BITCOIN: SPECULATION OR RESERVE

The ongoing crisis in global economy exacerbated by the coronavirus pandemic, collapse of the oil market, etc., prompts investors and traders to turn to precious metals and other reserve assets. Cryptocurrency has become one of such alternatives in recent years. However, despite the dynamics of the cryptocurrencies market, the exchange rates are very volatile, as evidenced by constant rises and falls of the most popular types recently.

At the same time, the lack of a regulatory framework, as well as the use of cryptocurrencies for money laundering and other criminal purposes, is causing increasing discontent among the central banks of the world, calling for tightening control of the virtual money market.

Market hypervolatility

Almost 12 years have passed since the creation of the first successful cryptocurrency called Bitcoin and claimed to have been created by Satoshi Nakamoto, who has developed the first version of software based on the principles of decentralization and complex cryptographic algorithms. Since then, the virtual money market based on the blockchain system has grown incredibly, adding in dozens of new names. According to CoinMarketCap, as of January 2021, the total capitalization of the cryptocurrency market is $1.1 trillion.

However, along with certain advantages, the virtual currency market is very volatile, which has repeatedly caused sharp rises and falls in exchange rates, reducing the cost of some cryptocurrencies ten times. An example is the processes, which started last spring, intensified in December and continued in January 2021, leading to sharp fluctuations in the world's most popular virtual currency, Bitcoin. Together with the second largest cryptocurrency by volume, Ethereum, it accounts for about 85% of the global cryptocurrencies market.

After the boom in 2017, when the rate of Bitcoin exceeded the historical maximum of $20,000, we have observed a period of prolonged depression, which lasted until March 2020, when the rate stabilised at $3,867. In the second half of December 2020, Bitcoin set another historical record of $42,000. But then the New Year rally ended. Having decreased by almost a quarter for no obvious reason, the exchange rate stabilized by January 24 at about $32,000.

Interestingly, world reserve currencies such as the US Dollar, Euro, UK Pound, Japanese Yen, etc. do not show such a steep exchange rate volatility. For comparison: American Dow Jones Industrial Average, S&P’s 500 and Nasdaq Composite increased by 1.5%, 1.6% and 1.4%, respectively, during the first working week of the new year. This is why the hypervolatility of cryptocurrencies continues to discourage the majority of institutional investors.

Investment tool

Meanwhile, some hedge funds and private investors actively use virtual currencies, since some experts consider Bitcoin as a potential hedging tool when the US dollar’s rate falls. Investors have become interested in investing in Bitcoin recently, as the 2017 exchange rate rally was mainly driven by demand from retail investors.

Since 2020, some large investors have stated that they own cryptocurrency. Then, PayPal allowed bitcoin trading in October 2020, joining other companies such as Robinhood Markets and Square.

Interest in Bitcoin has increased in recent months amid massive foreign exchange injections into the traditional market from the US Federal Reserve and other central banks, as well as expectations that the coronavirus pandemic will be brought under control thanks to new vaccines.

Numerous statements and estimates of analysts has further fuelled the demand for Bitcoin. For example, JPMorgan Chase believes that the price of Bitcoin can jump to $146,000 if it becomes a competitor to gold as a safe reserve currency. Analysts explain this by Bitcoin’s increasing competion with gold in investment flows. Thus, the market value of Bitcoin must increase by 4.6 times in order to satisfy general private sector investment such as ETFs or gold ingots and coins. For a similar reason, experts of Fundstrat Global Advisors predict a sevenfold increase in the rate of the second most widespread cryptocurrency Ethereum - up to $10,500. Its rate has also increased several times since March 2020, but declined by the end of January. In general, the market value of all cryptocurrencies by the end of January 2021 fell by almost $180 billion - from a record $1.1 trillion to $926 billion.

Accordingly, the estimates of BofA Global Research looked much more credible, warning that a sharp jump in the rate of leading cryptocurrencies may turn out to be unstable, as was observed in the second half of January.

Control is a must!

Considerable losses of retail investors and traders, who decided to speculate on the dynamic growth of the Bitcoin exchange rate, force financial regulators of the leading countries to raise the issue of tightening control in this area.

In particular, the European Central Bank (ECB) and the British regulator of financial markets (FCA) have recently announced the need for stricter control in the cryptocurrency market, highlighting its strong volatility and related criminal activities. "Bitcoin can be called an extremely speculative asset. Moreover, criminal investigations have shown that cryptocurrency is used for money laundering. Accordingly, global coordination and multilateral action in this area is needed, possibly at the G7 or G20 level," ECB head Christine Lagarde said recently. She also noted that cryptocurrencies have received increasing attention of the Financial Action Task Force, a group responsible for the development of financial tools to combat money laundering.

Experience of the last decade shows that the turnover of cryptocurrencies creates ideal conditions for criminal activities (money laundering, cybercrimes), including drug trafficking, terrorism, etc., given their properties such as anonymity, virtuality and convenience of cross-border circulation. Another fact confirming this negative trend was the recent decision of the German prosecutor's office to stop the illegal activities of the world's largest trading platform DarkMarket operating in DarkNet (a shadow network alternative to the legal Internet). The e-platform has a record of at least 320,000 transactions for a total amount of about 140 million euros with about 0.5 million buyers and 2,400 sellers buying and selling drugs, counterfeit money, stolen or counterfeit credit cards, anonymous SIM cards, hacked personal data and malware.

On the other hand, being a non-state financial instrument, virtual money does not have an emission centre, a legal status equivalent to classical currencies, and it is also not backed by any real assets. So, recently, the British regulator again warned investors that everyone involved in investment schemes with Bitcoin must be ready to lose all their money, and that in case of losses in the cryptocurrency market, the losers cannot count on FCA support.

A side effect caused by the recent boom in the virtual money market was the shortage of video cards used for mining (production) of cryptocurrencies: prices increased by an average of $100, and for some high-performance models - by 1.5-2 times. Experts do not exclude that the deficit for video cards will last until mid-2021.

Cautious approach

Despite numerous high risks associated with the spread of cryptocurrencies, the virtualization of money circulation and the emergence of new financial assets alternative to classical currency instruments is inevitable. “Today, both interest rates and confidence in government institutions are at historic lows due to the unprecedented emission rates observed in the US and Europe since the beginning of the pandemic. This shows that the inflation growth in the long term will be inevitable, which will also affect real assets. Not only classical assets such as gold and real estate, but also cryptocurrencies,” director of the St. Gotthard Fund Vladimir Vishnevsky believes.

Financial regulators in many countries of the world, in particular the US, come to similar conclusions. They believe that the development of the cryptocurrency market cannot be prohibited, but it is possible to regulate and try to adapt it to the existing world currency system. So, the secretary-elect of the US Treasury Janet Yellen published a statement, which says that cryptocurrencies and digital assets can improve the efficiency of the financial system. “Bitcoin and other digital and cryptocurrencies are providing financial transactions around the globe, like many technological developments, this offers potential benefits for the US, and our allies,” Yellen said.

In this vein, Facebook is going to launch its own cryptocurrency Libra in early 2021. Facebook said the new Libra model will support multiple versions of digital currencies, most of which will be pegged to classic currencies like the US dollar.

The cryptocurrency market provides new opportunities also for other states seeking to change the existing financial system. Today, China is the most advanced country in terms of the development of its own state cryptocurrency: in January, the state-owned Chinese bank Agricultural Bank of China (ABC) began testing the national digital currency at ATMs in Shenzhen.

So the future of cryptocurrencies seems controversial. On the one hand, there is a cautious approach and rejection of the traditional financial market, on the other hand, there are quite favourable prospects and genuine interest of investors. Who will be the winner remains an open question.