A financial transaction is an agreement, communication, or movement carried out between a buyer and a seller to exchange an asset for payment.
In ancient times, paper and coin were not the only form of money. Cowrie shells, Rai stones, rings, tobacco, knives and even human slaves have been used as forms of currency around the world. Along with globalisation and the internet boom, lots of financial innovation followed over the years to improve the ease and efficiency of transactions, such as gold, government-backed paper currencies (Fiat money), ATMs, phone banking, internet banking, credits cards, and online money transfer services like Paypal.
All of these have brought convenience to people’s lives. However, there were sceptics in every financial innovation throughout history, all surrounding four main issues:
- Trust and security
- Reliability – can it be counterfeited?
- The divisibility of the asset (ease of transaction)
- Store of value
In January 2009, the bitcoin – deemed to be one of the greatest financial innovation in the 21st century – was released. Many of its characteristics allowed it to be the solution to the four main issues mentioned, but it didn’t gain popularity immediately. Understandably, most people don’t get it. It is technical, and a lot of people cannot conceptualise what a ‘digital’ currency even is. Below is a simplified summary of its advantages:
- It is decentralised, meaning that the bitcoin network isn’t controlled by one central authority, so no one has control over it, unlike fiat money controlled by central banks
- It allows peer-to-peer transfer, removing the need for third parties like banks to approve transactions
- It cannot be forged with its proof of work system, and it has the reach of the internet
- It is scarce in a sense that it is limited to 21 million bitcoins ever created by miners, and it can be divided to one hundred millionth of a bitcoin easily
Its properties allow it to be one of the best financial transactions of all time. It provides speed, lower cost, trust, security, fewer errors and the elimination of central points. There are unlimited opportunities in the bitcoin protocol.
For example, it can be applied to the Global Aid sector to deliver funds in the cheapest and most efficient manner to those who have suffered in the face of natural disasters. The funds can be tracked with the transparency of the blockchain technology – which prevents the funds from being misspent and deters corruptive attempts from the local agencies.
However, there are always some limitations involved, namely security issues on the third party bitcoin platforms (e.g. Mt. Gox), money laundering and maybe unknown flaws in the code which allows hackers to exploit it (e.g. the DAO attack). There are lessons to be incorporated into the next generation of cryptocurrency and related services, but one can be sure that the blockchain technology is here to stay.
Investing In Bitcoin
Now to the main question: is it an asset one should invest in? Looking at the global markets, there’s lots of fear, uncertainty and doubts, worries about the equity markets and people fleeing into bonds. Starting with the fall in oil prices, the risk of Grexit, the China stock market crash and its economic slowdown, the prolonged dovish statements from the US Feed on the possibility of a rate hike, and Brexit. Here’s a simple timeline on relevant news that affects the price of the bitcoin.
Why did the possibility of Grexit affect bitcoin prices? A simple explanation is that Greek citizens buy bitcoin to get around capital controls on finances.
“The measures, which were announced in the dead of night, limit daily cash withdrawals to 60 euros ($66) and ban payments and transfers abroad. The stock market and banks will be closed at least until July 6, the day after Greeks will vote in a referendum on proposals needed to restore bailout aid.”
The ATM withdrawal limits prompted citizens to convert their currency into bitcoin, which was more accessible than the euro at the time. It indicated that people tended to embrace bitcoin in times of tightening financial regulations or currency devaluation.
Another important market player was China. In the summer of 2015, the Shanghai composite index crashed. On August 11th last year, along with fiscal stimulus and a set of regulations, the People’s Bank of China allowed the yuan to depreciate almost 2% against the dollar, the biggest one-day drop since 1994, sending a shock through currency markets. To make sense of the scale, it fell 0.7% during the global financial crisis in December 2008. It raised questions for Chinese people and investors around the globe about not only the currency but also the direction of the Chinese economy and even the system.
Investors were worried about the decreasing value of the yuan. They were protecting their investments by converting yuan into bitcoin. But why didn’t they convert to other safe haven currencies like the dollar?
Officially, China has maintained quasi-capital controls for years: no individual is allowed to move more than $50,000 out of the country in any given year (Chinese companies can exchange yuan for foreign currencies only for approved purposes).
Bitcoin allows the Chinese to evade capital controls, and acts as a hedge against depreciation. These fuelled to the rise of Huobi and OKCoin, two Chinese exchanges, which collectively account for 92% of global trading in bitcoin.
Ahead of the Britain EU referendum, the fear and uncertainty led to a surge in bitcoin prices. Following the Brexit vote, the EU markets plummeted, and the pound dropped 8% overnight. At the same time, bitcoin prices rose 9% and continued to surge for several days following the vote, as the possibility of a European turmoil increased. Meanwhile, gold prices also rose 8%. This showed that bitcoin might have become Gold 2.0. It gained strength when every major economy in the world was weak. This raised another question: is it a new safe haven asset like gold and the yen?
Safe haven is defined as “an investment expected to retain its value or even increase in value in times of market turbulence.” The bitcoin seems to fit the bill, and therefore it has become a popular discussion across the forums.
Generally, there are four main criteria associated with safe havens:
- Stability (including political and economy)
- Hedge to global risk
Central Banks Are Taking Away People’s Wealth
All around the world, expansionary monetary policies from the Central banks have been taking place, devaluing and decreasing the purchasing power of its citizens:
- ECB – Deposit facility at -0.40%, Governing Council confirms that the monthly asset purchases of €80bn are intended to run until the end of March 2017.
- BOJ – Interest rate at -0.10%, QE of ¥80trn annually began in 2013, Abenomics had arguably failed to devalue its currency, as the global market uncertainty pushed the investors to the yen as a safe haven asset. It has failed to boost growth as well, and its debt level increased to twice the size of the economy. With its risk-adverse ageing population, it is tough to boost spending.
The ‘cheap’ money will depreciate the yen, and investors will have doubts about whether yen is a safe-haven investment. If the central banks are continuing to print money for QE, the value of their fiat money will further decrease. It gives the investors more reasons to go long on bitcoin and other cryptocurrencies. The value of bitcoin wouldn’t decrease since it is decentralised and has limited supply.
How does bitcoin fare against hyperinflation countries? There are countries like Venezuela, with a 481.52% hyperinflation over the year since the price of oil dropped. This has taken to 70% of the population into poverty, and it has led to babies dying in large numbers because of the lack of simple medicines in hospitals. The IMF projects price hikes of 720% this year and 2200% in 2017, as well as a GDP decline of 6%, following the 10% drop in 2015.
With strict capital and currency controls, citizens have no way to store their wealth in a stable store of value, as they have no access to other currencies and asset classes. It’s no secret that Venezuelans try to hoard dollars and euros in large amounts, but holding large amounts of cash in one’s home can be risky. In these types of financial situations, holding independent currencies like bitcoin will allow them to bypass banks and capital controls, and is, arguably, safer than storing cash at home. Although bitcoin’s prices are volatile, it has a high international conversion rate and liquidity, which would greatly benefit the Venezuelans. There are ways to trade hard assets like real estate and precious metals for bitcoin, which can be sold during hyperinflation as the local currency devalues rapidly. Online freelancers can reach out and request for a bitcoin-denominated income. Merchants could start accepting bitcoin directly if it is not banned by the government.
In the times of political instability, an unreliable government and central banks, bitcoin is the solution. The huge premium from the market price of bitcoin in these countries with their local currencies has proven the booming demand and acceptance of the cryptocurrency.
Safe haven or not, investors are buying bitcoin when fears, uncertainty and doubts about the economy spike. In addition to the benefits of helping developing countries lighten their crises, there is a huge amount of start-ups related to bitcoin with the potential to reinvest the whole finance industry and change the way we transact in a revolutionary way. Therefore, one shouldn’t suppress but embrace the bitcoin, and its underlying Blockchain technology. It is the future of finance.