Let’s Take Bitcoin as a Short Case Study for Cryptocurrencies!

Bitcoin’s price is bouncing around 50,000 US-Dollar giving it an aggregate value of about 1 trillion US-Dollar. The digital currency is increasingly part of the modern financial landscape. The venerable BNY Mellon in now handling Bitcoin, MasterCard is integrating it into its US payments systems and Tesla bought 1.5 billion Dollar of Bitcoin for its corporate treasury.

Understanding this phenomenon requires separating two queries: What is Bitcoin and more important what is it worth?

First, Bitcoin is a decentralized, digital representation of value that functions more or less as a medium of exchange, a unit of account and a store of value. It runs on a decentralized peer-to-peer network of computers that validate and log transactions on a permanent, public distribution ledger known as blockchain.

In some ways, Bitcoin is not unlike the collective composition of Wikipedia.

From the start, the Internet enabled the sharing of information globally, instantaneously, and from person to person. Now Bitcoin is part of the latest Internet wave using technology to move valuable things – such as money – just as quickly and directly.

Supporters like us believe Bitcoin’s design provides a technological solution to the age-old verification problem of ensuring that unique items of value are sent only once to a valid recipient. Instead of trusted, central authorities, Bitcoin uses a decentralized, rules-based, open consensus mechanism. They argue that this innovation will expand access to financial services, ease remittances, reduce the cost of global economic activity and strengthen individual privacy.

Critics argue that this is all hype and technological alchemy. For them, Bitcoin is highly volatile and speculative, performs no socially useful function and, worse, can be used to evade law or conduct illicit finance. They see its heightened valuation as a fever and a bubble akin to the 17th century “tulip mania”.

There is for sure not shortage of opinions on Bitcoin. For some, it is technological revolution, a highly appreciating asset, a hedge against monetary depreciation and a rebuke to the existing financial system. For others, it’s a fraud, an object of manipulation and a way to separate the unsuspecting from their money.

However, there is one thing that Bitcoin is not. It is not a government construct. It is a social one. It bears no sovereign imprimatur, travels on no government payment rails and settles no government obligations. Perhaps most crucially, it is not subject to government monetary control. This freedom from central bank devaluation may be what most excites its champions including us.

That leads us to the other question: What is Bitcoin worth?

Of course, the opposing views of its utility stir opposing views of its value. Fortunately, forums exist to resolve those competing views. In fact, since 2017, regulated Bitcoin US futures and options marketplaces have aggregated liquidity, distributed bids and offers, matched buyers with sellers and settled trades in both cash and physical Bitcoin. The total volume of open Bitcoin futures hit 19 billion Dollar last month. This deepening pool of trading liquidity provides essential price discovery and allows both sides of the debate to express their opinion of Bitcoin’s worth.

The launch of regulated US Bitcoin futures initially faced scepticism – especially from central bankers concerned that it would “legitimize” the currency. Now they allow investors to conduct price discovery, transact in transparent and orderly markets and establish fair market value.

Scepticism over the viability of cryptocurrencies has in our opinion its roots in the framework of money as a medium of exchange, unit of account and store of value.

Critics of Bitcoin point to its instability and lack of nimbleness in transactions, but there are very good reasons for business leaders to invest in it.

In terms of exchange, cryptocurrencies are cumbersome and transactions are slow to execute compared with incumbent platforms, such as credit cards, and conventional currencies. Whereas Visa and PayPal can execute 24,000 and 193 transactions in a second respectively, Bitcoin can only complete seven transactions per second. Moreover, in order to achieve status as a medium of exchange, money has to be both widely trusted and have a critical mass of users. Today, Bitcoin still fails on both counts.

As a unit of account, critics say cryptocurrencies’ value is too unstable, hindering corporate leaders’ ability to plan and operate their businesses effectively. according to a report by JP Morgan: “Bitcoin’s three-month realized volatility, or actual price moves, is 87% versus 16% for gold.”

However, we at Calvin • Farel believe such currencies can be a reliable store of value and offer a solution to a number of problems – particularly in emerging economies. They provide an alternative way to park savings. Unlike conventional currencies, they do not contain the risk of inflation so can maintain purchasing power in real terms. In this sense, cryptocurrencies can avoid the risks of devaluation brought about by profligate governments.

They can in our opinion also provide stability and transparency in politically volatile environments. Finally, many emerging markets rely on remittances. Remittance flows to low and middle-income countries touched a record high of 548 billion Dollar in 2019, larger than foreign direct investment flows (543 billion Dollar) and overseas development assistance (about 166 billion Dollar).

Cryptocurrencies allow people to send money at a significantly lower cost than other currencies – transaction costs can be 50% to 90% lower than those of traditional methods. Clearly, there is in our opinion a compelling ease to be made for cryptocurrencies as a store of value – akin to digital gold. However, whether they can resolve structural issues on the medium of exchange and unit of account are less clear.

One could argue that a remaking of the global financial architecture or system is already under way, with China being the largest trading partner, foreign direct investor and lender to both developed and developing economies, and the second biggest foreign lender to the US government after Japan. Although, after a decade of expansion China has begun to pull back.

Furthermore, the Chinese political class is backing its own digital currency, a virtual yuan. This is issued and controlled by the central bank of China, unlike peer-to-peer cryptocurrencies, and could challenge both Bitcoin and the US-Dollar. The US Federal Reserve has also recently announced that it is exploring a digital dollar. The fact that dominant global economics could back digital currencies makes it impossible for business leaders and market watchers to discount the future of new currency platforms completely.

In December 2020, MicroStrategy – a business analytic and mobility platform – held 1.8 billion Dollar of Bitcoin on its balance sheet. Some corporate leaders are likely to follow suit, speculating that the currency’s price will go up and that they will be able to sell their holdings at a profit, reaping a windfall. Still others will conclude that they ought to secure some Bitcoin to match those in their customer base or supply chain that may wish to transact in the currency. How much they would bay would obviously depend on their client’s needs.

However, in our opinion there is a third reason seriously to consider adding Bitcoin to their balance sheets – that of risk mitigation. Even if a company’s leaders do not believe in the currency’s long-term efficacy, they should ensure that they do not find themselves “offside” against a rival. Were Bitcoin to continue to appreciate in value, a substantial increase in a competitor’s balance sheet could, in effect, place your company in strategic danger of being eclipsed in the marketplace or even being acquired. In this case, securing Bitcoin today would be prudent risk management and have little to do with whether the board and management believe in the longer-term efficacy of cryptocurrencies. Corporate leaders must instead be alert to the tipping point when the absolute risk of not owning Bitcoin outweighs the risk of owning it.

Bitcoin’s among other cryptocurrencies’ beauty may be in the eye of the beholder. Yet, one need not be a Bitcoin “maximalist” to take comfort knowing that its worth is increasingly determined, not by government, but by active give and take in well-regulated and liquid markets. This alone may be cause for some to deride Bitcoin.

For many others, it’s a reason to “HODL” – that’s Bitcoin slang for go long.