ refers to the ecosystem of the payment network, protocol, and general terms
‘bitcoin’ refers specifically to currency terms