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Bitcoin changes the landscape

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Over 400 years ago, explorers traded in beaver pelts. Today we pay for items with paper money and plastic. Tomorrow we may use a digital currency.

Following the 2007 global financial crisis and distrust of banking mortgage practices, central banks and information technology companies sought digital innovations for trade payments, clearing and settlements .

An innovation called distributed ledger technology is based on secure transactions rather than trusting a bank. Bitcoin launched in 2009 uses this technology for direct person-to-person payments.

Entrepreneurs and venture capitalists are developing other bitcoin applications ranging from securities and commodities trading to “exciting” plans for sports and crypto businesses based more on promise than profit.

So far, the acceptance of digital currency for business transactions has been slow. According to Payments Canada, merchants reported that Bitcoin, the most popular digital currency used in commercial payments, was “still in its infancy for Canadian consumers.”

It is useful to separate Bitcoin’s transactional purpose from its speculative appeal. Cyber-currencies are popular in the millennial mainstream for trading, lending, and buying on margin. They are promoted by Hollywood actor Matt Damon and newly created and mostly unregulated resellers and trading platforms.

Risk and fraud tend to go where the easy money flourishes.

Until today, the money was free, after central banks flooded the world with trillions of dollars during the COVID-19 pandemic. As this windfall floated the prices of all assets to higher and higher levels, speculation became rampant.

Recall how Bitcoin and other cybercurrencies have seen strong price rises (and falls) in recent months. From an initial value of less than $100 (US), Bitcoin rose to almost $70,000, before dropping to $47,000.

This boom was fueled more by speculative buying than commercial transactions. But the government stimulus is coming to an end. Central banks have reduced massive injections into the banking system. And interest rates started to rise. Thus, the cybercurrency trade will be more expensive to fund.

Central banks have conducted considerable research on a decentralized currency, but important questions remain: will a digital dollar earn interest? Will it be portable like cash? Will this help the Bank of Canada as a lender of last resort? Will it make capital gains and sales tax collection easier?

The Bank of Canada was authorized by law in 1934 “to control and protect the external value of the national monetary unit…” But this law does not speak of a digital currency. The bank said it would only introduce one if bill usage drops sharply and cryptocurrencies are used more.

Unlike investing in a company to share its growing earnings, dividends, and retained earnings, it is easier to trade Bitcoin’s price swings hoping for a quick profit by selling it to a more optimistic buyer. And computerized operators are trying to “mine” the supply of new bitcoins using complex algorithms.

Cybercurrency trading has become popular among millennials and even “teenagers with gaming experience”. The fact that bitcoins do not earn interest or pay dividends seems to matter little.

Apparently investing free or borrowed money today and losing it too has never been easier.

Investors considering buying Bitcoin should ask their advisors two questions: Would such an investment suit their goals? Can the advisor explain the potential return and risk of such a purchase? They are reminded that finance professor George Athanassakos advises “Just say no”.

This general comment is not intended to be a specific recommendation. A registered and qualified investment advisor is best suited to do this.

Norm Stefnitz, CFA, is a retired financial analyst and investment advisor. He can be reached at [email protected]