If you had to name the year 2017, it would be designated as the year of cryptos. Bitcoins, Ethereum, Litecoin and other cryptos have captured the imagination of investing population. There are debates on multiple forums whether it is the right time to enter into bitcoins. There have been talks of valuations, blockchain technology, ease of use, the revolution of 21st century etc.
The blockchain technique that decentralises the currency is immensely powerful and has multiple application across industries like Finance, Healthcare, Construction etc. But if we can look through the hype and focus on the basic purpose of this invention, it could clear the perspective. Cryptocurrencies are just plain and simple online currencies so they should satisfy the primary tenant that makes the currency viable.
For a currency to be accepted it should have following characteristics :
“General Acceptability “. Bitcoin fanatics may argue that as more and more people are getting exposed to this currency, the acceptability is improving. I agree with the fact that currency has a spiral recognition effect so as people start getting exposed to it the general acceptability improves
“ Portability“. With the currency being online it is extremely portable
“Durability “. Well, full score to bitcoins. If you own Bitcoins today, 100 years from now still you would own those bitcoins
“ Stability “. Well, this is where the economic utility comes under the radar. Bitcoins since its inception has been an incredibly volatile currency. The average volatility has been extremely high as compared to other traditional currencies like dollars. So how does this volatility impact the usage
So let’s say I am currently in Toronto and I am planning to go to Newyork for vacation. I decide to book a hotel in Newyork for the night, and the owner agrees to take payment in Bitcoins. Assuming the rate of exchange is one bitcoin equals 100 USD which is the rate for the night. I would pay the owner one Bitcoin. The owner has weekend plans to go to on a luxury yacht which has an entry fee of 100 USD. While encashing his Bitcoin, he realises that the currency is trading at 60 USD. So he would suffer a loss due to this transaction. Thus as the currency increases in volatile, it reduces its economic relevance.
When two parties interact in forex, they either assume the risk of currency being volatile or they insure their positions by demanding guarantees / by taking hedges (derivatives). But the cost of insurance is proportional to the possibility of loss. If the currency is extremely volatile, it would have a very high probability of loss and thus it would have huge insurance costs
Cryptocurrencies may be a good asset to invest due to sentiments but unless cryptocurrencies become less volatile, the economic utility is very less.
*This article does not intend to offend anyone These are my views and they may be wrong.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.