WEEKLY E-MAIL

19 October 2017

WHAT IS BITCOIN?

By Patrick Malcolm

Bitcoin is a worldwide cryptocurrency and digital payment system called the first decentralized digital currency, as the system works without a central repository or single administrator. It was invented by an unknown person or group of people under the name Satoshi Nakamoto and released as open-source software in 2009. Transactions take place between users directly, without an intermediary. These transactions are verified by network nodes and recorded in a public distributed ledger called a blockchain.

As noted in a recent article in the Wall Street Journal, with bitcoin up more than fourfold this year and a series of high-profile “initial coin offerings” raising more than US$2 billion in total, the number of investors interested in digital currencies has been picking up.

Bitcoin has a history of price swings related to security breaches, hacking and regulatory scrutiny and action. Trading for about US$13.50 at the beginning of 2013, it soared to more than US$1,200 before falling about 50% that December after China’s central bank barred financial institutions and payment companies from handling bitcoin transactions.

In early 2014, it plunged again when Tokyo-based Mt. Gox, one of the biggest bitcoin-trading platforms at that time, filed for bankruptcy protection after being beset by security breaches, theft and shutdowns. Bitcoin declined nearly 40% from February 1 through the end of March 2014.

Regulatory uncertainty is another risk factor. Government authorities could restrict or control the use and sale of bitcoin or other digital currencies.

No US funds currently track bitcoin, but several firms are trying to bring such investments to market. Regulatory approval of cryptocurrency investment funds could bring legitimacy to the asset, or rejections could shake investor confidence.

When an application to bring a bitcoin exchange traded fund (ETF) to market was initially denied by the Securities and Exchange Commission (SEC), bitcoin, which at that time had been trading as high as US$1,326 in anticipation of an approval, fell to as low as US$1,022. The SEC decision on that ETF is currently under review.

Similarly, the price of bitcoin and another popular cryptocurrency, ether, tumbled in late July 2017 after the SEC indicated in a report on a specific coin offering, called DAO, that U.S. federal securities law may apply to some cryptocurrency activities, which could bring heightened scrutiny.

In September 2017, bitcoin’s price plummeted for days after China said it would shut down the country’s bitcoin exchanges. The virtual currency recovered, then faltered again when South Korea said it would ban raising money through all forms of virtual currencies.

There’s also the threat of hackers engineering a theft, operational glitches and stolen security keys. There have already been several costly thefts of the currency.

Darker threats lurk as well. Among bitcoin’s benefits are its low-cost, anonymous payments, which are conducted with no intermediary. Those characteristics make the currency efficient and transferable but they also mean it could be used on the black market or for money laundering and other illegal activities.

As recently reported in the Wall Street Journal, at a conference in Washington, Jamie Dimon, the chairman and chief executive of JPMorgan Chase, noted recent moves to curb the circulation of bitcoin. These were signs of authorities getting a proper grip on virtual currencies, he said, because “they like to know where the money is, who has it, and what you’re doing with it”.

“But what is the use case for bitcoin? You’re in Venezuela, North Korea, you’re a criminal. Great product!” he said.

Mr Dimon’s stance was endorsed on stage by Larry Fink, chairman and chief executive of BlackRock, the world’s largest asset manager, who likened the price of bitcoin to an “index of money laundering”. The price of the virtual currency, “just shows how much demand for money laundering there is in the world”, Mr Fink said.

There are a number of market and regulatory risks inherent in trading cryptocurrencies. We believe that they remain speculative bets that investors should be wary of or avoid altogether.

Patrick Malcolm
Partner
Certified Financial Planner®
SMSF Specialist Advisor™
Authorised Representative No. 278061

If you have any questions or comments, please email me at patrick@gfmwealth.com.au

Disclaimer: This document is not an offer or invitation to any person to buy or sell any interest in or deposit funds with any institution. The information here is of a generic nature, and does not take into account your investment objectives or financial needs. No person should act upon this information without firstly seeking competent, professional advice specifically relating to their own particular situation.

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