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Bitcoin: A Cryptocurrency or an Asset Class?*

CASE STUDY, MANAGERIAL ECONOMICS
ET Cases - FLAME, 10 Pages
AUTHOR(S) : Dr. Abhay Kumar - Assistant Professor, Anubha Agrawal, Bhavya Gupta, Gaurav Shah, Vinayak Nautiyal - Students, NMIMS University

Case Preview

Bitcoin: A Cryptocurrency or an Asset Class?

 

The Reserve Bank of India had cautioned the users, holders and traders of virtual currencies, including bitcoins, about the potential financial, operational, legal, customer protection and security related risks that they are exposing themselves to, vide its press release dated December 24th 2013. The Reserve Bank of India had clarified that it has not given any license/authorization to any individual/entity/company to deal with Bitcoin or any virtual currency. The Central Bank of India clarified that any user, holder, investor, trader, etc. dealing with virtual currencies will be doing it at their own risk.

In the midst of mounting political and market risk following Brexit, Demonetization, US elections, stringent immigration policies, uncertainties in commodity prices, Mr. Malhotra, an entrepreneur, approaches Mr. Iyer, Vice President of Young India investment bank seeking his advice for investment and diversify his current portfolio. Mr. Iyer, after analyzing the needs of his client, Mr. Malhotra, and general market conditions, suggests him to invest in an emerging digital asset “Bitcoin”. However, Mr. Malhotra was skeptical as he thought that bitcoins are highly volatile, unsafe and unreliably priced. Mr. Iyer informs Mr. Malhotra about the recent developments of various bitcoin products like formation of ‘Digital Asset and Blockchain Foundation of India’ (DABFI) to raise awareness about the risks and benefits of digital currencies, lobby with the regulators and self-regulation on trading of bitcoin and other such cryptocurrencies. Therefore, in order to convince Mr. Malhotra about growing popularity of bitcoin among investors, he exemplified various nuances of bitcoin as asset and currency..................

Introduction and Background

On October 31st 2008, an anonymous cryptocurrency expert using the pseudonym Satoshi Nakamoto posted a whitepaper called “Bitcoin: A Peer-to-Peer Electronic Cash System” on a cryptography discussion group, outlining a new cryptocurrency called bitcoin. Bitcoin is an open source P2P payment network that enables a new secure and digital payment mechanism. Bitcoin is completely virtual and decentralized money. It is driven by its users around the world with no central bank as its guarantor. From a layman’s perspective, bitcoin is just a secure currency that can be transacted using a mobile wallet without anyone identifying the individual behind the public address of the wallet.............

Bitcoin as an Asset Class

In order to justify investment in bitcoin, Mr. Iyer compares various features of an asset class with bitcoin.

I. Liquidity and Opportunity to Invest

Exchange traded volume of bitcoin depicts the liquidity available to the investors. A robust environment has grown in the past 9 years and therefore giving a chance to the retail investors, to drive millions of dollars in daily liquidity.............

II. Risk and Reward

Risk is measured in terms of volatility and the reward in terms of absolute returns. Volatility is one of the imperative characteristics of bitcoin to be considered while making investment. Bitcoin is traded 24 hours and its daily price movements can go as high and low as 50%, which rarely occurs in case of any other asset class......

III. Politico-Economic Factors

Bitcoin is delineated from other asset classes on the basis of value, governance and its applications. Donald trump when elected as the 45th President of USA, the behavior of bitcoin mirrored other asset classes such as gold,.............................

IV. Price Independence

The correlation between the assets defines the market behavior. +1 signifies that the assets are correlated positively and -1 indicates that the assets are negatively correlated. The overall risk of the portfolio decreases as the correlation between the assets gets more negative leading to diversification of the portfolio. Bitcoin is the only asset that sustains minimum correlation with other asset classes as can be seen from the correlation table (Exhibit VI). This shows the independent behavior of bitcoin within the capital markets...............

After discussing all the features of Bitcoin, Mr. Iyer advises Mr. Malhotra to invest atleast 10% of his investible amount in this new asset class i.e Bitcoin. He emphasises that investment in Bitcoin is going to provide him real hedge against inflation...................

Assignment Questions

I. Do you think Bitcoin is better than fiat currency?
II. Do you think Bitcoin is more secure than fiat currency?
III. ............

Exhibits

Exihibit I: Journey of Bitcoin

Exihibit II: Daily Liquidity (Trailing Three Month Average)

Exhibit III: Market Price (USD)

Exhibit IV: Sharpe Ratio

Exhibit V: Global Daily Bitcoin Volumes: Trading Relative to Transacting

Exhibit VI: Correlation Matrix

Exhibit VII: Return & Risk of Bitcoin, Assets and Alternative Investments

Teaching Note Preview

Bitcoin: A Cryptocurrency or an Asset Class?

 

Synopsis

Bitcoin, a cryptocurrency, is a reward to the miners who finds solution to the mathematical puzzle. The process is very competitive and decentralized and known as mining. The bitcoin earned is credited to the bitcoin wallet of miner who can use it for transaction over 100,000 merchants and vendors or exchange it to another currency over specified stock exchanges or can keep it as an investment. The case endeavors to discuss the utility of bitcoin as a currency for medium of exchange or as an asset for investment to earn higher return or as a means to diversify the portfolio and minimize the risk.

Pre-requisite Conceptual Understandings

Currency and its functions from any Macroeconomics text book.

Case Positioning and Setting

This Teaching/ Research Case can be used as a Business Management Case for both first year MBA students for the course like Economics and second year MBA students for the elective course like Security Analysis, Financial Planning and Portfolio Management to elaborate the following topics:

• Characteristics of currencies
• Definition and function of money
• Difference between money and currency
• Monetary policy, fiscal policy and money supply
• Return and risk of assets
• Creating and managing portfolio

Expected Learning Objectives

• Understand the concept of Bitcoin
• Understand the economy as a whole and currencies in particular
• Understand the behaviour of assets

Assignment Questions

I. Do you think Bitcoin is better than fiat currency?
II. Do you think Bitcoin is more secure than fiat currency?
III..........

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Abstract

Bitcoin is a digital asset and a payment system classified as a decentralized digital currency. It is a form of digital money with decentralized ledger that keeps a record of each peer-to-peer transactions. It is an open source software that is owned by no person or company. It is also not backed by any Central Bank and anyone can verify payment and record the transaction into the block chain. Each of the coin has a unique block chain. It is created by miners electronically and is traded through computer networks.

The cryptocurrency, being a peer-to-peer system, transactions can be done without any intermediary like a Bank or PayPal. It is taken as a blend between fiat currency and commodity currency and is independent of monetary or government authority. Bitcoin prices have jumped from almost 0 in 2009 to $1200 in 2014, thus, giving astonishing returns. Currently, it is used worldwide as a mode of payment with Microsoft, PayPal and even US Federal Election Committee accepting Bitcoin in payments. The Bitcoin distributed ledger can be accessed by anyone to know which public key holds how much but the true identity behind the public key cannot be known; just like the creator of Bitcoin is unknown. This study is intended to determine whether Bitcoin is a cryptocurrency or an asset class.



Pedagogical Objectives

  • To understand the concept of Bitcoin
  • To understand the economy as a whole and currencies in particular
  • To understand the behaviour of assets

Case Positioning and Setting

This Teaching/ Research Case can be used as a Business Management Case for both first year MBA students for the course like Economics & Statistics and second year MBA students for the elective course like Security Analysis and Portfolio Management to elaborate the following topics:

  • Characteristics of currencies
  • Definition and function of money
  • Difference between money and currency
  • Monetary policy, fiscal policy and money supply
  • Creating and managing portfolio
  • Return and risk of assets

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- Abstract
- Case Study
- Teaching Note (**ONLY for Academicians)
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