Posted on Sep 14, 2017

If you watch much financial news, by now you’ve probably been exposed to the Bitcoin craze. Bitcoin has experienced an astounding increase in value in 2017 – from $967 to $4,627 at the time of writing – a rise of 378%. Worth just $358 at its 2016 low point, Bitcoin makes even the most unruly equity markets look relatively steady.

Invented in 2008 by an anonymous programmer and developed by an open-source team, Bitcoin is the largest of many cryptocurrencies that exist today, with a market cap of $160 billion. Unlike dollar bills that are printed and regulated by a Central Bank and Treasury Department, Bitcoin has no centralized control. It can be used on certain websites to make purchases and can be traded on online exchanges. Using Bitcoin ATMs installed across the US, it can be exchanged directly for cash.

Despite Bitcoin’s label and features, it has a long way to go to be considered a real currency.

Standard economic theory states that money has three functions: a medium of exchange, a store of value, and a unit of account. As a medium of exchange, while hundreds of online vendors accept Bitcoin, only three of the top 500 online retailers do. As a unit of account, businesspeople must be able to attribute a Bitcoin value to their good and services. With low adoption among retailers, they are not inclined to take on that risk. As a store of value, Bitcoin again fails, with average monthly price moves in excess of 10% in either direction. Given this knowledge, we consider Bitcoin more of a speculative asset than a real currency.

One questionable aspect of Bitcoin it that it is unregulated and anonymous, making it an attractive tool for money launderers. We cannot foresee the US or EU legitimizing cryptocurrencies with these protocols. In fact, a new EU Draft Law proposed in March seeks to end the anonymity of cryptocurrency users. Confronting the governance issue may cause the value of Bitcoin to decrease or stagnate. Of course, on the other side it may increase its notoriety, making it more attractive to users with that desire.

Another concern about Bitcoin is the threat of hacking. A cryptoexchange called Mt. Gox lost bitcoin worth nearly $500 million to thieves. The Hong Kong cryptoexchange Bitfinex lost bitcoin worth $72 million in 2016. While programmers learn from these mistakes, the risks are still great. Unlike a bank account where there is a paper trail, Bitcoin transactions are anonymous and irreversible, making it almost impossible to recover stolen funds.

Due to their volatility and speculative, get-rich-quick nature, we would not advise clients to bet the ranch on Bitcoin or other cryptocurrencies. In other words, don’t consider investing anything in Bitcoin that you cannot afford to lose.

That said, an aspect of Bitcoin that has real potential is blockchain, the underpinning technology that records and verifies secure transactions on a public ledger. With no need for central recordkeeping, blockchain presents a more efficient way of record keeping and decentralizing markets.

Blockchain technology has the potential to be useful across many industries and transform business operating models in the long term.

Using energy as an example, a Goldman Sachs report from 2016 says, “With the advent of rooftop solar and high-capacity battery technology, individuals can potentially act as distributed power providers. We think blockchain could be used to facilitate secure transactions of power between individuals on a distributed network who do not have an existing relationship.” Start-ups like TransActive Grid in Brooklyn and Grid Singularity in Austria are doing just that.

The secure, tamper-proof blockchain system also offers enhancements for administrators and their record-keeping. This efficiency boost could help in a variety of industries. SWIFT, the secure global financial messaging system, has started utilizing blockchain. Airbnb is exploring using it to manage digital credentials for guests and hosts. For technology as young as blockchain is, it is remarkable seeing how widely it is being applied.

What began as a small experiment is now a rapidly expanding ecosystem. We’re seeing people placing trust in systems and network protocols, as opposed to people and businesses. And that shouldn’t matter, as long as it’s cheaper, faster, more secure and more efficient.

Will Bitcoin become the ubiquitous currency of the future? It’s doubtful, at least under the current status quo. But we do believe the underlying technology is cementing itself as a future-builder. And we aren’t yanking your blockchain when we say that.

Learn more at: http://www.slaughterinvest.com/insight/market-and-economic-commentary/understanding-bitcoin