Global Rates & FX Research
11 February 2014John Normand(44-20) 7134-1816 email@example.com
Introduction: the most audacious currency since the euro
Unlike other asset markets, FXrarely welcomesnewcomers for the simple reason that launching a widely-used currency traditionally requiredcreating a sovereign or supra-sovereign entity with a central bank to issue the unitand manage its supply over time. The world’s last new currency was the euro launched in 1999, though it has simply replaced18 national onesas countries joined EMU.
audacity of bitcoin: it isastateless, virtual and peer-to-peercurrency.
Itexists only digitallyrather than physically; it is created via an algorithm and a network of programmers rather than by a central bank; and it is transferred directly amongst this network of programmers, consumers and corporatesrather than through the traditional third-party banking system.
It is also
(dailyturnover equivalent to the Mauritius Stock Exchange),
(20times more so than theyen) and
(allegedly only preferred bycriminals,libertariansand anarchists). After a brief Economics 101 refresher on the required functions of money (medium of exchange, unit of account, store of value), this research note addresses various
frequently-asked questions around this virtual currency.
These include: whatis it; how is it created and transferred; what are its advantages and disadvantages for corporates and investorscompared to fiat currencies; is it a serious contender for a global payments system; and can it prove more durable long-term than other somewhat fixed-supplycurrencies like gold. At the risk of sounding likea ludditeunable to recognise the transformative effects of evolving technologies –similar to the late 1970s prediction that “there is no reason forany individual to have a computer in his home”
–bitcoin looks like aninnovation worth limiting exposure to. As a medium of exchange, unit of account and store of value, it is vastly inferior to fiat currencies. Their greatest appeal is the
apparentcheapness of peer-to-peer fund transfers
, though it is unclear how economical these transactions truly are when the virtual world interacts with the real world. For
, the cost-benefit around bitcoin must weigh low transaction costsplus brand recognition from trialing a new technology against extreme illiquidity andvolatility,
We ignore the trivial case of the South Sudanese pound created in 2011 when South Sudan gained independence from Sudan.
The euro's launch was rather audacious too. Who would have thought to form a currency union without a central fiscal and political authority? Critics lined up in the early 1990s well before the euro's launch, though their predictions of inherent instability required ten years and two recessions to be provencorrect.
Ken Olsen, founder of now-defunct computer maker Digital Equipment Corporation in 1977.
Chart 1: Bitcoin’s daily turnover has averaged about $20mn over the past year with extreme volatility
Bitcoin price in USD versus average daily turnover in $mn. Turnover is based on the sum of three largest bitcoin exchanges (mtgoxUSD, bitstampUSD and bitceUSD) comprising about 70% of exchange-traded activity.
Source: J.P. Morgan
Chart 2: Bitcoin is over 20times more volatile than USD/JPY
3-mo realised volatility; note difference in scales
Source: J.P. Morgan
which impede risk management. A consumer’s trade-off is between lower transaction costs and the risk of operating in a payments system which lacks deposit insurance.
would normally avoid an instrument with bitcoin's trading properties. The unit's main investment appeal is the potential long-term price rise due to limited supply, much like some commodities when the market balance tightens.
Making money the old fashioned way
A discussion of bitcoin should begin with an Economics 101 refresher on money
what it is, how it is created and why we hold it.
The classic definition of money is anything that serves as
medium of exchange
unit of account
store of value.
medium of exchange
can be anything deliverable for a good or service, whether a mundane object, a precious metal or piece of paper. In all