Bitcoin: Is It a Currency, or Something Else?

I’m going to go ahead and kick this hornet’s nest and see what happens.

Bitcoin.

There, I said it. Jamie Dimon’s diatribe yesterday got me thinking again about Bitcoin cryptocurrencies at large. I’ll be the first to admit that I am an old school currency trader--I know first hand there is little else that draws the admiration of the citizenry of an autocratic regime with a hyperinflationary monetary policy than the US dollar.

If you were bold enough to click through to that link, you see that there has been 1 million percent inflation in Venezuela since Hugo Chavez took power in 1999. But that was way back in mid-May--now it is 3 million percent and counting. The Venezuelan Bolivar lost 2/3s of its (already worthless) value in only 77 days.

When a third world autocrat implements capital controls, the objective is generally to prevent the citizenry from fleeing the local financial system for the safety and security of the US dollar. In Argentina, until early last year you couldn’t just waltz into a bank and ask to have your pesos converted into dollars--moreover, grain exporters couldn’t freely repatriate dollars without a morass of taxes and red tape. So even from a corporate perspective, you can see the power of a currency system that would enable you to circumvent government controlled financial systems.

And that’s what makes Jamie Dimon nervous!! Few banks are as highly levered to the interaction of the US and international financial system than JP Morgan. Freedom of movement and libertarian absolutism is the basic, global value proposition for cryptos in the foreseeable future.

So what is, or should, Bitcoin be worth? I guess I am old enough that I have to go back to my international economics textbook to match up Bitcoin with the definition and uses of a currency:

  • A currency is a medium of exchange that is used to buy or sell assets, goods and services. We think of it as being tied to a country or central bank, but it can be stuff like airline miles too--a currency I try to convert into dollars, magazines or airfares as quickly as a Venezuelan with a sack full of bolivars.
  • What is a good currency? A solid currency needs trust. The entity and monetary system backing the currency needs to be predictable, legally stable, and widely recognized. Some currencies FX traders think of as lousy currencies, like the Turkish Lira have depreciated dramatically--but are still legally recognized tender in the international financial system.
  • A good currency must be a store of value--as a TRY holder, I would have lost money in USD/TRY over the past several years, but I would have made some of that back holding TRY assets at much higher interest rates over the years--and I would have had the freedom to convert to USD at my pleasure any time during that period. So the currency held its value--it didn’t go completely to pieces like the currencies of Venny or Zimbabwe.
  • Most simply, the changes in value of such currencies are driven by trends in real interest rates and the domestic expected return on capital relative to foreign return on capital.

How does Bitcoin fit into that system? Here’s where I am going to throw out my fuddy duddy opinions and we'll see if the millennial set or the cryptocurrency true believers can set me straight.
  • Medium of exchange: Bitcoin has a $65bn market cap and trades millions of dollars per day. You can get online, set up a wallet and buy into it relatively easily and virtually anywhere.  That makes it a widely recognized medium of exchange. Sure, it is well off the billions of dollars traded every day in EMFX currencies or trillions in DM currencies. But it is growing and will probably rival small country currency volumes soon. So a modest but growing “check” here.  
  • Store of value: Ok, so help me out here--I am long bitcoin--what interest rate am I going to draw on that? Can I lend it out? Nobody is borrowing in bitcoin. I see value in using it as a dark-web currency but not as an asset. I understand the value in being outside the traditional financial system but the PBOC moves last week show that governments have an incentive to make lives difficult for crypto traders and ICOs, even if they can’t completely shut it down.
  • Which leads to the last bullet...Trust: Do I have any confidence in what it will be worth tomorrow?  Not really. Do I think it will be equally liquid and accepted non-country based asset, like gold? Not really. Will it be overwhelmed by some other cryptocurrency long-term? Maybe. Will governments and established banks crush or co-opt it? Maybe. The tin-foil hat crowd will be happy to opine on how this will be the first discussion topic at the next annual illuminati jamboree.

I'd love to buy into this--it really does appeal to my anti-establishment impulses. But I’m from Missouri on this one. Show me.

No interest rates, no monetary policy, no capital markets, no derivatives...but long on hope and the blockchain story. I don’t even want to get into the “fair value”, bubble talk, or astronomical recent returns--I just need convincing on how cryptos are defined as a currency, and how that will interact with the establishment.

And again to throw my lot in with Jamie--blockchain is a totally different topic--that is a technology that has enormous value for payment systems and corporate supply chains. Even if and when the technology is there to implement blockchain’s promise of the “smart contracts”, distributed bookkeeping, and real-time payments, I still want to get paid in dollars!

And I don’t think that is going to change in my lifetime. Am I just behind the curve here? Convince me otherwise!
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LDiracDelta
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September 13, 2017 at 9:53 PM ×

One thing BTC is, is a global, public ledger. This is just insane. Everyone in the world can see I'm buying a pepsi?!? If you try to anonymize transactions through "coin tumblers", you just look like you're laundering money, which you are.. I don't trust BTC because of that. Perhaps a different crypto-currency that supports transaction privacy somehow, like Monero. If the dark web thwarts its attackers, then perhaps anonymous transactions can be conducted outside the view of the government, though I suspect they will attack the whole system successfully in the long run.

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Polemic
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September 13, 2017 at 10:11 PM ×

Right . I'll wade in here as bitcoin is one of my pet bugbears.
Here you go -
Covers a lot of what you have touched on and easier to put this link in than rewrite

https://polemics-pains.blogspot.co.uk/2017/07/bitcoin-pick-number-any-number.html - Its basically like investing in Trevithick's first steam engine

And yesterday - covering the energy it uses - consumes same power as Jordan annually just to mine.
https://polemics-pains.blogspot.co.uk/2017/09/ramblings-of-mad-man.html


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Shawn
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September 13, 2017 at 10:58 PM ×

If you watch the talking heads on CNBC respond to what Dimon said, they say things like "the genie is out of the bottle." So get on this unstoppable rocketship before it reaches the moon, I guess.

Maybe it was just a poorly written article but per your point... the overstock.com guy doesn't explain 1) why they hold anything in BTC and don't convert it to USD immediately upon receipt. They take in the BTC asset and have a USD liability on the other side of the balance sheet. Maybe I didn't show up for treasury management 101 that day but that would be a fireable offense at any normal firm, or 2) how accepting BTC makes it "easier for people to spend their money".

Re: some of the arguments made in the comment section of your article, I'd throw my lot in with the counterargument that there is an infinite number of potential competitors, and thus, supply. I can see the network effects argument, and maybe that will eventually imply some intrinsic value similar to gold--I might update your steam engine metaphor to point out that MySpace had network effects...for a while. And AOL had cash flow, market share and the "walled garden" for a while...And GM had unbeatable economies of scale in the 60s, and...

lastly re: the point on electricity consumption, the Venezuelan government threw some guys in jail for running a mining operation using a ton of electricity heavily subsidized with money they don't have. I'm guessing that won't be the last we hear of that kind of thing.

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johno
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September 14, 2017 at 1:24 AM ×

Bitcoin. My question is: putting aside all the speculative/investment transactions, what is this thing actually used for? I presume a large portion of non-speculative transactions facilitate illegal activities, so I want nothing to do with it.

Back to old school ...

Where to begin? Last Friday just had that feeling. Too much fear and dread. Sold the long leg of +TY/-RX trade, but put back on this week. Shortly after the open Sunday I shorted TU, just as a "front-end is too flat" trade. It probably is, too! (seriously, recession risk seems low and the global context supportive, inflation is likely to turn up a bit, Yellen/Dudley seem to want to hike when the data next gives them a chance with a view to getting to 0% real). Since then, also sold my USDJPY RKI put spreads and have gone long USDJPY as a carry-efficient bet on some closing of the striking global PMI vs 10Y divergence.

Hasn't been all good trades. Gored in EURUSD. Got drawn into a cash long after the Draghi presser, thinking it cleared the way for the rally to carry on. For a time it did. And then it faded and I didn't cut quickly enough. The EURUSD RKI call spreads I have also looking less good now. And didn't pick the best spot to get short EURNOK. Hanging on as I'm not convinced one low inflation print has changed the narrative back to H1's.

In EM, my biggest (still modest) position is in USDARS. Initiated a couple days after the primary result and added the other day as I saw further evidence the currency has found its feet/the momentum has broken.

Gold seems too high relative to real rates and USDCNY, but not anywhere near high enough to make me think we're seeing some regime change. So looks like a fade here. More recently, I have found the CNH-settled HK gold contract and planned CNH-settled oil contract stories to be interesting, but probably not relevant yet. Also, the North Korea is to be watched for its US-China relations implications. I still presume when Mnuchin says [if China doesn't implement the UN sanctions]: "We will put additional sanctions on them and prevent them from accessing the U.S. and international dollar system," he's talking about sanctions against particular offenders like Bank of Dandong, not Chinese companies broadly? All this "weaponizing" of the dollar, now against China, makes me nervous about gold being used more. But for now, I still think the old regime obtains.

Not much showing for anti-Macron protesters today. The French perhaps questioning how much "Liberté, égalité, fraternité" there is in this "two-tier" labor market CGT fights for? But maybe I'm all wrong about that. Care to open my eyes?

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Eddie
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September 14, 2017 at 8:05 AM ×

Re intrinsic value of Bitcoin and friends...

On the Value of Virtual Currencies (De Nederlandsche Bank Working Paper No. 521)

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2842557

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Polemic
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September 14, 2017 at 11:07 AM ×

THanks Shawn seems as though we are on the same page and appreciate the tuning of metaphors.

Eddie - Thanks for that paper.
I tried to read it looking for the salient point but ended up deciding that the paper itself fell into the black hope of bcyrptologic itself .. HUGE amount of theory and wiggly symbol equations used to bamboozle the reader into thinking this is really clever but at the end of the day there is f all to it. Long intellect yet short value. ie . it still didn't tell anyone what the stuff is worth

caveat - I didn't go and research what any of those equations actually meant because there was no conclusion for me to go back to substantiate. And I wouldn't have anyway.

Now back to other stuff - base metals rolling over? Copper iron ? telling us something about the reflation trade in general or just China's control over commodity prices?



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September 14, 2017 at 11:42 AM ×

There's our pal , Polemic, back in town. How'd you over the Ascot carnival just gone. I member you asking for tips here once. No tips for you pal! not ever, and I'd love for you to jump over my desk ask one on one.

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September 14, 2017 at 11:50 AM ×

I don't tip for money...I tip to get on it.

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September 14, 2017 at 12:37 PM ×

Go on, tell me pal, who the fuck am I going to get on it with over there!

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Polemic
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September 14, 2017 at 12:45 PM ×

well I do like a tipple now and then.,

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September 14, 2017 at 12:48 PM ×

At tipple! fuck off. What are you going to tell your partner where you're been for last 5 days!

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September 14, 2017 at 1:03 PM ×

Well, if you can't spell it out to me.....good luck with your partner!

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Shawn
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September 14, 2017 at 2:16 PM ×

Yeah thanks for this paper--I read as much as I could tolerate before my second cup of coffee but did drop it in evernote for future reference...I think it somewhat conflates "price" with "value". They use the model to determine the exchange rate and use demand from "forward-looking investors" as one of the elements of the model. That's like saying "the price is high because lots of people are buying it." Seems like they have a model for determining a price--but that's not so hard when you can write off your alpha to "forward looking investors" regulating supply. They make the metaphor of a high-inflation, high-vol currency--which is relatively apt--but carry is zero like gold. Intrinsic value or underlying factors are to some extent the inverse of global monetary policy. Good stuff, but I'll stick to usd/ars and 20% annual carry, thanks.

That's the price--what I want to understand better is value--the intro also points out that online prices instantly adjust to the local currency. There aren't any trade flows settled in BTC, and no responsible treasury manager is going to hold BTC without that offsetting liability. But there is indeed value in the *system* of the distributed ledger and ability to transact outside the traditional banking system, even if you never run a long or short position.

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Eddie
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September 14, 2017 at 3:27 PM ×

*lol* I knew you would love it. Joking aside, the key takeaway for me was on p. 18:

"This pricing rule shows that profit-maximizing fees for each side of the market are equal to the cost of providing the service (Ci), adjusted downward by the external benefit to the other side, and adjusted upward by a factor ((1 − Fi)/fi) that is related to the elasticity of participation."

To rephrase it in a unscientific, i.e. understandable way: the price depends on costs for production (hardware, electricity), demand and the velocity of the transactions. Not unlike to a commodity approach, but somehow mixed with the usual PT=MV.

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Shawn
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September 14, 2017 at 5:22 PM ×

I think that highlights it is a commodity, not a currency. There is a relatively definable cost of production. There are people that can and will find value in the product or *service*. And there are people who will find value in the anonymity. The latter are the only group I can see with an incentive to be structurally long--and even then they should have the ability to rotate/launder the position back into the international banking system.

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johno
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September 15, 2017 at 12:06 AM ×

Stepped away to listen to Hendry's interview and returned to see the news on TOP. Feeling like putting on Mozart's Requiem or something. Really too bad.

In the interview, incidentally, he predicted the demise of global macro as a strategy, premised on low real returns in bonds. Reminded me of Alex Gurevich's chart of total returns to the carry trade in the 10Y. A huge tailwind to any fund having that trade in their book the last three decades ...

So, is global macro dead without a viable carry trade at its core, as Hugh suggests?


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SRX
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September 15, 2017 at 5:37 AM ×

There have been derivatives on this since around 2014 and you can infer a yield curve on it from the futures.

That said; is there a bubble? Probably. Is herd stupidity infinite? Probably.

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abee crombie
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September 16, 2017 at 5:31 AM ×

Simple argument to buy Bitcoin. Where else can you make 100x returns in short period. It's a big bubble but timing it is hard. Much easier to always leave some long. But this China news is big.

But Bitcoin isn't going away. Why own gold which hasn't gone anywhere in a while. Buy Bitcoin. Seriously. Why not put a small allocation. Or make a big speculation. Bitcoin appeals to many players, so you have to understand them all, since it's a long only market. The technology is a big deal even if it consumes energy and isn't as efficient as a database. The point is that it's open, decentralized and rules based. What do you prefer, the rand, yuan, real, euro, dollar, gold. Sure there could be a new version of Bitcoin which renders the current one useless, but for now that doesn't seem to be a worry.

Also the comments of no interest , capital markets etc show just how much potential there is. Both are already established but yet not well understood..

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