Bitcoin: bubble, trend, new currency or pyramid?

Beyond its financial aspect, the bitcoin has become a social issue. Not a day goes by without the topic being discussed, for better or for worse, by a variety of protagonists including financiers, politicians, academics and computer scientists. Dr Luc Neuberg, CEO of BCEE Asset Management, gives us his view on the potential impact of this asset’s future trend on traditional investors, whether they own bitcoins or not.

What does bitcoin mean precisely?

The bitcoin is an example of a cryptocurrency[1]. Created after the 2009 financial crisis, it is the fruit of an idea formed by an IT engineer, or a group of engineers, known by the code name “Satoshi Nakamoto”. The bitcoin draws on a decentralised open-source software system for its functioning. When it was created, the objective of the bitcoin was to provide an alternative to traditional currencies for all holders with access to an internet connexion. The bitcoin was generated and circulates using blockchain technology which enables transactions to be validated without the intervention of a bank.

Each member of the community can approve a transaction by adding a block to the existing chain and thereby finding a unique identifier, or key, designed to name the new block.

The process involves resolving a mathematical equation which becomes increasingly complex as the chain grows. IT capacity requirements surge as the chain becomes more complex, with the quantity of energy required increasing exponentially. There are currently around 16.7 million bitcoins in circulation.

To satisfy the wishes of its creator(s) the total number of bitcoins in circulation will be capped at 21 million.

How could this asset impact traditional investors?

In terms of its economic aspects, bitcoin critics primarily condemn its incapacity to serve as an exchange currency for a significant volume of commercial transactions, even though there has been some progress. Furthermore, its value is totally decorrelated from any specific inflation rate and this factor raises questions over its reality. Are we dealing with fake money or a tangible currency and what are the risks incurred by the markets with this electronic coin in free circulation?

Almost all financial securities are currently experiencing a period of very low volatility. However, the bitcoin’s volatility has spiked to over ten times the level of traditional currencies. In addition, bitcoin forward contracts have been listed on the Chicago Board Options Exchange. This event only amplified the phenomenon and above all established a direct link with traditional currencies. Against this backdrop, market risk seems very high.

As regards regulatory risk, governments have not clearly announced their position in terms of applicable regulations.
Dr Luc Neuberg - CEO BCEE AM
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A recent study by the Cambridge Centre for Alternative Finance states that almost three million people are digital currency account holders. According to Bloomberg, 40% of bitcoins are in the hands of just 1,000 owners, whose majority are IT technicians for whom investment expertise is unchartered territory. Concentration risk is therefore just as much of a concern, as the consequences of decision-taking by these majority holders will weigh heavily on the security.

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What about security?

Its status as a decentralised open-source software means that the bitcoin is inevitably vulnerable. In terms of security, the current context is obviously an open invitation to bugs, pirating and the adoption of new versions. Moreover, its functioning seems somewhat opaque for holders, notably in terms of obtaining proof of bitcoin ownership or setting terms for buying and selling.

Decentralised open governance also implies operational risks. If the software breaks down or malfunctions, no one is really responsible for resolving the crisis. Nobody can legitimately act as the software arbitrator, while the developers managing the bitcoin blockchains appear to have more of a proven track record in computer coding than in risk management policy for financial market infrastructures.

Given the above comments, and even if we are not bitcoin holders, let's remain wary of the risks that we may incur from its future trend.
Dr Luc Neuberg - CEO BCEE AM
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[1] Much has been written about whether the bitcoin can be classified as a currency or not. In this article, we have sought to provide a broad outline of the technology underlying the functioning of the bitcoin.