Bitcoin is the largest of a new group of virtual currencies that has no central issuing authority and is not attached to a sovereign state.  As an online currency, you can purchase services and physical goods from a growing list of websites. There is even an ATM machine that can print out a Bitcoin in paper form.

China has a fast growing community of Bitcoin owners – so much so that Baidu (China’s largest internet search engine) has said it will accept Bitcoin as currency for online services it provides.

From a practical sense, Bitcoin is similar to store credits or credits in an airlines’ loyalty programme. Only that it is operated by a network of computers running a piece of publicly available software, which keeps track of transactions and records of who owns what, rather than relying on a single institution’s IT system.

Bitcoin was designed based on a cryptography structure that makes it a robust system in terms of not allowing duplicate transactions, alteration of past transactions, while controlling the rate at which new coins are produced and ultimately the total number of coins in circulation.

The system is outside of the traditional banking network and one of the benefits is a lower transaction cost, particularly for cross border small amount transfers between individuals, provided you have the coins to begin, otherwise these coins are still costly and can be inconvenient to acquire.

Bitcoins are issued to individuals or organizations that help process transactions by supplying computer processing resources as part of a distributed network of computers.  The coins are then traded on a number of global exchanges and have rapidly increased in value.  On 19 November 2013, the value of Bitcoin on the Mt. Gox exchange soared to a peak of US$900 following a United States Senate committee hearing, at which the committee was informed that virtual currencies were a legitimate financial service.  Subsequent to this, the value has gone higher than US$1,100.

Yesterday China’s central bank barred financial institutions from handling Bitcoin transactions, moving to regulate the virtual currency after an 89-fold jump in its value sparked a surge of investor interest in the country.

Bitcoin plunged more than 20 percent to below $1,000 on the BitStamp Internet exchange after the People’s Bank of China said it isn’t a currency with “real meaning” and doesn’t have the same legal status.

The ban reflects concern about the risk the digital currency may pose to China’s capital controls and financial stability after a surge in trading this year made the country the world’s biggest trader of Bitcoins, according to exchange operator BTC China. Bitcoin’s price jumped more than nine fold in the past two months alone, prompting former Federal Reserve Chairman Alan Greenspan to call it a “bubble.”

Bottom line, this is a massive experiment which now stands at US$12bn in market value and has spurred on its own ecosystem of exchanges and online shops.  At which point the bubble will burst is hard to tell, especially if merchant acceptance continues. This has the potential to threaten Visa, Mastercard and eBay long term if it becomes an efficient payment method.

Felix Fok

Portfolio Manager