Can the world’s top currency make it three in a row in 2017?

Bitcoin © Getty Images
Most bitcoin transactions are made in China

Here’s a bit of financial trivia for you – what do you reckon has been the best-performing currency (against the dollar) over the last two years?

The Brazilian real? Did great last year, but not the year before.

The haven that is the Swiss franc? Nope.

The pound? OK, now I’m just having a laugh.

No, it was bitcoin…

Bitcoin – nearly as valuable as gold

OK, you can quibble over whether bitcoin is exactly a currency or not, but I think most people would accept the notion at least.

Here’s a quick refresher for those who find the whole thing baffling. Bitcoin is a “cryptocurrency” – it’s digital cash. Here are the selling points of bitcoin.

It is limited in number (only 21 million will ever be created, apparently). So it’s not going to be subject to quantitative easing.

It is “decentralized” – everyone knows who owns any given bitcoin, basically, so there’s no central authority controlling it or controlling issuance. So it won’t be confiscated or demonetised by a government overnight.

And of course, it’s digital. You transfer it, and that’s it. It’s not like a bank transfer. It’s more like teleporting physical cash from your wallet to someone else’s.

So – assuming it all works like that and continues to work like that – you can see the potential benefits of bitcoin. Instantly and freely transferable across long distances, and free from manipulation by central banks and well-meaning (or not so well-meaning) governments. A libertarian’s utopia.

In practice, of course, it’s a bit different. The last time I tried to set up a bitcoin account (a while ago now, admittedly) I found the process too clunky to be bothered with. And while I’m hardly an “early adopter”, in marketing speak, I’m relatively comfortable with technology, so I imagine I’d be reasonably representative of a typical developed world user.

However, bitcoin remains small enough that it doesn’t take a huge amount of interest to send it higher. Thus the digital currency rose by around 35% against the US dollar in 2015, and last year it more than doubled.

Now it’s hitting the headlines again. It has soared above the $1,100 per coin mark, hitting an all-time high. In fact, it’s not far off hitting parity with the gold price (that’d be an early forecasting triumph for my colleague Dominic Frisby).

So what’s going on?

What makes bitcoin so valuable?

A lot of people sneer at bitcoin. That seems to be primarily a reaction to the libertarian politics associated with it – similarly to the intense dislike of gold in some quarters. And impatient people living in a stable democracy with no capital controls – like me – might find bitcoin a bit too fiddly to use.

But not everyone is that lucky. As Leonid Bershidsky notes on Bloomberg, bitcoin is currently “mostly useful to people seeking to bypass their country’s currency restrictions, as some Chinese and, for example, Venezuelans do”.

More than 90% of all bitcoin trades are carried out in Chinese yuan. And trading in Venezuela quadrupled last year. Demand in India has picked up as well, following the chaos caused by the repeal of low-denomination notes there late last year.

As Bershidsky points out, political upheaval makes bitcoin – a politically neutral, decentralised, borderless currency, under the direct control of no one – very appealing as a place to park at least some cash.

Demand for ways to circumvent draconian capital controls is hardly likely to fall in the near future, particularly if China continues to devalue the yuan. And so far regulators seem content to steer clear of imposing too many controls on bitcoin, though that may be purely due to its small size.

Indeed, as far as I can see, the biggest risk to bitcoin is not so much regulation as that China might liberalise its capital markets and allow more money to get out of the country. That would strip away one key function of bitcoin.

But what significance does it all hold for investors? In short, it’s still a punt.

I don’t have any money in bitcoin myself. I can certainly see the appeal. But I think it’s still finding its niche.

For a start, it’s going to struggle to work as a currency with this level of volatility. The very fact that it has been the best or worst-performing currency in the world each year for the past four years rather demonstrates its flaws as a medium of exchange.

For as long as each bitcoin represents something of a lottery ticket, people aren’t going to be keen to use it for everyday transactions. (It’s Gresham’s Law at work: if bitcoin really is a superior store of value, then individuals will always prefer to use inferior fiat currencies and keep the good stuff).

That said, my colleague Charlie Morris, who writes The Fleet Street Letter, reckons that bitcoin is still cheap. Charlie is one of the sharpest people I know when it comes to gold and the world of “alternative” currencies.

His view is that bitcoin is a play on the size of the network behind it. And he believes that right now it’s cheap, and that it’s got a lot further to go in 2017.

So one of my New Year’s resolutions is to get to grips with the digital currency. I’m not going to stick more than a tiny chunk of my portfolio in it, but if it reaches anything like its potential at some point in the future, a tiny bit will probably be enough.

If you’ve bought bit coin or even better, used it for transactions, drop me a line – I’d be curious to hear how you’re getting on with it. I’d also like to know your views on how much of a future it has.

By the way, bitcoin was one of the “five most important charts of 2016” that I highlighted in the final 2016 edition of MoneyWeek Unlimited. If you’re not aware of MoneyWeek Unlimited, it’s our weekly subscriber-only email in which I delve further into the entrails of the financial markets to try to figure out what’s going on, and also post snippets of the best research that crosses my desk each week. (For example, I recently pulled out my favourite stock tips from London’s Sohn Conference, where well-known hedge fund managers share their best ideas for charity).

Anyway, if you’d like to start receiving MoneyWeek Unlimited, you have to be a subscriber to MoneyWeek magazine. The good news is, once you get the magazine, MoneyWeek Unlimited is free. So sign up now to get all your financial information needs covered for 2017.