Perception is bitcoin's biggest battle

Along with the general media attention bitcoin has attracted in recent months, there’s been much talk about whether bitcoin is merely a tool for financial speculation … or is a currency as real as any other, capable of being used to buy and sell goods, as well as for investment purposes.

The media frenzy accompanying the bitcoin roller-coaster of late has resulted in a surge of demand. Transaction volumes are steadily increasing and more online outlets now accept bitcoin payments. Consequently, players in the bitcoin ecosystem have fared well: With $120 million (US) in trading volumes in March 2013 (as reported by Mt.Gox, the largest bitcoin exchange) and a trade commission of 0.6 percent, this equates to revenues of around $1 million per month.

With low operating costs, that means substantial profits. This has led some to speculate that the bitcoin marketplace could create billion-dollar businesses. Even if this might be exaggerated, bitcoin – and bitcoin exchanges in particular – could in fact become attractive investments for venture capital firms at some point.

So does the steady increase in transactions make bitcoin an adequate tool for investors and speculators? Apart from potential revenues as a result of an external investment into an exchange, there are two principal ways to make money with the virtual currency: Either by mining bitcoins yourself (despite eye-watering costs for electricity, profit margins are currently over 53 percent) … or by starting to speculate and trade with bitcoins.

Investors’ money is used to purchase bitcoins and the investors are issued the fund shares. Exante takes custody of them by keeping encrypted flash drive copies of the bitcoin wallet in bank safes around the world. To cover that level of security and wallet management, the annual management fee for the fund is 0.5 percent of the fund’s Net Share Value. The fund currently manages a portfolio of 81,000 BTC and, according to Exante, has been extremely successful so far. The initial minimum subscription is $100,000 with a 0.5 percent upfront subscription fee. Unlike conventional hedge funds, there is no performance-based fee.

Being completely unattached to any economic developments that have a direct impact on traditional currencies, investing in bitcoin is to a large extent pure speculation.

The media play a crucial role in defining and changing bitcoin’s value. When the mainstream media picked up on the bitcoin phenomenon and began reporting on the topic, the currency’s value shot up. After coverage turned more negative and concerns about the sustainability and volatility of the currency got the upper hand, the exchange rates imploded.

No traditional currency has ever seen its value increase and decrease at such an amazing pace. At the same time, though, it is exactly that volatility that attracts speculators’ attention. Investing in bitcoin is comparable to sinking money in risky financial instruments such as CFDs or spread betting, both of which are popular with retail investors.

As a consequence, IG Markets, the biggest spread-betting operator in the UK by sales, introduced binary options on bitcoin's price in April 2013, allowing investors to bet whether the currency will be below or above a certain price by the end of May.

Coinsetter plans to launch a Forex trading platform for bitcoin that allows people to make leveraged trades (via margin) and short the market. The New York-based startup recently raised $500,000 in venture capital for the launch. Investors include the Bitcoin Opportunity Fund, an investment vehicle for bitcoins and bitcoin-related companies.

Then there is ICBIT, a platform that enables traders to make bets using futures and trade commodities such as oil in bitcoins; and Hong Kong-based Bitfinex, which allows bitcoin holders to act like brokers and lend bitcoins to people who want to trade them. However, both are unregulated … and it will be interesting to see how large and authorized trading platform providers will react.

IG Markets’ move, on the other hand, could indicate the beginning of a more regulated bitcoin trading environment, which could have the potential to help stabilize the future of the currency. This in turn would help bitcoin attract even more innovation and interest.

A functioning derivatives market for bitcoin holds significance in light of the debate over whether this would make prices more stable … or less.

Some, for example, point to the US decision to ban onion futures in the 1950s; prices have been volatile ever since. It is unclear, though, whether this analogy could apply to bitcoin, a virtual product with limited availability.

The key question remains whether bitcoin could ever lead to a market where trading on a large scale is possible. At the moment, there are only around 11 million bitcoins in existence … and there can never be more than 21 million. This means the market is not very liquid and never will be. It also means it will always be difficult to buy or sell assets in a timely manner.

Entrepreneurs Cameron and Tyler Winklevoss reportedly hold approximately one percent of all bitcoins, currently worth several million dollars. Maybe they were just lucky when they started buying bitcoins last summer, when prices bounced somewhere between $5 and $15. Or maybe they’re true visionaries. It remains to be seen whether the Winklevii will sell off their bitcoin holdings or keep them for speculative reasons. Either way, their interest in the currency gives a tantalizing hint of the potential to make real money with bitcoins.