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Are Cryptocurrencies Enduring?

bitcoin title image.jpg

Bitcoin is all the rage these days. But what is it exactly?

Bitcoin is one of hundreds of Cryptocurrencies that have developed over the past decade and for the purpose of simplicity, are digital/virtual assets that purport to store value. A common characteristic of cryptocurrencies is that they are all decentralized, math-based digital assets in which transactions can be performed cryptographically without the need for a central issuing authority, such as the US Treasury, in order to exist. They all use a block chain, which is the concept that the ownership is tracked since inception and represents true and unalterable record. Unalterable in theory since the data exists throughout the network and is not centralized.

However, what is it purpose and therefore its intrinsic value? Here are a few of our thoughts on a way to frame this relatively new asset.

We view the entire world of investable assets into three broad categories: Equity (stock), Credit & Currency (Bonds) and Hard Assets (commodities and collectables). Virtually every conceivable investment can neatly fit into one of these broad buckets and those that don’t, such as a convertible bond can be deconstructed into its basic elements and those pieces can be easily categorized. However cryptocurrencies such as Bitcoin do not conveniently fit into these conventional buckets and therefore lack a convention method to value the opportunities and risks.

Bitcoin is clearly not an equity as it does not represent ownership of business. It is hard to define as a credit since there is no identifiable issuing entity who records the instrument as a liability with defined obligations. It is also challenging to identify this as a commodity in the traditional sense it is not tangible. Last time we checked, cryptocurrencies are not listed on the periodic table found in chemistry class rooms.

That leaves the label of a currency as the last plausible item. Here it also lacks basic characteristics that have developed in modern times. It is not issued by a sovereign entity, regulated by any recognized body or protected or supported by any government. Money represents a store of value that can be exchanged for goods or services. What makes traditional currencies work is our shared confidence (or lack thereof) in the issuer and its economic and political outlook. For example, there is a reason the Swiss Franc is highly valued as a currency. The country has been around in its current form for more than 700 years, has avoided two world wars, has a highly developed legal system and operates in a very fiscally responsible fashion.  Although small, the country and currency provides unparalleled stability leading many to pay in order to hold the Franc. The biggest risk we perceive for Bitcoin is the concept of substitution. There are a finite number of Bitcoins that can be created by computers, but the number of digital alternatives are nearly limitless. A year from now, who is not to say that Ethereum or litecoin are not the preferred mediums.

Below is a chart showing the price of the Bitcoin Investment Trust (GBTC), an Exchange Traded Fund that is designed to track the price of Bitcoins in US Dollars. The trust commenced trading in 2015.

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Source: Blomberg LP

It is worth noting that the IRS ruled in 20124 that bitcoins will be treated as property as opposed to currency for tax purposes. That means in the eyes of at least one department our government, it is viewed more like real estate rather than a means to purchase groceries or a car.

Our answer to the title of this post is yes, they are enduring. However, the issues that cryptocurrencies are posed to solve will inevitably lead to new and different challenges and along the way, we will likely experience continued volatility.

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