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
