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Currency Risk is important to consider when dealing in Bitcoin

Unpredictable Bitcoin Pricing and Currency RiskARTICLE

By Gianvito Grieco

By now, we’ve heard it all about Bitcoin. It’s going to revolutionize business, as well as the legal, music, and even video-gaming industries. It’s going to prevent global banking crises. It’s going to empower small-scale entrepreneurs with its cheap, low risk way of transferring money. It’s going to be so valuable that if you buy just one bitcoin today, there is a higher than 50 percent chance that it will be worth more than a US$1 million some day.1 We won’t trade stocks, or transfer property title, or buy a cup of coffee the same way ever again. Will it really do these things? Maybe. Maybe not.

Bitcoin: The Most Volatile Asset in the World

One thing is certainly true about Bitcoin: since its inception, the price has had a history of wild swings. The International Monetary Fund (IMF) has recognized it as one of the most volatile assets in the world.2 Bitcoin went from being worth pennies in 2011, to over US$1,200 in November, 2013, it’s current all-time high.3 Since then, there have been countless rallies and crashes.

As the IMF described, there is still a very low level of acceptance as a medium of exchange, and it is widely “hoarded” for speculative purposes. Even Tyler Winkelvoss, one of the biggest proponents of Bitcoin and co-founder of a Bitcoin exchange, doesn’t use bitcoin for everyday purchases because he is worried about “overpaying down the road.”4 Many clearly share his views and hold onto the virtual currency with hopes that its value will increase in the future. The incentive is provided by the price volatility, and past returns have been extreme on both ends.

Volatility Hinders Adoption of Currency Risk

Price volatility means uncertainty. When accepting Bitcoin, merchants have to be aware of the currency risk and be prepared to take significant losses when converting to another currency. So far, many merchants accepting Bitcoin have had to internalize the cost of the volatility. There are companies that take on the currency risk, at a cost. Regardless, currency analysts have expressed concerns regarding how much longer merchants will be willing to assume the currency risks.5 Merchants are left balancing whether or not the increased traffic by Bitcoin enthusiasts is worth the significant risks that comes with holding onto Bitcoin.

Volatility is especially bad for the people that Bitcoin could help the most: those in countries plagued with high inflation and where confidence in monetary policy is low. Bitcoin has developed a robust following in such countries.6 Traditionally, U.S currency is held abroad for security against inflation and economic instability.7 However, if Bitcoin’s volatility is too high, holding dollars still remains a more attractive option.

Period of Stability in Bitcoin Pricing

Bitcoin’s price managed to remain stable for most of 2015 and 2016. In 2015, the price hovered around US$250. The price rose in 2016, but remained stable at around US$425 for the year. Volatility has also declined sharply.8 The meteoric rise and falls common in 2013, and 2014, have been less frequent.

The cause of this stability is unknown. It may be due to the fact that a regulatory framework for virtual currencies has begun to form, providing answers and alleviating concern investor concerns. It may also be that the low volume and price movements of 2013, and 2014, “sapped the interest of many traders.”9

Recent Developments

However, volatility recently took a turn for the worse. Since June 18, 2016, Bitcoin has dropped over 25 percent. Traders have cited concerns over the closing of the Bitfinex exchange for a few hours due to “networking issues.”10 Temporary exchange closures due to tech and security concerns have caused price drops in the past. There is no doubt that investors still remember well the Mt. Gox implosion and fear that another exchange will follow in its footsteps.

The Takeaway

Bitcoin keeps proving to investors, traders, and users alike, that its price cannot be predicted. There is a long-term trend indicating that volatility is on the decline, but currency risk remains an important consideration when trading in the cryptocurrency.

Gianvito Grieco

The Author

Gianvito Grieco

Gianvito Grieco has served in a variety of roles in investment banking, financial services, and law. Gianvito holds a Bachelor of Science in Finance from the University of Florida, and a Juris Doctor from Stetson University College of Law. He is also fluent in English, Italian, and Spanish.

Sources

1. Xapo’s Casares: There is a Higher than 50% Chance a Bitcoin is Worth More Than $1 Million, CoinGecko, https://www.coingecko.com/buzz/xapo-casares-50-percent-chance-bitcoin-more-than-1-million.
2. Virtual Currencies and Beyond: Initial Considerations, IMF Staff Discussion Note, https://www.imf.org/external/pubs/ft/sdn/2016/sdn1603.pdf.
3. Market Price, BlockChain, https://blockchain.info/charts/market-price.
4. We are Cameron and Tyler Winklevoss, But You Probably Know Us as the Winklevii. We are Here to Talk About Gemini, our New Bitcoin Exchange. AMA, or Rather AUA, Reddit, https://np.reddit.com/r/IAmA/comments/3nu7gj/we_are_cameron_and_tyler_winklevoss_but_you/cvrbydg.
5. Bitcoin’s High Volatility May Hinder General Acceptance: Report, LiveMint, http://www.livemint.com/Money/vOyNAxB0hY6KtpVE9xNWdJ/Bitcoins-high-volatility-may-hinder-general-acceptance-Rep.html.
6. Can Bitcoin Conquer Argentina?, New York Times, http://www.nytimes.com/2015/05/03/magazine/how-bitcoin-is-disrupting-argentinas-economy.html?_r=0
7. The Use and Counterfeiting of U.S. Currency Abroad, Part II, United States Treasury Department, http://www.federalreserve.gov/boarddocs/rptcongress/counterfeit2003.pdf.
8. Bitcoin Volatility Time Series, Bitcoin Volume, https://btcvol.info/.
9. Bitcoin Bores Traders as Volume Declines on Price Stability, CoinDesk, http://www.coindesk.com/bitcoin-price-bore-traders/.
10. Bitcoin Plunges Nearly 25% in 6 days; Here’s 3 Reasons Why, CNBC, http://www.cnbc.com/2016/06/23/bitcoin-plunges-nearly-25-percent-in-6-days-heres-3-reasons-why-brexit-china-yuan-halving.html.

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