In my line of work, friends and family often ask for my thoughts on various investments. Generally, they ask about stocks but, lately, the questions have been about Bitcoin.
I see why Bitcoin might grab your attention: Its price has more than tripled, year-to-date. (At yesterday’s close, a Bitcoin was valued at more than CDN$5,800). Another prominent rival, Ether, is on the rise, recently trading at close to 50 times its 2016 year-end value of US$8.
I can’t say whether these prices will go up or down because, as with all speculative assets, fundamentals don’t drive their movements—your guess is as good as mine (or anyone’s). However, when I look at a chart of Bitcoin’s ups and downs over time, I see what looks more like an early venture stock price than an exchange rate.
If you ask about Bitcoin, I’ll reframe our talk around a more important question: Can Bitcoin legitimately be treated as a currency? The short answer: not so much.
What’s the deal with digital money?
Cryptocurrencies, or digital currencies, are created by computer algorithm to record transactions on what’s called a blockchain ledger over a decentralized, peer-to-peer network. This distributed public database continually reconciles every Bitcoin and every transaction to prevent foul play.
There’s no actual coin in your pocket; just an electronic token, or key, in a digital wallet. Bitcoin is the most popular, but there are now more than 850 cryptocurrencies.
Cryptocurrencies are anonymous in nature, outside the regulated world of central banks. As such, they’ve been a popular medium to conduct transactions of a nefarious nature (like blackmail, ransom ware attacks and drug deals). This has brought notoriety to Bitcoin, even as more mainstream vendors, such as Microsoft, accept it as payment.
When we talk about Bitcoin, are we even talking about money?
Currencies serve both as a means of exchange and a store of value. To be useful, a currency needs to be stable and readily accepted as a means of payment.
In daily life, you regularly quote the value of things in units of currency: How much does a coffee cost? How much is your house worth? How much do you make in a year? If we were to quote the value in Bitcoin, the costs of everyday items, the worth of your assets and your annual salary might change by the minute.
As a medium of exchange, Bitcoin remains marginal in terms of its use by consumers and businesses, relative to standard currencies.
Our currency team at CIBC Asset Management view Bitcoin more as a highly speculative asset rather than a currency. MD portfolios do not hold Bitcoin, or any other cryptocurrency, due to their speculative nature.
A lesson in currency, and Bitcoin buyer’s remorse
Money, as we know it, is a depreciating asset—buying power tends to shrink over time as a result of inflation. Central banks of major developed currencies, such as the Bank of Canada, target an annual rate of inflation, generally about 2%.
The expectation that the buying power of cash will erode over time (via higher prices) creates an incentive to use it to consume goods and services. In contrast, if a currency is appreciating, it can be an incentive to horde, curbing economic activity.
Think of your buyer’s remorse if whatever item you spent Bitcoin on at the end of last year was now three times less expensive—you should have waited!
Beyond Bitcoin, greater innovation at work
My money isn’t on Bitcoin—and neither is yours in our portfolios—but I am interested in what else will come of it: its existence has sparked innovation that may have far-reaching effects.
Central banks, regulators and the financial industry have all become very interested in the underlying technology invented to enable Bitcoin. That blockchain ledger system, briefly described earlier, holds great potential to strengthen the financial system, reduce costs for financial services, and be a source of technological disruption.
Talking about Bitcoin still makes for good cocktail party chatter—what comes after it may be more profound.
Mark Fairbairn, CFA, B.Eng., is a Senior Investment Analyst with the Investment Management team at MD Financial Management. He is responsible for the non-North American equity funds and pools as well as the currency overlay program within the equity funds.