Whatever you might say about the gold standard, the gold-backed, fixed exchange-rate system that characterised the early 20th century’s approach to global foreign exchange, at least it had something real behind it.
Now, I am not arguing for the end to fiat currencies and a return to gold, because ultimately a currency whose legitimacy is backed by government makes a great deal of sense and suggesting that a ‘return to gold’ would solve the world’s problems seems a reactionary and probably more a theoretical than practical suggestion. However, there is a substantial difference between a currency backed by a government and one backed by one or more corporations, particularly when such corporations are in fact small companies or individuals. My local newsagent might be quite effective in delivering my newspaper each morning, but would I really trust it if it said it had developed a new currency that I could use in certain places (mostly the newsagent’s shop) and also trade at a rate set by supply and demand (neither of which I could really see or understand) and that I should consider using this rather than pounds sterling? I think not. Yet, in the online world (and we all know just how safe that can be) virtual currencies are growing in popularity.
Bitcoin, one such virtual currency, has been in the headlines recently for all of the wrong reasons. Its owners have been hacked and their currency stolen, its value has spiked and plummeted like an out of control roller coaster – according to its own data, in the course of a week recently the value of a Bitcoin ranged from $266 (£174) to $50 (£33). In addition, Bitcoins are hard to regulate and transactions are difficult to trace making the currency a safe haven for black market and money laundering activity. So does this make it doomed? The problem with these criticisms, and this has been overlooked by much of the media, is that they apply equally to cash – it can be easily stolen, currencies can at times fluctuate in value substantially (my recent US vacation certainly cost a great deal more than I would have liked given the current cable rate) and cash can be easily used as part of money laundering and purchasing illegal goods. So are the accusations against virtual currencies based more on a political agenda than on reality?
This is precisely what its supporters would claim, who like the anonymity and the independence of government, state and company that Bitcoin offers. And demand for the currency has been helped by distrust of financial institutions after the credit crisis. The reality, of course, is that the fundamental flaw in these virtual currencies – practicality aside – is that both total volume in issuance and the amount traded at any one time are very low. The result is that at times a Bitcoin could find itself trading more like antique wine or art than a currency. And the fact that Bitcoin was specifically designed to have a finite number of currency units in issuance (which compared to any major currency is utterly de minimis) means that it is unlikely to ever behave like a ‘real’ currency – but perhaps more like gold where the price (in part) is affected by the supply available. But this is a design flaw which another virtual currency could overcome. The issue is therefore one of volume traded: unless the currency is used by millions worldwide, its behaviour is unlikely to be like that of a currency as spikes and troughs through ebbing and flowing volumes are inevitable.
unless the currency is used by millions worldwide, its behaviour is unlikely to be like that of a currency as spikes and troughs through ebbing and flowing volumes are inevitable.Which brings me back to an article I wrote some time ago on MasterCard. Probably only credit card and payment providers are in a position to build a business around an ‘alternative’ currency, and give it the potential to reach a sufficiently sizeable audience for it to ‘trade’ against other currencies on an equal footing. I doubt they will, and this is fundamentally why virtual currencies as a practical concept will not succeed on a large and global scale. At the moment, and probably forever, they will remain the medium of exchange for gamers, those who reject capitalist constructs such as the state and conventional currencies, those potentially not on the right side of the law and, of course, opportunistic traders. It is the latter who interest me most as an investor – the lack of knowledge regarding the range in which Bitcoins should trade creates opportunities for speculators. I suspect there are major gains (and also major losses) to be made trading virtual currencies in the coming years, albeit without the risk protection you might expect when investing. Those who would normally invest in, for example, exotic commodities may now be tempted by virtual currencies, taking big risks in exchange for the potential of large rewards by trading some of the most inefficient markets in the modern world.
James Bateman is head of multi-manager and multi-asset portfolio management for Fidelity Worldwide Investment
