Last year I wrote a few articles discussing the origins of money and how its development arose from the need to have some sort of commonly accepted medium for storing and exchanging value, led by governments who could enforce and guarantee the value of currency. More generally, this is the case for the vast majority of assets as there must be some guarantee of value before a counterparty would be willing to make a trade: a stake in a company for shares, the right to collateral for debt and a government backing for fiat currencies. Rationally it doesn’t make much sense for people to use something without any form of intrinsic value or guarantee as a medium for exchange.
One of my interests is exploring these anomalies in the economy and it just so happens that such a currency has emerged: it is called the BitCoin, a virtual currency which can be created and used by running a program on your average home PC.
Not only does it not have any form of guarantee whatsoever, which the creators are very open about, there is no centrally organised exchange for the production, regulation or clearing of transfers of this ‘currency’. Everything you could ever want to do with it is done on a complete ‘peer-to-peer’ basis with other people who are also running the BitCoin program. You can get more detailed information here and here, but suffice to say that the program slowly generates unique ‘Coins’ or serial numbers protected by encryption, which you can trade.
The whole concept might sound outlandish, but the really interesting part is that the BitCoin has been rapidly gaining popularity and attention in the past few months, with the spot price for buying these Coins using USD or other currencies going through the roof (Fig 1) in the past two months accompanied by a similar percentage increase in the number of users. Whilst previously seen as a novelty or medium for exchange of less than legal goods due to the anonymity it provides, with the increase in adoption services which accept BitCoin as payments now range from anything from pizza to gold.
This is an interesting phenomenon because its popularity coincides at a time where faith in governments around the world, primarily in the Eurozone, and their ability to back their currencies is being tested. For those who would bet against the Euro a currency completely outside of the influence of central banks, financial instructions and other forms of authority presents a unique asset class for speculating on. By following the timeline (a very accessible version here) of the Euro Crisis over the past two months mainly with respect to Cyprus, we observe an interesting correlation (Fig 1).
The need for a bailout of Cypriot banks was first noted by its government back in November 2012 to little fanfare. However as the issue dragged on, we observed the trend of an increase in the value of BitCoin whenever news regarding Cyprus’ contemplated exit of the Eurozone was released. Of note is the perception that Cyprus is an offshore tax haven for Russian interests, causing the government to issue a disproportionate reaction relative to the size of the bailout needed to rescue Cyprus. Following up on Google shows that the majority of search terms for BitCoin in the past month (Fig 2) originates from Russia, which may or may not be related to the rapid rise in BitCoin’s exchange value.
The fact is, as an asset class BitCoins managed to reach 1 billion USD market capitalisation from 200 million over two months, one of the fastest increases in history. Could this be an indication of a lack of confidence towards governments that will continue in the long run? Or is the recent spike purely the work of speculators? Most likely without intending to, the creators of BitCoin have set up what is potentially one of the most interesting experiments in the field of economics. Time will tell if this is the next currency revolution or just another bubble waiting to burst.
Graphics and sources:
Source: Blockchain, Guardian UK
UK Guardian Euro Crisis Interactive Infographic:
Official BitCoin Site: