Bitcoin (BTC) is a virtual currency that was initially created for peer-to-peer e-commerce, to replace the costly and frequent currency conversions required to transact across borders. It has been in existence (or, you could say, ‘circulation’) since 2009, but has seen a major uptick in interest in the past few months. It is highly polarizing topic, and viewpoints from both ends of the spectrum abound. In fact in just one day in May 2013, Bloomberg carried a byline from a prominent venture capitalist stating that he’s investing in bitcoin, while the UK’s The Guardian breathlessly reported that “Bitcoin will continue to function beyond the reach of government and law.”
portals allow conversion to bitcoin from any market currency and, once held, bitcoins are electronically stored without the need for a bank account. As a result, bitcoin and other electronic currencies minimize storage and transaction costs (presuming much of one’s business is in bitcoin) and offer another alternative to manage currency risk.
For corporate finance, it is incredibly difficult to justify the use of bitcoin or other virtual currencies due to their effect on corporate liquidity and counterparty risk. However, it is worth expanding on both the positive and negative impacts of the bitcoin, from a corporate finance perspective.
Because bitcoin floats against every currency and isn’t tied into any country’s economy, it is by definition insulated from the effects of fiscal/monetary policy and economic events (for example the EU debt crisis). Supporters will argue that shifting balances to bitcoin will protect against dips in currencies because the bitcoin, in effect, doesn’t move – every other currency moves instead. While currency transfers to the bitcoin are obviously speculative, some suggest that if done properly it is yet another tool within an FX manager’s toolkit.
However, bitcoin’s value is volatile, driven by factors in many cases outside the typical supply and demand for the currency itself. Recently, trade in bitcoin has been significantly influenced by news that regulatory bodies (including the U.S.) see the virtual currency as a haven for money laundering. This volatility is highlighted by this graph of the BTC-USD exchange rate
. In 2013 alone, its value has increased from under $20 to over $260 and back down to $50 then up to $130, with more than 65 percent swings in the course of a single day’s trading.
Lack of liquidity
For corporate FX managers, the bitcoin is not a substantial alternative to “real” market currencies due to the lack of liquidity. The amount of bitcoins in existence is low (approximately $1 billion worth, at early June exchange rates), which obviously makes it difficult for companies of any meaningful size to be able to trade. Although the availability of bitcoins will increase over time, half of the total volume of bitcoins which will ever be released (or “mined
“) is currently on the market (11 million of 21 million). So, unless the value of bitcoins follow the same trajectory, as, say Berkshire Hathaway shares
, it’s unlikely ever to have enough volume to be viewed as a serious global business currency. In fact, the lack of supply is one of several reasons why many suggest that bitcoin and its peers behave more as commodities than currencies.
Lack of an established market
The lack of market participants is just as significant an issue. Banks aren’t involved in bitcoin, meaning that a corporate looking to transact has limited options. While a handful of online FX portals will trade virtual currencies, the lack of system integration and formalized confirmation procedures significantly increase the time and effort for corporates to complete their diligence and regulatory compliance to support these transactions. Combine this with the lack of a derivative market – a must for corporates who are required to hedge projected currency balances – and the tools simply aren’t there for a corporate to reliably utilize the bitcoin.
While bitcoin may do a great job of protecting against sovereign risk, reputational risk remains an issue in its infancy. Combine that with the lack of liquidity and absence of any sort of market regulation, reputable counterparty involvement, or derivative instruments and it really isn’t a good alternative for corporates looking for another form of protection.
The negatives far outweigh the benefits of lower transaction costs, which is the only win that a corporate would otherwise receive given their mandate. Virtual currencies are interesting to watch and, as they and their respective markets mature, may someday become interesting for corporates to utilize.
As a speculative tool, the bitcoin could be a lot of fun to play with. From a corporate perspective, where the mandate is hedging and protection, the bitcoin is not ready for roll out and treasury should view it with extreme caution.
This article first appeared in IDG Connect on June 20, 2013.