Is Bitcoin A Currency?

Definition of currency

Bitcoin is a virtual currency developed by Satoshi Nakamoto of Japan in 2008. Bitcoin is based on block chain concept and was developed to avoid the issue of double spending. It is decentralized and a peer-to peer currency and operates as an alternative to physical currencies and commodities.

Transactions in Bitcoins take place between the buyer and seller online directly, with both having a unique encryption. Transactions are recorded in a decentralized ledger which is available for network users to validate and verify transactions. The verification process is seen by special users on the network (“miners”). For verification, miners are paid with twenty five newly generated Bitcoins; this is how the total number of Bitcoins grows.

For analyzing this question, we need to first look at the definition of currency. In terms of oxford dictionary currency means “the fact or quality of being generally accepted or in use”. Further, money is defined by economists comprise three attributes: (Yermack, 2013)

• Functions as a medium of exchange;
• A unit of account and
• Storage of value.

In this regard, as far as Bitcoin is concerned it is recognized as a medium of exchange across globe with many countries listing it on stock exchange for the purpose of investment. Further, in the recent advent of technology it has been gaining the heat out of its low transaction cost and ease of transaction. However, the coin is still in a budding stage and has been in use for a decade from its invention. Further, the numbers of coins that can be mined are limited and shall be mined till 2140.

As far as unit of account is concerned, Bitcoins have a very high value, trading roughly between 7000-8000 US dollars as on 02-06-2018. Thus majority of goods that are available in public domain are not properly represented in terms of Bitcoins and generally go to 4 to 5 decimal points. Thus, it can puzzle and make transaction representation difficult for daily odd transactions.

As far as storage of value is concerned, it is subject to hacking, thefts, loss of data and other incidental catastrophe. Further, there is no insurance, government backing as in case of fiat currency. Further, Bitcoin are decentralized and driven by market forces of demand and supply, the speculative investors have accounted for a very high time series volatility of Bitcoin. Further, the spread between inter stock market is very wide and gives arbitrage opportunities to speculative investor. Thus, the coins are not stable and exhibit a very high fluctuation. The curve of the Bitcoin has been shown here-in under:

Bitcoin as a currency

Thus on the basis of the above it may be understood that for Bitcoin to become a bonafide currency, it needs to be stabilized to serve as unit of account and store of value. Further, the price of Bitcoins needs to be limited and the volatility must be restricted to fiat coins. The success and acceptance of Bitcoin as a currency also depends on financial inclusion of currency all over the globe. However, it can have only a limited presence and cannot be a global changer due to its limited capacity and shall not correspond to economic growth. Further, no government intervention can collapse a country using Bitcoin as a common currency.

Is Bitcoin a hedging tool?

The term hedging is primarily defined as an investment position intended for offsetting price volatility. In plain words, hedging is used to reduce losses or gain exposure of an individual or organization.

In this regard, let us consider the view point of Mr. Brian Strutland, President of Equity Armor Investments who believes that Bitcoins perfectly predicts the dynamic behavior of VIX, the volatility index of fear and states that it is an excellent hedging tool. He further adds that there exists a strong negative correlation between the two and thus Bitcoin can be used a hedging tool in stock market. The graph has been illustrated below to showcase 30 day relation:-

The VIX (Volatility Index) is an indicator calculated by the CBOE exchange at option prices which reflect market expectations with regard to the future volatility of options for the S & P 500 index. 

Further, recently US Securities and Exchange Commission head stated that Bitcoin is less volatile in comparison to VIX.

Dyhrberg (Bitcoin, gold and dollar –A GARCH volatility analysis) analyzes the relationship between Bitcoin, Gold, and the US Dollar and he states that somewhere Bitcoin can be classified between Gold and US Dollar. (Dyhrberg, 2015)

Since the Creation of Bitcoin in 2009, this crypto currency has come in more popularity over the earth. People from all around the world from small village to big cities attracted to invest in this new currency. There are lots of Professionals who are interested in Bitcoin. It acts as medium of exchange, it is now considered as an investment tool since many of them buy for investment purpose. Rather than as currency. Because Bitcoin lacks its guaranteed value so its purchase has got high risk. Bitcoin has got a several risk associated with it. To manage that risk GARCH (Generalized autoregressive conditional heteroscedasticity) model has come up as a tool to quantify the risk. GARCH model in analyzing the risk management and Bitcoin exchange rate.

Challenges for Bitcoin as a currency

Bollersev (1987) firstly developed the GARCH model .Dyhrberg investigated the hedging capabilities of Bitcoin by applying asymmetric GARCH method and showed that Bitcoin can be used an hedging instrument against stock in the Financial Times Stock Exchange Index and against the American Dollar in the short term. Dyhrberg also explored several similarity to Gold and Dollar indicating hedging capacity of Bitcoin and can be acted as medium of exchange.

Replication

Bitcoin Price data is downloaded from coindesk.com all other data are retrieved from DataStream. It consists of 1769 daily observation including weekends since Bitcoin trading is not limited to only Working days. On Saturday and Sunday assumes Zero Return .We use the data and sample from July 19, 2010 to May 22, 2015.

The above provide the statistics From July 10,2010to May 22, 2015 and it includes weekends. For all assets weekend return are assumed to be zero except for Bitcoin.AR(1) provides the first autocorrelation estimate.ADF Provides t statistics of an Augmented Dicky Fuller test.***(*,**) denotes significance at 1%(5%,10%) significance level.

Dhyrberg found that Bitcoin and gold have similarities when it comes to volatility to the return. Since the GARCH model is estimated for Bitcoin return, it does not provide any information about the volatility of Gold, or any other assets, so a proper comparison is impossible. All other analysis is somehow incorrect, further results do not show that Bitcoin may be useful for hedging against dollar. Since the two highly correlated exchange rate was used.

Descriptive Analysis

Now we construct the descriptive statistics which shows that Bitcoin is nowhere near Gold ,the US Dollar and MSCI World equity Index  which the below Table depicts.

The Daily mean return is 0.4011%for Bitcoin and thus the largest return. The MSCI World equity index shows the next highest mean return namely 0.0319% which is more than normal Bitcoin return. The standard deviation provides a similar picture and puts Bitcoin with a standard deviation of 5.90% followed by Gold future returns (1.06%) and FTSE 100(0.95%)

The above table presents the unconditional co relation of Bitcoin return with all other return for all daily and weekly (like Tuesday to Tuesday) returns. It shows that Bitcoin returns are uncorrelated with all other except we can see a small negative correlation with the USD/GBP exchange rate).This Provides opportunity for managing the risk management Portfolio. The correlation estimate between Bitcoin and other assets is not significantly correct due to different trading hours exist and they exactly do not reflect the true figure except for the USD/GBP exchange rate.

Hence the correlation suggesttaht Bitcoin is not related to asset such as gold, exchangerates, or stock market. Hence we can draw that the exchange rates are correlated with all class of assets except Bitcoin.

Conclusion

 Bitcoin is a medium of exchange and have appearance of currency but the lack of government control signifies the feature of gold. The table and findings show that Bitcoin doesn’t resemble gold and other currencies. Our Findings Proved that Bitcoin when compared with other assets shows a different risk return characteristics, follow different volatility process when we compare Bitcoin with other assets and they are uncorrelated with other assets. As Bitcoin is highly volatile in nature and has got excess return characteristics made it a speculative assets as compared to gold and other currencies.

It can be argued that it is easier to criticize on the work done by others rather than do a new research and findings. We acknowledge Dyhrberg works she advanced the research on Bitcoin and proving it through many data and research on Bitcoin.

Dyhrberg, A. H., 2015. Bitcoin, Gold and the Dollar – a GARCH Volatility Analysis. [Online] Available at: https://hdl.handle.net/10197/7168[Accessed 4 June 2018].

Yermack, D., 2013. IS BITCOIN A REAL CURRENCY? AN ECONOMIC APPRAISAL. [Online] Available at: https://www.nber.org/papers/w19747.pdf[Accessed 4 June 2018].

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