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Bringing Virtual Currencies into the Real World

March 14, 2014

David Atkinson
Senior Vice President City National Foreign Exchange Manager

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Is Bitcoin really a currency? Is it the future of international transactions? Is it a good investment? We get these questions often. If you strip away the sensational side stories around Bitcoin, you get a far less compelling story.

Bitcoin’s best attraction is as an electronic means of payment, and in this vein could foreshadow how transactions are processed in the future.

Outside of its promise as a future payment system however, Bitcoin is a tough sell. Ironically, the advantages that supporters of Bitcoin tout also result in serious shortcomings. Bitcoin’s lack of regulation has been on spectacular display with the recent loss of funds at the Mt. Gox exchange in Japan. There are certainly debates to be had regarding government oversight, but the complete absence of any authority, is a wide open invitation for fraud, tax evasion, and theft.

Bitcoin’s other claim is that the system is designed so that after all coins are “mined” there will not be any more, thus keeping the currency safe from central bankers who may devalue the currency with a flood of supply. However, the limited supply of Bitcoins -- 21 million after all are mined, with 11 million already in circulation -- turns the currency into the digital equivalent of a metal-based currency system. Say all you want about central bankers’ ability to conduct monetary policy, but all major economies decided long ago to abandon metals-based currencies due to the volatility of their economies under a fixed stock.

In that respect, Bitcoin has been shocking. For the last three years, Bitcoin’s volatility has averaged 120%, while the typical G10 currency volatility has ranged from 7% to 16%. The last time currency markets experienced 120% volatility, was with the Argentine peso during that country’s 2002 default.

So while Bitcoin holds promise as yet another innovation in payment systems, it cannot escape the basic laws of behavior and economics in two ways; the tendency to cheat in the absence of a watchdog, and the volatility that arises with a limited commodity.

My view: Bitcoin may be here to stay, but in its current form will be relegated to the world of illiquid, speculative investments, rather than a functional replacement for established currencies.

This report is for general information and education only and was compiled from data and sources believed to be reliable. City National Bank does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors as of the date of the report with no obligation to update or notify of inaccuracy or change. This report is not a recommendation or an offer or solicitation to buy or sell any financial instrument discussed. It is not specific investment advice. Financial instruments discussed may not be suitable for the reader. Readers must make an independent investment decisions based on their own investment objectives and financial situations. Prices and financial instruments discussed are subject to change without notice. Instruments denominated in a foreign currency are subject to exchange rate and other risks. The Bank (and its clients or associated persons) may engage in transactions inconsistent with this report and may buy from or sell to clients or others the financial instruments discussed on a principal basis. Past performance is not an indication of future results. This report may not be reproduced, distributed or further published by any person without the written consent of City National Bank. Please cite source when quoting.

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