Bitcoin – The Non-Systemic Asset

By 2020, Global assets under management (i.e. directly within the financial system) will exceed $102 Trillion.  Roughly one third of this figure will be pension funds alone.

As illustrated in 2008/09, the financial system is intertwined with such complexity that knock on effects are nearly impossible to predict.  Movements in ‘fair value’ of assets can swing with incredible volatility, rendering enormous banks insolvent.  Savvy investors diversify across asset classes, currencies and institutions to reduce systemic risk and reduce potential exposure to interest rate changes, inflation, wars, recessions, banking failures, etc..

However, how can an investor properly hedge against systemic risk when nearly every asset type is affected?  How can an individual or even a business protect itself should a nation’s banking system cease to function even temporarily?

Ten years ago, thinking about these supposed doomsday scenarios would have seemed irrational and paranoid.  However, if you are resident in Greece, an EU country, you know exactly what capital controls and banking restrictions feel like.  A few years ago it was Cypriots who experienced the previously unthinkable … a banking bail-in.

Domino effect

Systemic risk is real and possibly higher than ever before given the indebtedness of nation states (reducing the likelihood of a government bail-out).  Today’s EU *policy* is that banks will have to bail-in their customers to rescue themselves going forward.

Enter Bitcoin:  The World’s first truly non-systemic asset that is still highly portable (electronic) and divisible.

What would the value of an asset be if it is one of the only ways to trade or move value? How much Bitcoin should a business buy should it want the ability to continue to trade on a Sunday or during a bank holiday … or during capital controls?  What percentage of assets should be held in Bitcoin to provide adequate ‘insurance’?

Governments around the World are quietly enabling Bitcoin to flourish (e.g. changing categorisation so it is VAT exempt), and one of the reasons is that they too would prefer to reduce the systemic risk within their economies. Nations, like their people, must become resilient against banking/systemic failure.

During the period where Greece was close to leaving the Eurozone, the price of Bitcoin rallied strongly.  Not due to Greek panic buying, but instead due to buying pressure from others worldwide who realised having some Bitcoin may be the best way currently available to hedge against systemic risks over which they have no control.

Asset managers globally will gradually realise that Bitcoin is a non-systemic asset, a very valuable hedging option and therefore make it a small part of their portfolios.

Bitcoin’s Supply & Demand

During the past 14-15 months of Bitcoin’s price decline, much has been made of Bitcoin’s inflation rate … i.e. the speed at which new Bitcoins are discovered each day and, at least some of the time, sold into the market.  Currently 3600 BTC are created every day and the market must absorb this supply in order to maintain current prices.

Short sellers focused on this, especially when the price was >$500/coin, stating that there is no way current demand levels can absorb $millions of new bitcoins being sold every day.  Fundamentally, without huge hype as per late 2013, they have been proven correct … but at the current ~$235 level, the same argument becomes weaker.  Especially given recent changes in the market.

Firstly, at $235 per coin, fresh supply of bitcoins is valued at ‘just’ $846,000 per day. This sounds like a lot, until you divide it among 1000’s of individuals.

Supply and Demand

Secondly, the weak holders of Bitcoin have already been flushed out. If they didn’t panic sell at $200 or $180, it seems unlikely they will at $150 or even lower. The only way a short seller can push the price down is to temporarily create a large oversupply by scaring people into selling.  It would appear that their influence is waning.

Thirdly, more people than ever can buy bitcoins! itBit’s volume has increased significantly since it announced it was fully regulated in the US. Very roughly I’d say their volume has increased by 2000BTC/day.  Coinbase is also now US regulated – at least in part – and has launched in the under-served UK market.

Even more exciting for those of us cheering on the demand side of the equation are the stock-exchange listed vehicles currently available for the first time.  We have GBTC (Bitcoin Investment Trust) in the US and XBT (Bitcoin Tracker One) in Sweden … with more to follow.  GBTC is a little odd in that newly created shares must be held for 12 months, however we can assume that now it is listed it continues to grow in size.  More obviously beneficial to the quest for equilibrium is the Swedish XBT exchange traded note.  Since launch, volume has averaged >500BTC per day … as it is so new, one can assume that these are pretty much all buy orders.

So, being really pessimistic, these new developments together look to have absorbed around 20% of the supply of new bitcoins.  That is a significant change in just a couple of months.  If you were very optimistic you may feel that, at least for now, they account for the acquisition of ~50% of all new supply.

We do not know the magnitude of the overhang of supply (e.g. from miners who have hoarded coins and seek to sell them). However, I expect that if this level of demand were maintained for just a couple of months then the price will have to move upwards.

One thing is for sure, ETFs and ETNs nearly always grow over time (so much so that many believe they pose systemic risk to equity/bond markets). Traders can control the price of Bitcoin, but only temporarily if moving against fundamentals.  It is entirely possible that we have already passed equilibrium but a supply crunch has not happened yet.

Cyber crime

Why Bitcoin’s Illicit Image is Temporary

Until fairly recently, most media attention on Bitcoin has centered around its use on the Dark Web, thefts/hacking/blackmail and generally painted a picture that it is somehow in itself illicit and ‘dirty money’.  Many well-educated people still believe those interested in Bitcoin must be involved in something of questionable morality.

Last week I was in a meeting with two developers discussing smartphone/laptop/camera recycling sites. Both individuals are technically capable and know what Bitcoin is … one even mined Litecoin back when it was profitable.  When I suggested creating a site in the UK to pay people Bitcoin for their recycled devices, the reply was that customers interested in receiving Bitcoin instead of Fiat currency were probably ‘the wrong type of customer’ and that we’d likely get a lot of stolen devices sent in.

This meeting roughly coincided with the publication of an article on Coindesk where Alasdair Rambaud, SVP for Cardinal Commerce said that “Everyone thinks Bitcoin is the currency of criminals“.

Cyber crime

It is pretty obvious that Bitcoin’s image problem is real among the mainstream but early adopters do not need to feel ashamed. Illicit use of new technology is pretty standard throughout history as criminals are often the most motivated to try new technology that may benefit them. Some examples:

Gangsters would buy the best weapons, the fastest cars, etc. to rob banks and/or escape law enforcement.

Criminals would use the first telegraphs / telephones to obtain information more quickly, enabling them to front-run, defraud, tip off, etc..

Banks have been used to launder money since they were first created.

Pagers only seemed to catch on with doctors and drug-dealers. Having more than one mobile phone was also once associated with drug dealing. The use of ‘burner’ phones is still assumed to be motivated by something illicit.

The first software enabling credit cards to be taken securely over the Internet was made for porn sites. For a significant period of the Internet’s history, the overwhelming majority of eCommerce was porn-related. Not illegal, but some view it as of questionable morality.

The Internet created a whole new genre of ‘cyber crime’. Spam and viruses threatened to make e-mail less useful/desirable. Terrorists promote themselves on Twitter and Facebook.

None of the above resulted in a technology failing to become more mainstream. Perception of Bitcoin will change with time and growth in mainstream use. As law enforcement agencies become more savvy with the blockchain, criminals may start to avoid using Bitcoin and move to other more secretive cryptocurrencies … or simply go back to using cash, diamonds, weapons, etc. as their currency of choice!

One Less Customer for Western Union / Moneygram / etc.

Yesterday I decided to see how easy it would be to convince an EU citizen with family in the Philippines that she should no longer be using Western Union / MoneyGram or even smaller companies like Sigue or Ria to remit money to her brother.

Many people won’t have heard of Sigue or Ria. They are more reasonably priced (around 1% transfer cost + margin on the currency exchange for larger amounts >€500) but they also require her to turn up in person, fill out the forms, bring cash, provide ID, etc. … every time!  This family are happy to go to the trouble of shopping around as every Peso that arrives matters a lot.

As an experiment, I sent a small amount of Bitcoin to her e-mail address via Coinbase. I then told her about Coins.ph and asked her to try sending some Philippine Pesos to her brother as quickly and cheaply as possible.

western-union-moneygram-bitcoin

Within a few minutes, she had registered with Coinbase and Coins.ph, moved the Bitcoin across and arranged for about $30 worth of Pesos to be sent directly to her brother’s bank account the next day.  In reality nearly all remittances to the Philippines from Europe are next-day due to the time difference.  Many companies take two days to send funds across.

Using Coinbase and Coins.ph for small remittances is something none of the traditional services available can compete with.  They are roughly equivalent with Sigue and Ria for larger amounts, but so much more convenient (everything can be done from home/office, setup is done just once, etc.).

No more saving up a large amount to send to the Philippines simply to minimise fees.  No more hunting around for the best deal because they are constantly changing.  No more form filling each and every time.

“Tell everyone”, I said.  “Absolutely!”, she replied.

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