Rebecca Teltscher

In an article posted by CNNMoney, (“Bitcoin is not just digital currency. It’s Napster for finance” by David Z. Morris), it has been said that Bitcoin is the Napster for finance, in that it is a game changing concept for the financial industry similarly to how Napster and subsequently Apple’s I-tunes changed the dynamics of the music industry forever.  The hype built during 2013 (see chart below) saw the value of one Bitcoin currency increased from 26.8146 XBT/USD  to as high as 1230 XBT/USD.  However, the comparison with Napster still doesn’t sit right with me.

Source www.xe.com

Source www.xe.com

So what is a Bitcoin and why is there so much hype about it? In “simple” terms, Bitcoin is a decentralized digital cryptocurrency and peer-to-peer payment system. Still confused? Me too. Ok, let’s break this down.  Decentralized means the currency isn’t regulated by a government and that the currency is not backed by anything valuable such as gold. The currency is digital which means it is primarily used for online transactions and cryptography is used to control the creation and transfer of the currency. Price volatility has recently surged upward as speculators think the Bitcoin is the currency of the future.

The rapid rise in the value of bitcoins is as confusing as it is troubling and leaves far more questions than answers.  Is Bitcoin just a fad? Is its lack of traceability a catalyst to fund illegal activity? Is the currency’s value sustainable over the long term? All these uncertainties create the risk/reward profile that I wouldn’t bet on just yet.

If I go back to Economics 101, I recall some of the main factors that drive a currency. Factors including government control of monetary and fiscal policy, inflation, and interest rates directly influence currency values. As do other factors based on Gross Domestic Product (GDP) including consumption, production, exports, and imports. But what drives the price of a completely unregulated online currency? So far it appears as if the value of Bitcoins is driven solely by supply and demand, where the current demand seems to be influenced heavily by speculators.  Where do you draw the line between investments that are purely speculative and gambling?

In this day and age where technology evolves faster and faster, it’s easy to get caught up in the buildup. When we evaluate potential investments at Leon Frazer we always try to avoid hype and look at the fundamentals such as the factors driving return and its sustainability. Since the Bitcoin is unregulated, there is nothing stopping speculators from dumping the currency and moving on to the next tech fad, thereby making the currency worthless. I may sound traditional, but I’d rather invest my money in something backed with real fundamentals and stable cash flows. Game changer or not, my RRSP contribution this year will be invested in a stable blue chip that grows its earnings and pays a decent yield.

 

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