Very few financial managers currently use Bitcoin or other crypto currencies in their business. Bitcoin has however been enormously talked about in 2017 because its course has literally taken off before starting a sharp decline in these last days of the year. Exchange instrument, investment tool, safe haven, speculative bubble without a future? Analysts believe that it constitutes a “financial object very difficult to apprehend”. In any case, it is essential for all financiers to have a minimum of culture on this subject.
What is Bitcoin?
Bitcoin is the first and most famous virtual currency or cryptocurrency and also the first to be created in 2008 by Japanese called Satoshi Nakamoto. Like Homer, the author of the Odyssey, Satoshi Nakamoto seems not to have existed but to be the pseudonym behind which has gathered a small group of anonymous computer scientists. The block chain is the technology that supports this currency.
Crypto-currencies should not be confused with the technology that supports them, the block chain. While many monetary authorities express mistrust of Bitcoin, this is not the case with Block chain.
Bruno Lemaire, French Minister of the Economy and Finance posted mid-December all his caution with regard to:
- A “speculative asset *” that “may conceal all sorts of obviously illegal activities”.
At the same time, the Council of Ministers adopted an order authorizing the transmission of unlisted financial securities using block chain technology, welcoming in passing the innovative and secure nature of this tool.
Other virtual currencies have since been created, Litecoin, Peercoin, Monero, Ethereum, which for the most part are inspired by Bitcoin which remains the one mainly used.
Crypto currencies are now an alternative currency because they have no legal tender; their value is neither guaranteed nor supported by a central bank or institution. They are exchanged directly from computer to computer without passing through a bank playing the role of “trusted third party”, as one would for an electronic purse payment. The Bitcoin transactions are part of a set of big books shared between a large numbers of computers around the world called Block Chain (or chains of blocks) that track all transactions since it started. The inviolability of this cryptographic process guarantees the use of this currency.
What trust can we have in Cryptocurrency?
The coins of antiquity consisted of gold or silver coins. Confidence in money rested on the rare and unalterable nature of these metals. Then the notes and coins in circulation were no longer precious metal but their value was guaranteed by the gold held by the central bank, the currencies then being convertible into gold by any individual. The 1944 Bretton Woods agreements enshrined the end of the convertibility of currencies into gold, excluding the US dollar. In 1971, the United States abandoned the convertibility of the dollar into gold to have more freedom in the expansion of their money supply needed to support growth.
Confidence in the currency was based on the ability to convert it into an underlying asset whose value was recognized by all, gold. This confidence is now based on confidence in the economy of the country or economic zone that issued it. The link is established between the value of the currency and the economy of the country by the notion of legal tender, the currency that is legal tender cannot be refused for payments.
The exchange rate of a currency is fundamentally based on the supply and demand of this currency which is itself based on its economy. Thus, a country with a positive foreign trade balance will see its currency increase as foreign buyers buy it to pay for their purchases. Demand for the currency will also increase if many external economic agents invest in the country.
Confidence in the economy is thus the asset that underlies the value of the currency, the economic agents of this country being anyway forced to use it in the context of their exchanges. The US dollar is a special case; the United States can maintain a significant trade deficit without depreciation of the dollar because their currency is used for international trade. Thus, the price of the dollar tends to increase when the price of oil increases because more money is needed to settle transactions in this commodity.
Proponents of Bitcoin say that trust in the currency is based on two essential elements:
- The inviolability of the cryptographic process of the Block Chain;
- The fact that the issue of bit coins is limited. The maximum number of bit coins has been programmed to a maximum of 21 million units. However, 16.5 million have already been created thanks to the computing power of computers
However, the value of crypto currencies is not supported by any underlying asset such as gold, nor is it based on the economy of a country.
Is Bitcoin really a Currency?
In the magazine DAF MAGAZINE of December 2017, lawyer Thibault VERBIEST indicates that today in France, crypto currencies have the status of good, certainly negotiable, and not money.
Aristotle had assigned three functions to a currency: a standard for measuring the value of things, a means of payment in exchange, and a store of value (investment). Since then, new individual uses have developed. The currency is used for the financing of investments by debt or capital. In addition, some economic agents use currencies to make speculative gains.
However, the currency is not limited to individual uses, it also plays a public role it is the preferred tool of the monetary policy of a state or monetary institution such as the European Central Bank. The primary mission of a central bank is to guarantee the purchasing power of its currency, avoid excess inflation and depreciation in the foreign exchange market. It acts in particular by setting the key rates at which it finances banks, decreasing it when it comes to boosting the economy and increasing it to avoid inflationary pressure. The central bank also increases money supply to facilitate trade during growth.
Cryptocurrencies fulfill only a few of the roles of a currency that we have just defined.
They are used only marginally as a means of payment.
Of course, anyone can buy crypto currencies on specialized platforms like Coin base. In April 2017, Japan also recognized Bitcoin and other crypto currencies as legal but not necessarily accepted modes of payment. Some shops “connected” in tourist areas offer payment in cryptocurrency, mainly for marketing communication reasons (Figaro December 3, 2018: “In New York, you can buy its ice cream bitcoin”). The transaction cost is often prohibitive compared to the amount of the purchase. The high volatility of cryptocurrencies would introduce a currency risk for companies that they usually seek to avoid.
They constitute a mode of financing for certain start-ups via the Initial Coin Offerings (ICO) issued on the block chain.
This non-negligible mode of financing, $ 4 billion issued in 2017, however, seems limited to businesses in the digital sector. This method of financing has allowed some startups to raise funds for very large amounts. However, it remains linked to a good valuation of the cryptocurrency because the funds raised must then be converted into money at legal tender to finance investments and pay operating expenses.
It is clear that the craze for Bitcoin is essentially based on the prospect of speculative gains.
What’s future Bitcoins have?
One thing is certain. Opinions are much divided on the future of cryptocurrencies.
According to Jamie Dimon, CEO of JPMorgan Bank Chase & Co, “Bitcoin is” fraud “that will explode in flight. This currency will not work. We cannot have a system where people create a currency with wind and think that the people who buy it are really smart, “he said at a conference in New York. If traders from JPMorgan exchange cryptocurrency, “I would fire them in the second and this for two reasons: it is against our rules and they are stupid. In both cases, it’s dangerous, “Jamie Dimon added.
In mid-December, the governor of the Bank of England refuses to see cryptocurrencies as a threat to financial stability. He notes, however, that because of their volatility, they behave more like stocks than currencies.
In 2017, the US bank Goldman Sachs has announced its intention to engage in trading cryptocurrencies to meet the demands of its customers.
In early December 2017, the Chicago Board Options Exchange (CBOP), the world’s largest futures market, successfully launched the (future) Bitcoin futures contract. Remember that a futures contract constitutes a firm commitment to buy or sell an asset (currencies, stocks, commodities,) on a date and a price agreed in advance. On the first trading day, the Bitcoin futures price rose to $ 18,500 and stabilized at the end of the trading session at $ 17,500, while the spot price was only $ 15,000 reflecting expectations at the end of trading. Increase of this currency. It should be noted, however, that CBOP had imposed significant margin calls to guard against any loss due to customer default.
At the end of November 2017, the French asset manager TOBAM launched the first European Bitcoin investment fund. This is an unregulated fund but approved by the AMF. The manager admits that the fund is exposed to a high risk due to the volatility of the cryptocurrency but that it offers advantages in terms of portfolio diversification in a global context of low returns.
Bitcoin does not only have friends. Several severe warnings were issued.
In November 2017, the Moroccan National Exchange Office announced the ban on transactions in all virtual currencies. Some Moroccan individuals or companies had indeed begun to accept payments in Bitcoin, especially with foreign companies, thus circumventing the strict regulation on exchange controls.
At the beginning of December 2017, the governor of the Banque de France, François Villeroy de Galhau, sends an extremely harsh warning against the dangers of Bitcoin: “There must be no ambiguity: Bitcoin is in no way a currency, or even a cryptocurrency. (…) It is a speculative asset. Its value and its high volatility have no economic base and it is nobody’s responsibility. The Banque de France reminds those who invest in Bitcoin that they do so at their own risk. ”
This warning echoes that of the vice-president of the European Central Bank, Vitor Constancio, who had previously said:
“Investors buying Bitcoin at such a high price are taking significant risks.”
The 2014 Nobel Prize in Economics, Jean TIROLE brings a triple criticized argument to Bitcoin, he announces that it should be banned:
- First, he warns about the risk of loss of value, stating that “Bitcoin is an asset with no intrinsic value, nothing protects individuals and financial agents from a possible collapse … Its price could fall to zero if trust in the system were to disappear “;
- He then warned against the possible drifts of the ICO: “announced as a tool of financial disintermediation, the ICO neglect the fundamentals of finance: the use of reliable and well capitalized intermediaries to monitor projects.”
- Finally, he questions the social role of this currency. “The creation of a currency should benefit the community through a government that directs a budget, monetary creation traditionally provides the government with additional resources.” With Bitcoin, we are witnessing the privatization of the currency: “Bitcoins are concentrated in private hands, which raise the question of public policies for anyone who sees money as a necessary complement to market economies.”
Several central banks believe that the development of cryptocurrencies could eventually pose a number of challenges including their ability to implement monetary policy by acting on interest rates to control the money supply and exchange rates. In addition, it would make it more difficult to collect statistics on economic activity used by states to guide the economy.
For the European Central Bank, Bitcoin is a preferred means of money laundering. However, anonymity seems relative, buyers or sellers can be identified at the time of transfer or conversion.
In conclusion, the risk is very high that the speculative bubble bursts because crypto currencies are not legal tender and their value is not supported by any underlying asset. When the price of Bitcoin stops rising, holders will start selling it in search of returns on other assets and a deflationary spiral will begin. The losers will be the last to buy.
Hello everyone! This is Richard Daniels, a full-time passionate researcher & blogger. He holds a Ph.D. degree in Economics. He loves to write about economics, e-commerce, and business-related topics for students to assist them in their studies. That's the sole purpose of Business Study Notes.
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