Bitcoin clobbers metals

December 14, 2017

Pat Heller

Over the past two months, a number of sellers of physical gold and silver in my company’s store have told us they were planning to use the proceeds to purchase Bitcoins, or other cryptocurrencies. I am certain that some people who would have otherwise purchased physical gold and silver in 2017 have instead spent some or all of those funds on cryptocurrencies.

On the opposite side, we only know of one customer who said they had cashed out their Bitcoin profits to purchase bullion-priced physical gold and silver.

At the same time, our company is now receiving many more inquiries about Bitcoin and other cryptocurrencies from members of the public who have little familiarity with them.

I personally do not have any expertise on the nuts and bolts of buying and selling cryptocurrencies. When I did a limited investigation a couple years ago, I was dismayed that the transaction fees were relatively high. I don’t know if that is still applicable. However, personal friends of mine and multiple younger employees at my company do own cryptocurrencies.

Bitcoin is gaining the greatest attention of all cryptocurrencies, largely because it has the greatest total current market value, well over $200 billion, and also because its value has increased more than 10 times over the course of 2017.

There are multiple questions to ask about cryptocurrencies. Are they a legitimate form of “money?” Are current prices in a bubble where at some point values will tumble (and, if so, what will be the peak)? How susceptible are these electronic monies to government regulation or control?

The first question is the easiest to answer. First, ask yourself, “What is something worth?” The correct answer is – whatever someone is willing to pay for it. If other parties are willing to take cryptocurrencies that you own in exchange for other assets, it can serve as money. In my mind, I anticipate that some form of electronic money will dominate everyday commerce in the future. It may take some time before all of the kinks and wrinkles are worked out for one or more forms, possibly waiting to yet be established, to last in the long term.

As to whether prices are in a bubble, that more reflects one of the limitations of current cryptocurrencies – their fixed quantity limits. To serve as a practical medium of exchange, it is desirable that the outstanding quantity can expand as the total supply of goods and services grows. For example, current gold mining activity adds about 1.5 percent to extant gold supplies each year. While that does not match the increase in material wealth, it does smooth out price changes and makes gold a relatively stable monetary asset. At some point, it is virtually certain that soaring cryptocurrency prices, like any other asset whose price becomes overheated, will overshoot their long-term equilibrium and experience a major selloff. As for the timing of that event, I just can’t guess. The answer also depends on whether the decline starts because the boom simply runs its course, or if it is forced down by political means.

One development that could have a major impact, for better or worse, is the opening of Bitcoin futures contract trading. CBOE began trading futures on Dec. 11. CME Group (which owns the COMEX, NYMEX, Chicago Board of Trade, and other exchanges) begins its futures market trading on Dec. 18. Traders on the CBOE are limited to open positions equal to 1 percent of Bitcoin’s value, while the CME Group open positions will be limited to 5 percent of total Bitcoin value.

These futures exchanges can help establish Bitcoin as a legitimate asset, which would enhance its desirability as an asset to hold as part of an investment portfolio. Or, these exchanges could have a negative impact because they could enable massive short-selling of contracts that will crush the value of the underlying Bitcoins (such as I contend has happened for gold and silver assets).

Now for the third question. If nothing else, cryptocurrencies are proving to be disruptive to financial institutions and governments. Cryptocurrencies can be traded without the involvement of a bank. To the extent that people keep their “money” outside of the banking system, that will reduce banking profits. In doing so, that can create negative blowback from the banking industry.

For instance, not long ago JPMorgan Chase CEO Jamie Dimon called Bitcoin a fraud. However, in late November, his bank announced that it was looking to trade Bitcoins on behalf of the bank’s customers.

As for governments, Japan earlier this year recognized Bitcoin as legal tender. At the opposite extreme, the British Treasury recently announced a crackdown on Bitcoin over concerns that it is being used to launder money and evade taxes.

Two weeks ago, the U.S. Senate Judiciary Committee held hearings on S. 1241, which would expand the definition of financial institutions to include operators of cryptocurrency exchanges. If enacted into law, Americans with cryptocurrency accounts at exchanges would have the financial information either available to, or actually reported to, the IRS.

Also, two weeks ago a California federal court ordered Coinbase, a Bitcoin exchange, to report details to the Internal Revenue Service of anyone who bought, sold, sent, or received $20,000 or more in a single year between 2013 and 2015. The information to be provided to the IRS includes name, address, birth date, taxpayer ID, and records of account transactions.

The IRS considers every disposition of a cryptocurrency, even for making payments for purchases, to be a taxable event where the profits and losses are required to be included on tax returns and subject to income taxes.

One reason touted for owning cryptocurrencies is financial privacy. Governments almost certainly would be opposed to allowing such privacy to continue. Anyone considering acquiring such assets should assume that government reports on such transactions will eventually be similar to those now required government reports for other financial transactions.

Cryptocurrencies are still in the development stage. Fortunes have already been made, and some people have suffered huge losses. In the future, others will also make fortunes or take losses. Unfortunately, such volatile markets attract crooks and scam artists looking for a way to steal the wealth from people who do not practice common sense and due diligence.

If it turns out the cryptocurrencies peak at some point and the bubble bursts, look for renewed interest in purchasing physical precious metals. Physical gold and silver have multi-thousand-year track records serving as money and never failing. That is a huge advantage for being a safe haven asset that cryptocurrencies, at least for now, cannot offer.