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The Investment Merits of Bitcoin, Part 1

The topic of Bitcoin has been one that has emerged with much more frequency over the last two to three years. There is, perhaps, a small element of general interest in how the subject is then navigated in the conversation. Questions like “what on earth is it,” “apparently it was invented by some Japanese bloke,” and “can I get a book on it from Exclusive?” However, the most dominant theme in any discussion centres on the financial aspect. “A friend of mine has made a truck ton of money on Bitcoin”, “have you seen the price of Bitcoin, it’s doubled in the last month”, and “why do you need to follow the market, just look at the bitcoin price”.

In my 30+ years in the investment industry, I have never seen anything like Bitcoin and the hype and aura around it. Markets are dynamic and change every day. There are new fads and products, themes and theses, events and stories, on a seemingly more regular basis. But Bitcoin seems to levitate above all these daily passings.

I have clear memories of the Global Financial Crisis (GFC) in late 2008. Working on the equities desk at a major SA bank which was in a joint venture with a prestigious global investment bank, we were one step removed from the carnage going on in London and New York. However, if our offshore partner had gone to the wall (which it nearly did), there would have been an impact, a sizeable one, trust me. In all of this, the explanation of the problem sweeping the world’s financial system contained investment jargon and acronyms that made it indecipherable to the man on the street. From my experience in the markets, I sort of knew, at least the theory, around Collateralised Debt Obligations (CDOs), Collateralised Mortgage-Backed Securities (CMBSs), and other derivative weapons of mass destruction (as Warren Buffet called them). Bitcoin – the truth is that knowing pretty much zero, I have turned my shoulder. Being in a Financial Advisory business and managing clients’ hard-earned money, the obvious question is, what would my advice be if asked about the investment merits of Bitcoin. And to supply that answer, I would need to understand why, and more importantly, how, I had reached my conclusion.

A history of coins, the Gold Standard and its impact on currencies

There is evidence that the first gold coin was moulded in 1500 BC in Egypt, known as a shekel, and used as a medium of exchange. In the book, The End of Money, the authors go on to explain how coinage was introduced to Europe in 1066 by William of Normandy (remember the battle of Hastings?), and over time formalised into the British system of pounds, shillings and pence. In the late 18th century, the Coinage Act was passed in the US, establishing a bimetallic silver-gold standard which, in one form or another, would form the foundation of the monetary system for nearly 200 years.

Countries through the developed world adopted the gold standard to settle debts in a global economy struggling to arrive at any other standardised form of valuing different nations currencies. This mechanism required sovereign governments to hold gold against any currency (money) created, and its value would be based on the weight of gold held. However, World War 1 saw the gold standard suspended as countries had to print more money to pay for the war. The wall street crash of 1929 and the Great Depression that followed saw the gold standard buckle entirely, as people exchanged US$ for gold and hoarded it, as banks around them collapsed. In response, in 1933, the US Government made it mandatory for citizens to return their gold and coins in exchange for dollars. This meant that as World War 2 concluded, the US’s gold reserves put them in a position of strength. The Bretton Woods agreement of 1944 thus decreed the US$ would be pegged to the gold price, and all other currencies would be pegged to the dollar. The gold standard was therefore replaced with the “dollar” standard”. A few countries had reservations about the supremacy the US dollar was bestowed with, and when dollars held by other countries began to exceed US gold reserves in the early 1970s, some of them (including France, Germany, UK, Belgium, Netherlands) came to Fort Knox to remove the gold being held on their behalf. There is a legend that the French President at the time, Georges Pompidou, ordered a warship to enter New York harbour to retrieve his country’s gold and bring it back to Banque de France! A temporary suspension of the dollar’s convertibility to gold was put in place, and in March 1973, the Bretton Woods system collapsed. Thus began the system of floating exchange rates (fiat currency) that exists today.

In the next edition of the Beacon, I will discuss The fiat currency world, the GFC, and the Bitcoin cryptocurrency’s emergence, as well as the mechanics of Bitcoin (as best a non-technician understands), and then….. some thoughts on what the hypothetical future perhaps holds.

Click here to read the second part of the article.