Pfennig and PfriendsSM Edition
Mystery Currency No Longer A Bit Player
Since February, this “currency” has appreciated 485%. No, that’s not a typo.
Despite these huge gains, until recently most people had never even heard of it. In fact, one website reports that earlier this month someone asked Paul Volcker, former chairman of the Federal Reserve, what his thoughts on this currency were. He had not heard of it either.1
But everything changed in mid-April, when this currency skyrocketed and, as a result, quickly took the world by storm and quickly became the hottest topic in global finance. There’s even a fierce debate going on. Some believe this currency could revolutionize economies by challenging the modern system of central banking. Others think it’s nothing more than an investment fad that resembles a Ponzi scheme.
So what is this mystery currency?
A Different Kind of Currency
I’m talking about Bitcoin, a virtual currency that exists in an online peer-to-peer network. Stored in anonymous “electronic wallets,” each Bitcoin unit contains a code that records its entire transaction history and identifies its owner at any single moment. This prevents owners from spending the same coin a second time.
They are “mined” based on a pre-defined mathematical algorithm. In other words, if you own a powerful computer that can crack some really hard math problems, you could “mine” Bitcoin. Also, the more units of Bitcoin that are produced, the harder the randomized mathematical puzzles become. This limits the creation of new units of the currency. Similar to real physical mining, it takes capital, labor and time to “mine” new Bitcoin units. And the production is subject to decreasing returns, which also resembles physical mines.
The mysterious identity of Bitcoin’s creator makes this story even more interesting. All we know is someone called Satoshi Nakamoto developed the software in November 2008. But nobody knows exactly who he/she is.
Bitcoin Mania Strikes in Full Force
Bitcoin started as a weird underground movement that took place only among a small internet group. But recently, more and more merchants have been accepting payments in Bitcoin. For example, earlier this month, New York-based Alvic Property Management said it would begin accepting Bitcoin currency as payment for rent and maintenance fees. Management thinks accepting Bitcoin will increase its potential pool of tenants.2
There’s even an entrepreneur who has developed a Bitcoin ATM that will allow the conversion of cash to Bitcoin, and vice-versa. According to him, orders for this new ATM “are coming in by the hundreds from 30 different countries.”3
But it was the banking crisis in Cyprus that really catapulted Bitcoin onto the front pages of just about every newspaper in the world. After authorities confiscated depositors’ money in Cyprus, the popularity of Bitcoin, viewed by many as an alternate to fiat currencies, exploded. Bitcoin mania struck in full force. The demand increased so quickly that it overwhelmed the exchanges where it trades, causing shutdowns, outages, and wild price swings. The chart below shows the crazy price action.
Bitcoin Goes on a Wild Roller Coaster Ride
Source: Bitcoincharts.com
(Click here to view a larger image.)To give you an idea of how crazy things got, on April 10, a unit of Bitcoin started the day trading at $230. Then, it spiked to $266, crashed all the way to $105, and then settled at just above $170.4
To put that into perspective, this would be comparable to gold rallying from $1,400 to $1,624, then dropping all the way to $633, and finally settling at $1,026—all in a single day. The volume of trades on that day was so high that it froze the trading engine. Mt.Gox, the largest Bitcoin exchange, released a statement the next day explaining the situation:
| “The number of trades executed tripled in the last 24hrs. The number of new accounts opened went from 60k for March alone to 75k new accounts created for the first few days of April! We now have roughly 20,000 new accounts created each day.”5 |
Given the booming popularity of Bitcoin, should you buy it?
Why You Shouldn’t Buy Bitcoin, Unless You Want to Gamble
Obviously, this kind of volatility is a big problem for Bitcoin. And it’s not the only one. In the past, hackers have stolen the currency from “electronic wallets.” It also got some bad press because of its association with illegal activities. Criminals have used the anonymous currency to pay for everything from drugs to pornography.
Bitcoin is not ready to challenge the monetary system. And if it ever becomes a threat to central bankers, I have no doubt the government will quickly make it illegal. In other words, regulation is another big threat to Bitcoin.
Because of all these problems, you shouldn’t buy Bitcoin, unless you want to gamble. But at the same time, those who dismiss the virtual currency out of hand are missing a big point. The currency is completely decentralized. Central banks cannot create them out of thin air, like they do with fiat currencies. That’s what makes Bitcoin an interesting concept. And its popularity is yet another sign that people are losing faith in fiat currencies.
In that regard, there’s no denying the appearance of Bitcoin is important to our monetary system. It shows people are looking for alternatives to all the “funny money” governments and central banks are creating.
But for now, there’s a much better way to protect your portfolio against the central bankers’ printing presses: gold. History shows the yellow metal can be a real and viable alternative to fiat currencies. So, you could use the recent correction to add more gold to your portfolio.
And, by the way, if you’re still confused about Bitcoin, I’ve found this great 3-minute video that explains the basics of it. You can watch it here.
Until the next Pfennig and PfriendsSM Edition…
Sincerely,
Chris Gaffney
SVP & Director of Sales
EverBank World Markets, a division of EverBank
800.926.4922
P.S. Do you think Bitcoin has a chance of becoming a valid currency or is it a passing fad? Post your comments at DailyPfennig.com.
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