BitGold: The Digitalisation of Metal

Earlier this year I wrote about several attempts to back cryptocurrencies with Gold (The Truth About "Gold Backed" CryptoCurrencies). Most of those I covered weren't backed by Gold in the conventional sense (i.e. a fixed amount of Gold that could be redeemed per currency unit), instead offering only partial backing. There were exceptions such as Ripple Singapore which offers fully backed units on the Ripple network, but totals held are still very modest (not quite 53 ounces of Gold).

Since that article I've noticed new entrants being marketed in this space and interestingly two competing products appear to be jostling for the same name, BitGold.

The first of those to market comes from Bitreserve, a company offering a digital wallet service where you can transfer between Bitcoin, various currencies (USD, EUR, CNY, YEN, GBP) and now Gold (stored and audited by GBI) all through their 'card' system. Think of it like having accounts in various currencies, you can only deposit funds into their system using Bitcoin, but once deposited you can diversify that value across any of the aforementioned currencies if you don't want exposure to Bitcoin's fluctuating value. Bitreserve maintains real reserves to cover their obligations to customers which are published live on a status page.

With our Gold Card, we are reviving gold for the purchase of goods and services. Bitreserve members can convert their bitcoin to bitgold, whose value is substantiated by bullion in our reserve, but still spend it as bitcoin. By creating a bridge between the revolutionary Bitcoin protocol and good old gold bullion, we enable our members to instantly send or spend bitcoin from the ounces of gold held in their Bitreserve wallet. Our Gold Card makes this ancient store of value instantly transferable, infinitely divisible and accessible to anyone with a networked device. Now anybody with some bitcoin and a Bitreserve wallet can have the Midas touch. Old King Croesus would be chuffed. Bitreserve

They're also introducing a similarly structured card that offers their customers exposure to the oil price.

For the first time in history, oil will become a form of payment and compete against all major global fiat currencies. Using Bitreserve’s Oil Card, anyone can hold their value as oil — the fuel for the modern world economy — and transfer that value instantly and for free.

Bitoil™ will work just as bitgold does today. Oil value can instantly be converted into five currencies, gold, or bitcoin at very low cost and can be spent immediately. Oil has a massive and direct impact on the global economy, and a currency that tracks oil prices could become one of the world’s most widely used digital currencies. Whether you are a consumer looking to hold money that’s tied to gas prices, or a business with a large portion of your expenses in oil related activities, Bitreserve’s Oil Card gives you yet another welcome currency option for holding and spending digital value. Bitreserve

To be honest their system sounds quite innovative, but I am still skeptical about attempts to digitise physical assets as I will explain shortly.

The second "BitGold", is being launched early next year. The site is taking email addresses for pre-launch access at BitGold.com and they've raised C$3.5 million from investors. The founders are Roy Sebag (CEO of Natural Resource Holdings Ltd) and Josh Crumb (Former Senior Metals Analyst at Goldman Sachs).

"The Toronto-based company will allow account holders to purchase bitcoins and exchange them for gold redeemable in various vaults around the world, as well as convert the metal back into the digital currency. Customers will also get a debit card, said Sebag, 29.

The company is trying to muscle in on traditional bullion dealers and gold-backed exchange-traded funds, two of the most popular ways for retail investors to get hold of physical gold." Bloomberg

Interestingly the name that both of these new products are launching with, Bit Gold, has already been used by Nick Szabo to describe what could be considered the inspiration for Bitcoin. 

The Bit Gold proposal, by Nick Szabo, describes a system for the decentralized creation of unforgeable chains of proofs of work, with each one being attributed to its discoverer's public key, using timestamps and digital signatures. It is said that these proofs of work would have value because they would be scarce, difficult to produce, and securely stored and transferred. Bitcoin.it

His early proposal was so closely worded to the way Bitcoin works that many speculated Nick may in fact be Satoshi Nakamoto (or form part of a team that wrote the Bitcoin whitepaper).

Even ignoring the naming issue, I'm still not convinced that trying to link physical Gold with a digital representation is a good idea and here are some reasons why...

Counterparty Risk: As I said in a recent post (How Safe Are Unallocated Bullion Accounts?), I own precious metals because they have a lower level of counterparty risk, putting other parties between myself and a claim on the physical metal is counterproductive to one of the reasons I hold them. Some of these products are structured so that your claim is with the company providing the digital wallet service, while the actual custodian of the Gold may be another layer or two down. Even if regular audits occur, I would not be comfortable that my Gold would be easily retrievable if something were to go wrong (and not all are offering the ability for redemption of the Gold).

Trusted Third Party: One of the key attributes of Bitcoin and many other cryptocurrencies is the lack of need for a trusted third party to confirm the transfer of units. Transactions occur on a shared public ledger (called the block chain). With no physical asset to account for this can all occur through the use of private keys to sign transactions. The benefit of this is lower transaction costs. Introducing a physical asset to the mix means that you do need a trusted third party (sometimes multiple) to verify the assets, even if a public ledger is still used for transparency of transactions.

Spending Gold: Around 12 months ago I stumbled across a comment from Pierre Rochard talking about the consumer behaviour of those spending Bitcoin, he claimed "Consumers making payments generally replenish their bitcoin balance simultaneously, so it's a net zero." My response, why not just hold their Bitcoin balance steady and use fiat currency to make the purchase? Those introducing these digital Gold products assume there's lots of people out there who want an easier solution for 'spending' their Gold. My Gold holdings are not held for the purpose of short term spending on groceries or electrical goods, I'm not interested in giving up the security of possession for the ability to spend it more easily.

Capital Gains Tax: As I have covered on this site before, Gold (Let Australians Save in Gold Instead of Debt) and cryptocurrencies (Glenn Stevens Talks Bitcoin & Competing Currencies) are not really setup from a tax perspective to facilitate their use as a regular currency (despite the ATO recently giving a break to those using Bitcoins). It's likely that in most situations those using these digital wallet services are expected to keep records of any capital gains or losses (relative to their Australian Dollar value) to tally at the end of year for the purpose of declaring a loss or gain. The Australian tax system is not setup to cater for the use of assets (other than the Australian Dollar) as money and I suspect it would be similar in many other countries. We don't have competing currencies despite Glenn Stevens (Governor of the Reserve Bank of Australia) insistence that we do.

Government Regulation: The idea behind most cryptocurrencies is to have a distributed electronic method of creating and transferring value with no need to be in a specific physical location. Adding Gold to the mix literally destroys the advantages of a cryptocurrency because the asset it's linked to is stored centrally, leaving it vulnerable to the negative effects of government regulation.

One advocate for the mixing of these two assets has been Jan Skoyles, CEO at The Real Asset Company, whose opinion was recently covered by a Forbes contributor:

Jan’s argument therefore that there is demand for both a gold-backed currency, and a fully-transparent and accessible gold-trading system, is a persuasive one. By recording gold purchases on a block chain style ledger, the currency can be used not only as a medium of exchange, but also to facilitate gold ownership, and challenge the status quo for clearing and settlement in the gold market. In other words, you can buy your gold, and you can spend it too.

The article goes on to say that The Real Asset Company has their own product in the works. I tried to reach Jan (by email and Twitter) to confirm that's still the case and get some clarification on how it would work, but I'm yet to hear back (will update this post if I do). I'd think most Gold investors would prefer a level of privacy for their 'digital stack', something a public ledger wouldn't easily accommodate.

Everyone has different wants and needs from their assets, especially those used as a monetary resource, so perhaps there are some individuals who are prepared to look past the described shortcomings of a digitalised Gold product for the flexibility and convenience that it offers. If you are one of those people I'd love to hear your reasoning in the comments below.

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Bitcoin Gets Capital Gains Tax Break, Why Not Gold?

Late last year ('Glenn Stevens Talks Bitcoin & Competing Currencies') I pointed out that Bitcoin effectively can't be used as a competing currency (likewise for foreign currency or other assets such as Gold) given that it is subject to Capital Gains Tax (CGT) and monitoring the value of Bitcoins as they are acquired and disposed of would not be practical:

"Can you just imagine the administrative nightmare that would result from performing regular transactions in a foreign currency and having to maintain a record of whether you made a gain or loss as a result of fluctuation in the currency markets? It is simply not practical. Bitcoin is not immune from the same requirements." - Bullion Baron

However, earlier today the Australian Tax Office (ATO) released a statement (ATO delivers guidance on Bitcoin) in regards to Bitcoins and their tax treatment. Further information is available on the following page 'Tax treatment of crypto-currencies in Australia – specifically bitcoin' which specifies the following in regards to Bitcoins used in personal transactions:

Using Bitcoin to pay for personal transactions

Generally, there will be no income tax or GST implications if you are not in business or carrying on an enterprise and you simply pay for goods or services in bitcoin (for example, acquiring personal goods or services on the internet using Bitcoin). Where you use bitcoin to purchase goods or services for personal use or consumption, any capital gain or loss from disposal of the bitcoin will be disregarded (as a personal use asset) provided the cost of the bitcoin is $10,000 or less.

The 'personal use asset' exemption would normally be reserved for items such as a boat, furniture, electrical goods or other household items which are exempt from CGT if purchased for less than $10,000.

The wording on the ATO website is somewhat ambiguous. Does the limit apply per year or can I buy low (to a maximum of $10,000 worth of Bitcoin) and spend high several times in the same financial year and still avoid CGT?

I think this is a good start and would like to see a similar CGT exemption for Gold (as I suggested last year in 'Let Australians Save in Gold Instead of Debt'). That said, I think the limit imposed is patronizing, why impose a limit at all if the Bitcoins are being purchased with the intention of spending them at a later time? Putting a $10,000 cap on the exemption limits the spending of Bitcoins to novelty use only, it wouldn't be adequate for someone having their income paid in Bitcoins, which was also covered on the site:

Paying salary or wages in bitcoins

Where an employee has a valid salary sacrifice arrangement with their employer to receive bitcoins as remuneration instead of Australian dollars, the payment of the bitcoins is a fringe benefit and the employer is subject to the provisions of the Fringe Benefits Tax Assessment Act.

In the absence of a valid salary sacrifice agreement, the remuneration is treated as normal salary or wages and the employer will need to meet their pay as you go obligations as usual.

I would like to see any monetary asset (Bitcoin, Gold or otherwise) that is saved for future consumption be exempt of Capital Gains Tax. That would allow us to truly have competing currencies in Australia. Being forced to save in a currency whose value is purposefully devalued (via central bank mandate to target 2-3% annual inflation) is madness, especially when interest earned on those savings is taxed and with the real cash rate already below 0.

Those who have purchased and sold Bitcoin specifically for investment are subject to CGT (or taxed as part of your income if traded in the business of regular profit-making):

Disposing of bitcoin acquired for investment

If you have acquired bitcoin as an investment, but are not carrying on a business of bitcoin investment, you will not be assessed on any profits resulting from the sale or be allowed any deductions for any losses made (however, capital gains tax could apply – although see the comments above about personal transactions). However, if your transactions amount to a profit-making undertaking or plan then the profits on disposal of the bitcoin will be assessable income.

There are no GST consequences where the bitcoin is not supplied or acquired in the course or furtherance of an enterprise you are carrying on.

There is another section for those in the business of mining Bitcoins:

Mining Bitcoin

Where you are in the business of mining bitcoin, any income that you derive from the transfer of the mined bitcoin to a third party would be included in your assessable income. Any expenses incurred in respect to the mining activity would be allowed as a deduction. Losses you make from the mining activity may also be subject to the non-commercial loss provisions.

Your bitcoin is trading stock and you are required to bring to account any bitcoin on hand at the end of each income year.

GST is payable on the supply of bitcoin made in the course or furtherance of your bitcoin mining enterprise. Input tax credits may be available for acquisitions made in carrying on your bitcoin mining enterprise.

The section that deals with ATMs and exchanges is probably the most off putting with an indication that businesses in this area will need to charge Goods and Services Tax (GST), likewise in the supply via mining as mentioned above:

Taxpayers conducting a bitcoin exchange (including bitcoin ATMs)

Where you are carrying on a business of buying and selling bitcoin as an exchange service, the proceeds you derive from the sale of bitcoin are included in assessable income. Any expenses incurred in respect to the exchange service, including the acquisition of bitcoin for sale, are allowed as a deduction. In these circumstances, the bitcoin is trading stock and you are required to bring to account any bitcoin on hand at the end of each income year.

GST is payable on a supply of bitcoin by you in the course or furtherance of your exchange service enterprise. Input tax credits are available for bitcoin acquired if the supply of bitcoin to you is a taxable supply.

This seems to put local Bitcoin exchange and supply businesses at a competitive disadvantage if they have to charge buyers a 10% premium. It would be likely to drive Australian Bitcoin buyers to international sources which don't charge GST.

It is good to see that the ATO has finally addressed Bitcoins for tax purposes, but I don't think they've done a particularly good job here.

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The Truth About "Gold Backed" Cryptocurrencies

Another day, another salesman tries to sell us the story that they are launching the first Gold backed cryptocurrency. On this occasion it's Anthem Vault (founded by Anthem Blanchard, son of well known Gold advocate Jim Blanchard):

Newnote Financial Corp. is pleased to announce the successful development and launch of the first open-source gold-backed alternative crypto-currency, commissioned by Anthem Vault Inc. Business Wire

So are they really the first? They certainly aren't the first to launch a "Gold backed" cryptocurrency. The first I recall reading about was NoFiatCoin (XNF) which trades on the Ripple Network and was launched earlier this year:

Click Chart To Enlarge

Despite this cryptocurrencies favourable return for early adopters, the claim that it's backed by Gold (bullion) is dubious. The company simply allows those holding the cryptocurrency to exchange it for precious metals they have in stock. As Michael Suede wrote shortly after the announcement of XNF:

NoFiatCoin says that only a 1/3rd of XNFs are backed by bullion and that the market will determine the price for an XNF.  To me, this doesn’t make much sense.  This means an XNF does not represent a fixed weight of gold.  Further, NoFiatCoin says redemption of XNFs for bullion requires a minimum of $3000 worth of XNFs at current market prices.

If XNFs were actually a “gold backed” currency, each XNF would have to represent a fixed unit of weight.  For example, they could set an XNF to be worth .001 ounces of gold, and if you saved up 1000 XNFs, then you could always exchange them with NoFiatCoin for an ounce of bullion.  Of course, under this system, it would be impossible to have a fixed limit of currency creation, and there would have to be a way to take XNFs out of circulation once they were redeemed for physical specie.

Without convertibility at a fixed ratio with the coins, how is this Gold backed?

Other cryptocurrencies purporting to be Gold backed include Gold Backed Coin (GBC) which also trades on the Ripple Network, they suggest that each of these coins is backed by 1/10oz of Gold. But what do we really know about this company and how or where they are storing the Gold that is supposedly backing all these coins? The domain for the website was registered only a few months ago.

Then there is Ripple Singapore which claim to be able to load your Ripple wallet with XAU (Gold), XAG (Silver) and XPT (Platinum) with the bullion backing these positions stored in Singapore by Silver Bullion Pte Ltd. Though take up doesn't appear strong, they published these audit figures on their website:

What is the benefit of storing these in your Ripple wallet? There's not much liquidity given the published reserves, why not just setup a regular unallocated account with the dealer? Not that I would recommend storing your precious metal that way either.

Further to those already mentioned there is also G8Coin, MinaCoin, XGOLD (a work in progress) and probably others that I've missed. None of these currencies really offer anything that hasn't been seen before in one form or another, for example E-gold was founded in 1996 and topped 5 million users before the Gold was eventually seized and company placed into receivership. Also, there are already online exchanges where one can buy precious metals electronically or trade peer to peer with other account holders, some of which are well established and trusted, such as BullionVault and Gold Money.

So... Anthem Vault's new offering may be the first open source currency in this space (although some of those mentioned do trade on Ripple, which is an open source platform), but it's far from something new and exciting. Let's hear more about it though...

The virtual currency was secretly launched on the 4th of July 2014 by Anthem Vault’s technology team, in conjunction with Newnote Financial Corp. Dubbed the 4th of July Coin, this first Anthem Vault alt-coin is commonly referred to as MGC (Micro Gold Coin).

The MGC is an open source crypto-currency which means any person can download and look at the source code behind the coin, which is similar to Bitcoin. However, the coin has some unique attributes which sets it apart from Bitcoin. For example, there will only be a total of 10 million MGC’s in this series. All coins will be fully mined within one year, meaning all 10 million MGC’s will be in circulation and/or ownership by July of 2015. The entire series of MGC’s are backed by 100 grams of Gold stored at Anthem Vault, providing a base value to all MGC’s from the first moment the coins are “mined”. Business Wire

So the whole currency is "backed" by only 100 grams of Gold (spot value currently US$4192)? Based on 10 million coins, that means each coin will be worth 0.00001 gram of Gold. Talk about an anticlimax, this is nothing more than a marketing stunt designed to attract new customers to the brand or to have people write about it (game, set, match, they got me). Though according to the company founder this was only a taste of what's to come:

Blanchard said Wednesday's launch was a promotional offering, and the company has plans to offer a full suite of virtual currencies backed by a larger amount of gold as well as other precious metals at the end of September. Reuters

Let's face it though. Most of these "Gold backed" cryptocurrencies are a complete farce.

Those that aren't linked to a fixed amount of Gold, 100% backed and redeemable (by physical delivery of your Gold portion) I wouldn't consider to be Gold backed. Otherwise one could make the argument that any fiat currency is Gold backed (where the issuing country has official reserves), which is preposterous.

Those that are linked to a fixed amount of Gold, 100% backed and redeemable by physical delivery are illiquid or have been launched by unknown entities, not a system you want to be relying on for your exposure to Gold.

The reality is that combining cryptocurrencies with Gold doesn't make a lot of sense. The whole idea behind most cryptocurrencies is having a distributed electronic method of transferring value without the need to be tied to a physical location. Adding Gold to the mix literally destroys the advantages of a cryptocurrency because the asset it's tied to is stored centrally, leaving it vulnerable to the negative effects of government regulation.

If you want exposure to cryptocurrencies, then do some research, find one that fits your risk profile and take a punt.

If you want exposure to Gold, then buy it physically from a trusted source.

There's absolutely no reason at this point in time to try and combine these two very different assets.

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Bitcoin: The First Crypto-Curreny, Not The Last & Only

I have been fairly vocal on Twitter about Bitcoin and last year wrote a couple of articles about the cryptocurrency. The first (Bitcoin Bubble or New Virtual Currency Paradigm?) covered the basics of the technology, discussed some of the risks and shared some comparisons with precious metals (which many were measuring it up against at the time). I ended on the note that we might be nearing the top of a bubble in price:

My gut tells me that at US$70 Bitcoins are probably closer to a short term bubble peak (given the short term nature of the rise) than at the base of an immediate move to $150 or other high price targets I have seen thrown around ($500+), but that doesn't mean they can't head higher (in the short or long term).

I got the short term call wrong, although I didn't discount the possibility of higher prices.

Click Chart To Enlarge

After an almost immediate move to $150, turning my gut (on this occasion) into a similar contrarian indicator to the Pascometer, the price retreated back under $100, before regaining it's composure over a few months and then soaring to over $1200. Recently the price has been fluctuating between around $900-1000.

The second post I wrote about Bitcoin covered some of the gaffes Glenn Stevens' (Governor, Reserve Bank of Australia) made about Bitcoin in an interview (Glenn Stevens Talks Bitcoin & Competing Currencies). I discussed the errors in his characterisation of Bitcoin, showed how we don't have competing currencies in Australia as he claimed and had a chuckle at this oxymoron:

Ironically Stevens ends his interview on a point, 'the ones [BB: currencies] that survive will be the ones that hold their value' and in the same breath says 'which is why we have an inflation target which we’re hitting'. How Stevens equates holding value with hitting an inflation target is beyond my comprehension, it seems more like an oxymoron.

Although I feel my posts have been relatively balanced, if you follow me on twitter or read my posts on Silver Stackers you could be forgiven for thinking that I'm anti-Bitcoin, in fact nothing could be further from the truth.

On one hand, I am a big fan of the Bitcoin protocol, the technology itself is innovative and has laid the ground work for some incredible advances in the way that we transfer value in the future (amongst other applications). The fact that a decentralised and secure payment system has been developed outside the traditional global banking system is fascinating.  On the other hand I am wary of those promoting Bitcoin, exaggerting it's benefits, talking as if it's 6 months away from mass adoption & expecting it to retain it's dominance over other cryptocurrencies forever.

To be fair I don't only cast a skeptical eye over the Bitcoin pumpers, I've also blogged extensively on precious metals commentary I don't agree with. For example, I questioned Andrew Maguire's central bank Gold buying figures, looked for non-conspiratorial explanations for the slow delivery of Germany's Gold from the United States and corrected inaccuracies in an article claiming we were nearing the end of the paper Gold market.

Exaggeration, conspiracy and irrational commentary abounds in the precious metals space, facts are distorted or ignored, comments are taken out of context and exploited by those trying to sell you their subscription trading service, market report or the physical metals themselves. I empathise with some of those in this space who are just trying get readers into an asset they think is essential to hold, but there is no way I can condone the tactics used (by some) to achieve their goals, the ends simply don't justify the means.

The cryptocurrency market (including Bitcoin and other cryptocurrencies, known by many as altcoins) shares some of the same exaggerated commentary as the precious metals sector, although arguably not to the same extent.

Most asset classes have highly emotive supporters prepared to pump them incessantly, but I suspect that the money / currency topics tend to attract the worst kind of this attention due to the 'nemesis' (i.e. fiat currencies and central banks) having such a large impact on our everyday lives.

One of the most common misrepresentations I see is this constant stream of businesses now 'accepting' Bitcoin in exchange for goods and services. Every time a large company accepts Bitcoin it's deemed the next nail in the coffin for fiat currencies and a watershed moment for Bitcoin. The reality is that most of these businesses organise Bitcoin conversion into fiat instantly using a payment processor such as BitPay.

Suggesting a business is 'accepting Bitcoin', when they are having it instantly converted to fiat, is a fallacy. As I pointed out on Twitter, a company would accept payment in just about anything provided there was a market and payment processor available to instantly convert it into the local fiat currency:

A business would accept payment in Cheetos so long as a payment processor can convert them to $ instantly. #Bitcoin pic.twitter.com/wZMHJcNnBG
— Bullion Baron (@BullionBaron) December 9, 2013

What businesses are really saying when use a payment processor, is that we want the purchasing power of Bitcoin owners, but are not really interested in holding the currency itself. This article from The Motley Fool explains how retailers benefit without any of the risks the consumers take with Bitcoin:

Overstock's partner on this is Coinbase, which allows the company to do an instant exchange from Bitcoin into dollars. Overstock CEO Patrick Byrne is a self-declared "true believer" in Bitcoin, but he and his team obviously understand that it is not yet a desirable asset for a publicly traded company (unless you are a Winklevoss and starting a publicly traded Bitcoin ETF). With zero regulatory infrastructure and wildly fluctuating value, it just doesn't make sense for Overstock to hold on to Bitcoin for more than a nanosecond.

Cash, at least in the foreseeable future, will remain king.

So what Overstock has done is benefit from all of the noise surrounding Bitcoin, and immediately mitigate the risk of actually dealing with it.

While Patrick Byrne claims to be a true believer in Bitcoin, an old saying comes to mind, about watching what they do, this exchange from a recent interview with Fortune:

Fortune: Do you own any bitcoins? Patrick Byrne: No. I own gold.
Fortune: Really, how much gold? Patrick Byrne: A lot.

Some have argued that in time businesses will accept Bitcoins, provide them to their suppliers, pay their employees in Bitcoin, essentially closing the loop:

They are forced to change out from bitcoin to fiat right now because their suppliers expect repayment in dollars, and employees expect wages in dollars. But that expectation is not set in stone.

The next big revolution will be when bitcoin takes the B2B market by storm when they realize they can settle accounts instantly, especially for international transactions and import/exporters.

When your suppliers are willing to take bitcoin, the next leap is when employees prefer being paid in bitcoin.

When that finally happens you have the closed loop and can do all your business in bitcoin without switching out--which will prove to be quite profitable over dealing in fiat. Reddit

However, for a closed loop to take place, it would mean that everyone is prepared to take the risk of price movements in the Bitcoin currency or utilise hedging. Imagine the inconvenience of being an employee paid in Bitcoins and not knowing what your pay packet would buy in two weeks when you received it. It would be like trying to perform daily transactions using a foreign currency, the difficulties of which (for Australian consumers) I pointed out in my last post on Bitcoin:

Can you just imagine the administrative nightmare that would result from performing regular transactions in a foreign currency and having to maintain a record of whether you made a gain or loss as a result of fluctuation in the currency markets? It is simply not practical.

Bitcoin is not immune from the same requirements, earlier this year the ATO commented specifically on the topic (although the comments have a business focus, it does not exempt individuals from the same requirements)...

Another regular way that Bitcoin supporters misrepresent the cryptocurrency is by comparing it's daily volume with that of PayPal, Western Union or other payment systems used by consumers to purchase goods or transfer currency. Coinometrics publishes these figures:

Click Image To Enlarge

But what is often ignored when making these comparisons is that it's not possible to separate the Bitcoin transactions which are speculative in nature vs those used for a genuine purpose such as purchasing goods and services. So comparing the two directly is disingenuous. A more valid comparison to make would be to compare the largest cryptocurrency payment processor, BitPay, who processed over $100 million worth of transactions in 2013 versus PayPal who processed $44 billion in the 3rd quarter alone.

It's impossible to know how many Bitcoin transactions are used for consumer purchases. A recent estimate in a Forbes article says buyers spent $500,000 worth of Bitcoins at Overstock since it started accepting them two weeks ago. That may sounds like a lot, but with Overstock revenues expected at $1.3 billion in 2013, we are talking about an annualised increase from Bitcoin of $13 million or 1% (assuming these buyers only went to Overstock due to their acceptance of Bitcoin).

Many of the so called advantages of Bitcoin only benefit one side of the transaction. For example, Bitcoin features non-reversible transactions, which can be a benefit for the business, but poses a risk to the consumer. This seems to be lost on some who claim that no trust is required in either direction when using Bitcoin:

It is a way to exchange money or assets between parties with no pre-existing trust: A string of numbers is sent over email or text message in the simplest case. The sender doesn’t need to know or trust the receiver or vice versa. Related, there are no chargebacks – this is the part that is literally like cash – if you have the money or the asset, you can pay with it; if you don’t, you can’t. Why Bitcoin Matters

Where an exchange occurs with Bitcoin going in one direction and goods or services going in the other, of course there has to be trust. Those arguing blindly for Bitcoin will normally introduce the potential for trusted third party transactions at this point, but I am yet to see this in practice for consumers and there are unknown side effects attached which could harm Bitcoins other advantages such as instant settlement and low cost.
 
From my observation, most of those who own Bitcoins are either technologists, those with a speculative interest in seeing the currency rise in value or those dissatisfied with the existing system which centralises money creation and control in the hands of the few (banks, governments), i.e. they have ideological reasons for owning it. I am yet to come across anyone who owns Bitcoin purely for the fact that it's a superior form of currency for online purchases or the transfer of value.

While Bitcoin is the largest cryptocurrency by far (market cap circa $11 billion), there are many other competitors that offer improvements or differences that appeal to various individuals tastes. They vary in size with market caps as small as $100k, to $50 million or more (the 20 largest are listed below via coinmarketcap.com):

Click Image To Enlarge

Some Bitcoin supporters argue that the first cryptocurrency is already too popular in the market and unlikely to be surpassed by a competitor due to it's ability to adapt and add new features. Another argument is that too much developement has already gone into Bitcoin for it to lose the top spot, but this is very short sighted given that many of the Bitcoin services, sites and apps in use or being developed could be modified to work with any cryptocurrency.

Primary issue I see with Bitcoin, is lack of stability in price. The biggest competition to Bitcoin may be evolution of a cryptocurrency which is stable in value, perhaps even one that is backed by another asset (such as Gold):

After extensive testing in the Pacific, KlickEx is pleased to announce the development of a new asset-backed and algorithmic crypto-currency for institutional and retail use. A stable, international risk-free asset is a key foundation for efficient financial markets, and KlickEx’s award winning interbank payment network has an exemplary track record in stability, and efficiency. Having eradicated the significant systematic deficiencies of Bitcoin, then bridged the portfolio limitations of the IMF’s SDR, the new base asset is a proactive response to recent negative public sentiment towards banking in general, and recent global events including The GFC, Euro-Crisis, BASEL II, III, and fiscal & political instability in Prime currencies. KlickEx At FinovateAsia

Or as speculated by Felix Salmon early last year, perhaps a cryptocurrency itself won't be the future, but rather a network that will facilitate transactions of any currency (Maybe Ripple has a chance or something similar):

A peer-to-peer payments system, allowing anybody on the internet to pay anybody else on the internet without having to sign up with some financial-services behemoth first, could revolutionize global commerce. It would have to be able to work with any currency, including bitcoin; it wouldn’t need its own unit of account. It would have to be flexible, too: some transactions would be cashlike and irreversible, while others would allow some kind of chargeback.

And, most importantly, it would work with, rather than against, today’s established monetary institutions...

...But whatever it looks like, in the end, we can be sure of one thing: it will owe a very large debt to Satoshi Nakamoto and his audacious attempt to invent a whole new currency. Bitcoin isn’t the future. But it has helped to light the way ahead.

Of course the Bitcoin purists won't like the sound of centralising an asset to back a cryptocurrency or the thought of involving existing financial institutions in the final solution, but the choice ultimately won't be theirs. The market will decide and I can't see the majority of people choosing a currency that puts them at a distinct disadvantage due it's wildly fluctuating price.

Betting on Bitcoin being the permanent global leader of cryptocurrencies is like putting your money on MySpace (in 2004) to be the leading social network (wouldn't have worked out too well). The cryptocurrency journey is just getting started. Take a punt if you like, but don't put all your eggs in the Bitcoin basket.

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BB.

 

Glenn Stevens Talks Bitcoin & Competing Currencies

Some topics of interest were raised in an interview with Glenn Stevens (Governor, Reserve Bank of Australia) which was published on Friday at the AFR. 

The conversation on competing currencies stems from an initial question about Bitcoin (my emphasis):

Stutchbury: What do you make of Bitcoin and does that potentially have any effect on operation of monetary policy if those sort of artificial currencies or means of exchange became prevalent?

Stevens: I’m still trying to understand it to be honest but as best I can see it would be open to you to create a currency called the Michael and get people to buy it and you could promise to, you know, only issue so much of it and if people had confidence in that they could use that as a kind of numeraire. You could measure things in Michaels. You could buy and sell them.

Stutchbury: We call them “Stevens”.

Stevens: Yes. Well, and it might or might not hold its value depending on whether you keep the promise. You could also get speculative excesses in it I would imagine where its market value went up and down as people speculated on its future value and we see elements of that, I guess, with Bitcoin. I – and I think there are several other, aren’t there, similar things around so it’s a very interesting space. I don’t think it has caused us a material problem yet. I suppose it’s possible that any of these potential – these innovations financially potentially if they take off enough could – it will come back to, does it become an object of speculation with a lot of leverage behind it like a tulip mania or not. I don’t know the answer to that. I don’t know. It is certainly fascinating.

Stevens later clarifies (rightfully so) that cryptocurrencies are limited by a computer algorithm. So, unlike the initial example Stevens provides, there isn't need to worry about them holding value based on whether the issuer keeps a promise on how many will be created as it is built into the protocol. 

Fiat currencies (money declared by government to be legal tender) on the other hand are not limited by an algorithm or physical backing, so are at risk of losing their value as central banks engage in various monetary policies which either directly increase the money supply or are intended to encourage borrowing which results in the same. In fact the RBA's monetary policy includes a promise to devalue the currency (with no end date):

"The Governor and the Treasurer have agreed that the appropriate target for monetary policy in Australia is to achieve an inflation rate of 2–3 per cent, on average, over the cycle." RBA

Furthermore the measure that the RBA uses as the basis of inflation is the 'Consumer Price Index' (CPI) rather than an accurate measure of the increase in Australian Dollars circulating (which are mostly borrowed into existence through private and public debt at a higher rate than the CPI).

Bitcoin has an inflation rate (increase in total Bitcoins, not a cost of living index), which is currently higher than many fiat currencies. However, the rate is known in advance, it will drop over time so that within the next decade it will be lower than the RBA's measure and there will come a time when no further Bitcoins will be created.

[Click Chart To Enlarge] Source

In the response above Stevens goes on to say that cryptocurrencies may become an object of speculation 'with a lot of leverage behind it'. I would suggest there is already a lot of speculation behind the recent rise in many of their prices, but unlike traditional assets it is very difficult to do so using leverage. A bank won't lend you money to speculate on the price of Bitcoin (at least not knowingly, you may get away with using an unsecured personal loan or credit card), but they will allow you to leverage 20:1 (i.e. 95% LVR) to purchase a house. Which object of speculation using leverage is more likely to pose a risk to Australia?

In the next question the interviewer poses a question around competing currencies...

Stutchbury: Could it be that the new technology will potentially take us back to a world where there were competing currencies in any one economic system?

Stevens: Well, there are competing currencies now. I mean, you know, you can hold US dollars or Euros or whatever in Australia completely freely if you want to and there would be nothing to stop people in this country deciding to transact in some other currency in a shop if they wanted to. There’s no law against that so we do have competing currencies. Maybe – maybe there will be a world in which currencies based on some computer algorithm to limit supply as opposed to physical gold or something. There have been many such currencies through the ages. The Pacific Islands used to use shells, didn’t they? So there have been many bases for currencies and in the end, I suppose, the ones that will, and this will be a good note to finish on, the ones that survive will be the ones that hold their value which is why we have an inflation target which we’re hitting.

For starters, Australia does not allow competing currencies. The Reserve Bank Act 1959 clearly states:

Other persons not to issue notes
             (1)  A person shall not issue a bill or note for the payment of money payable to bearer on demand and intended for circulation.

And even prior to this Act the issuance of private notes was discouraged through the Bank Notes Tax Act of 1910 which imposed a tax of 10% per annum on all banknotes issued (by private banks).

Granted Bitcoin and other cryptocurrencies don't circulate in the form of notes, however I suspect if the creation and circulation of Bitcoin was specific to a single country then regulatory authorities would crack down on it (if they were able to, take for example the recent shutdown of physical Casascius Bitcoins in the US). It's only Bitcoin's globally distributed & digitally stored/transmitted nature that allows it to circulate outside the control of regulatory bodies.

If we ignore the fact that it's not legal to circulate private currencies and concentrate on Stevens reference to using foreign currencies in Australia, it still remains largely impractical if we are to remain within the bounds of the law. It's true that a business or individual may legally agree to transact in a currency other than the Australian Dollar:

"Every sale, transaction or dealing relating to money, or involving the payment of, or a liability to pay, money in Australia is to be done in Australian currency unless it is done, or the parties to the sale, transaction or dealing agree that it will be done, in the currency of another country." RBA

However, all parties involved are also required to report any capital gains or losses that occur as a result of foreign currency transactions. Foreign currencies are not considered a personal use asset or collectible, so fall under the title 'other assets' and are not excluded from Capital Gains Tax (CGT). Here is what the ATO has to say on foreign currency transactions:

Forex realisation event 1 occurs when there is a disposal from one entity to another (that is, a change in the beneficial ownership happens - capital gains tax (CGT event) A1 - of foreign currency, or a right or part of a right to receive foreign currency.

The time of the event is when the foreign currency, or the right or part of the right is disposed of.

You make a foreign exchange (forex) realisation gain if you dispose of foreign currency, or a right or part of a right to receive foreign currency for more than you paid for it, to the extent that the gain is due to fluctuations in the value of the foreign currency. This will usually be when the proceeds on disposal of the foreign currency, measured in Australian dollars, are more than the cost of acquiring the foreign currency, measured in Australian dollars.

You make a forex realisation loss if you dispose of foreign currency, or rights or parts of rights to foreign currency for less than you paid for them. This is to the extent that a loss is due to fluctuations in the value of the foreign currency. ATO

Can you just imagine the administrative nightmare that would result from performing regular transactions in a foreign currency and having to maintain a record of whether you made a gain or loss as a result of fluctuation in the currency markets? It is simply not practical.

Bitcoin is not immune from the same requirements, earlier this year the ATO commented specifically on the topic (although the comments have a business focus, it does not exempt individuals from the same requirements):

"The tax legislation that applies to conventional commercial transactions also applies to transactions undertaken via the internet or with emerging payment systems.

Paying for goods and services with new types of payment tokens still means that the seller may need to account for GST or include the income in their business tax return.

The buyer may also need to keep records of the value of the purchase if it represents a business expense or if the purchase is an asset which may be subject to a capital gain or loss.

The value used by the buyer and the seller in these transactions needs to be identical and consistent with market prices.

It is most important that people engaged in any type of transaction with Bitcoin or other payment systems keep detailed records and evidence about what trades they make and the source of any assumptions about the value of any transaction in Australian dollars.

This will minimise the risk of there being a difference of opinion between a taxpayer and the ATO over the correct valuation and treatment of a transaction for taxation purposes." Business Insider

Ironically Stevens ends his interview on a point, 'the ones [BB: currencies] that survive will be the ones that hold their value' and in the same breath says 'which is why we have an inflation target which we’re hitting'. How Stevens equates holding value with hitting an inflation target is beyond my comprehension, it seems more like an oxymoron.

The suggestion from Stevens that we have competing currencies in Australia is, quite frankly, a joke. For true competition the laws revoking legality of private currencies need to be scrapped as do capital gains events on foreign currency transactions and for that matter Gold as I argued in an earlier post 'Let Australians Save in Gold Instead of Debt'.

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BB.

 

Bitcoin Bubble or New Virtual Currency Paradigm?

Will speculating on the Bitcoin mania make you rich?

Bitcoins have been making headlines on mainstream news sites, on blogs and even on precious metal forums recently and with good reason given the vertical rise in price per Bitcoin:

Bitcoin: Market Price (USD)

But is this rise part of a bubble or a new paradigm for virtual currencies as their utility increases and becomes more mainstream?

There is a lot of speculation that the Bitcoin mania has been a result of the recent Cyrpus crisis, however much of this speculation was due to an increase in app downloads in a single country where iPhones do not have a large market share:

This was spotted by BGR writer Tero Kuittinen, who noted that three iOS apps -- Bitcoin Gold, Bitcoin Ticker and Bitcoin App -- each jumped up the App Store charts in Spain, all on the same day, as the news broke from Cyprus. Compare their download histories to those from a country like the UK and it's clear that the upward trend is more pronounced in the more at-risk nation. Bitcoin Gold's all-time high ranking of 83 in Spain came on 17 March; for Bitcoin Ticker, 68 on 17 March; Bitcoin App reached a high of 147 on 19 March. The highest rankings for those apps in the UK are lower -- 293, 201 and 48 -- and they were all records set months or even years ago. Indeed, there hasn't been any kind of correlation between the Cyprus news and an uptick in Bitcoin app interest in the UK, going from this.

The huge caveat to this, though, is that the iPhone's market share in Spain is tiny, at roughly four percent of the total smartphone market as of mid-2012. Only a percentage of people who trade Bitcoins will trade or keep up to date with prices on their smartphones, too. A spike in iOS app downloads in one Eurozone country is a terribly small sample from which to draw conclusions about whether the Eurozone crisis is driving more people across the continent to Bitcoins. Wired

It seems more likely to me that the increase in Bitcoin app activity was a result of the surge in Bitcoin price that had recently taken the price to all new highs by the 17th of March, the further rally which took the price to levels above US$50 (which probably sparked even more interest) & the crash that had occurred several days earlier due to a glitch in the blocks/programming.

Click to Enlarge: Timeline of Events, 2 Months

With this number of events all occurring in unison, it's not hard to see there were other reasons for the increase in Bitcoin activity, other than finding a safe haven currency to avoid depositor haircuts as some have speculated was the case.

For those who are not familiar with Bitcoins, they are a virtual currency. First created in 2009, they can be transacted peer to peer and through exchanges such as the most popular Mt.Gox. Their creation is not controlled by a central authority, their supply is expanded with the use of a mathematical algorithm.

The price of a Bitcoin has risen from around US$10 to over US$70 in the space of 4 months. Some might call that a bubble with little more thought given, but scratch under the surface of the price and there could be valid reasons for the increase in price.

One of the reasons for the large rise in price is a combination of a slowing number of them being added to circulation:

Bitcoin: Total Bitcoins in Circulation

Starting from 2009 the number of Bitcoins generated every 10 minutes was roughly 50, every 210,000 generations (approximately 4 years) the creation rate drops in half (50, 25, 12.5, etc), the number of Bitcoins in circulation will never number more than 21 million:

Total Bitcoins Over Time

As is evident from the above charts, the first halving of Bitcoin inflation has taken place toward the end of 2012, near the recent price lows and start of the rally which culminated in the parabolic spike. Plenty of speculation on what would happen (including expectations of a rising price) was taking place last year:

The implications to this are huge and for the most part unknowable.  There are two ways I can see it going;-

    - Mining is a delicate balance of difficulty vs electricity costs, the price of bitcoin depends on the electricity cost to generate those coins so if the cost to generate a bitcoin increases the price of a bitcoin rises to match.
    - People stop mining bitcoin because the cost outweighs the return and the difficulty of generating a bitcoin (currently at 3368767) plummets until it is once again profitable to mine.

I believe that it will be a mix of both, I think the price will rise and the difficulty will drop but that is just me speculating.  The truth is we are in for an interesting time, I don’t even want to factor in the new bitcoin mining hardware (ASIC) that seem to be about to hit the market. MineForeman

Can the halving of creation rate alone justify a 7x rise in the price of Bitcoins? Probably not by itself.

Along with the halving of creation rate, we've also seen the number of transactions and unique addresses used for transactions rise (together these numbers indicate an increasing number of people using Bitcoin rather than increase in number of addresses used per person):

Bitcoin: Number of Transactions Per Day

Bitcoin: Number of Unique Bitcoin Addresses Used

An increased number of people using Bitcoin has resulted in a "network effect" where it's value has risen as demand increases:

In economics and business, a network effect (also called network externality or demand-side economies of scale) is the effect that one user of a good or service has on the value of that product to other people. When network effect is present, the value of a product or service is dependent on the number of others using it.

The classic example is the telephone. The more people own telephones, the more valuable the telephone is to each owner. This creates a positive externality because a user may purchase a telephone without intending to create value for other users, but does so in any case. Online social networks work in the same way, with sites like Twitter, Facebook, and Google+ becoming more useful as more users join.

The expression "network effect" is applied most commonly to positive network externalities as in the case of the telephone. Negative network externalities can also occur, where more users make a product less valuable, but are more commonly referred to as "congestion" (as in traffic congestion or network congestion).

Over time, positive network effects can create a bandwagon effect as the network becomes more valuable and more people join, in a positive feedback loop. Wikipedia

The network effect can very much apply to currencies, especially so where the Government/central banks can't increase the number of currency units to meet demand, so Gold has also benefited from the network effect over the bull market as an increasing number of people want to own it, but where there is no easy way to increase the amount (while Gold doesn't have a known limit like Bitcoin, there are other reasons we can't dig more up on a whim including declining grades available to mine).

Despite the positives for Bitcoin, there are still risks which have the potential to impact on price.

ASIC(s) - Application Specific Integrated Circuits are essentially specialised computer chips designed for mining Bitcoins in the most efficient way possible. To date much of the Bitcoin mining that occurs has been via powerful computers which also have a high running cost (e.g. gaming rigs with specific graphics cards which lend themselves to the process), but with these new systems comes lower entry& running costs which will result in more competition... how much effect this will have on the price of Bitcoins is yet to be seen as consumer ASICs have only started shipping early this year (read more here). They could have a dampening effect on the price in the short term (lower cost to mine), but then as they become more common the competition will force a reduction in the profits for the early adopters, driving the cost to mine higher again.

Regulation -  Recent news out of the US includes threats of regulation of the BitCoin market:

The U.S. is applying money-laundering rules to "virtual currencies," amid growing concern that new forms of cash bought on the Internet are being used to fund illicit activities.

The move means that firms that issue or exchange the increasingly popular online cash will now be regulated in a similar manner as traditional money-order providers such as Western Union Co. WU +1.04% They would have new bookkeeping requirements and mandatory reporting for transactions of more than $10,000.

Moreover, firms that receive legal tender in exchange for online currencies or anyone conducting a transaction on someone else's behalf would be subject to new scrutiny, said proponents of Internet currencies. Wall Street Journal

As transacting the currency can occur peer to peer, there is little any one Government could do to stamp out use, however if the large exchanges (where currency for Bitcoin swaps take place) were targeted, there is the potential for it to have a negative effect on the ease of use and market for Bitcoins.

Hacking - The most obvious risk to a virtual currency is the risk of storing them. Hold them on your local computer and they are at risk if you accidentally delete them or your hard drive crashes. There is also the potential someone could hack into your computer and transfer them out if you haven't stored them securely enough. The problem is that all transactions are irreversible and difficult to trace, so once they are gone it's unlikely you will see them again. Not only are criminals targeting individuals who hold Bitcoins, but also exchanges and sites offering online stored wallets/Bitcoins. As the value of Bitcoins increases so will the sophistication and efforts of criminals to steal them. It was a hacked exchange which resulted in the 2011 crash in price (from a peak just above US$30):

Click to Enlarge: Bitcoin Chart Showing 2011 Crash and Today's Boom

The Bitcoin community faced another crisis on Sunday afternoon as the price of the currency on the most popular exchange, Mt.Gox, fell from $17 to pennies in a matter of minutes. Trading was quickly suspended and visitors to the home page were redirected to a statement blaming the crash on a compromised user account. Mt.Gox's Mark Karpeles said that the exchange would be taken offline to give administrators time to roll back the suspect transactions.

The extent of the compromise became clear when a copy of Mt.Gox's user database began circulating online. The file included username, email addres, and hashed password for thousands of Mt.Gox users. Karpeles's statement was updated to acknowledge the breach. He warned users who have re-used the Mt.Gox passwords on other sites to change them. Ars Technica

The increase in value of Bitcoins (market capitalisation of all Bitcoins rose from just over $100m to almost $800m with the recent price rise) is likely to paint a larger target on the Bitcoin exchanges and people with a large number of Bitcoins in their virtual wallets. Who knows what sort of exchange hacks or malicious code could end up affecting the Bitcoin market in a negative way.

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So all this said, with rational reasons for an increase in price (although perhaps not to the extent it has) is the Bullion Baron about to run out and purchase some Bitcoins and hope their utility and in turn value continues to increase? Not likely. The main problem I see for the investor/speculator (see this post for my definitions) is that there is no accurate way to value the Bitcoin and while precious metals are much the same, there are several key differences:

• Precious metals are a physical commodity, Bitcoins are a virtual currency.
• Precious metals have history spanning thousands of years as money and a store of value, Bitcoins have a few short & volatile years as a virtual currency.
• Precious metals have utility outside of monetary use (industrial, jewellery, etc), Bitcoins are only useful as a currency used in transactions.
• Precious metals are more easily purchased (at least that is the case in Australia, from my experience).
• Precious metals have a history of cycling in value against other assets such as oil, stocks & land, Bitcoins have no such history.

They do also have some similarities:

• Neither have a governing body/central authority that can produce them in unlimited quantities.  
• They are both a limited resource (Gold by it's natural occurrence in the earths crust and Bitcoins by the algorithm which controls the number created).
• Both will be harder and more expensive to mine over time (Gold due to decreasing grades and rising input costs, Bitcoins due to increased competition, technology advances and the reducing number created until peak 21m reached).
• Precious metals and Bitcoins are both seen as a threat to official currencies and are likely to see action as a result (more regulation).

There is no reason to expect that Bitcoins will act as a store of value over the long term, but then if their popularity continues to increase then likely so will their price over the long term. The number of sites and services that can be used with Bitcoins is increasing regularly, there is quite an extensive list here: Spend Bitcoins and there has even been news of Bitcoin ATMs to make funding your account even easier:

Zach Harvey has an ambitious plan to accelerate adoption of the Internet's favorite alternative currency: installing in thousands of bars, restaurants, and grocery stores ATMs that will let you buy Bitcoins anonymously.

It's the opposite of a traditional automated teller that dispenses currency. Instead, these Bitcoin ATMs will accept dollar bills -- using the same validation mechanism as vending machines -- and instantly convert the amount to Bitcoins and deposit the result in your account. CNET

My gut tells me that at US$70 Bitcoins are probably closer to a short term bubble peak (given the short term nature of the rise) than at the base of an immediate move to $150 or other high price targets I have seen thrown around ($500+), but that doesn't mean they can't head higher (in the short or long term). 

I think to a degree the price in the short term will depend a lot on who is holding Bitcoins and for what purpose. If there are a lot of speculators or people storing large amounts with no reason to transact then a move to sell and take profit could drive the price lower. If there are few of these types though and the price is being driven higher by a genuine need for Bitcoins for use in transactions then the price could keep moving higher.

Personally though even if I thought Bitcoins were undervalued, after rising 700%, their risks and weaknesses would stop me from putting any significant amount of money into them, a couple of thousand dollars maybe for a punt, but nothing serious. Although they have similarities to precious metals, they are far from a replacement.

You can follow me on Twitter. I'm usually sharing links and opinions daily (@BullionBaron). You can also CLICK HERE to signup for free email updates.

BB.