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Mohamed Fathalla
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Couple of years ago, when I first heard about Bitcoin, I rejected the idea entirely, believed that there is no way for that to survive. When you read about inventors through the history, they faced resistance. Same rejection faced the newcomer once it was declared in 2008 by the anonymous writer ‘Satochi nakamoto”. However, today, Bitcoin imposed itself as the best trade in the markets as it has reached 18,000,000% in 8 just years.

Cryptocurrencies sounds complicated, especially if we want to know more about the security of this system and the legal aspects. In this article we focus on Bitcoin as the leading first coin of its type followed by tens of other cytpocurrencies. We will discover all about cryptocurrencies, its history, the legal situation, usages; moreover, how to analyze and trade cryptocurrency.

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What is Cryptocurrency?

Cryptocurrency is a digital currency asset, executed only electronically and not physically. It is not issued or subsided to any governmental body; instead, it is decentralized currency using block chains cryptography to circulate peep to peer without the supervision of central banks, in a short time with low cost. That is the definition for the “Cryptocurrency“. 

First let me demonstrate the genesis of cryptocurrency. On November 2nd, 2008, just one month after the collapse of financial markets, a paper titled Bitcoin: A Peer-to-Peer Electronic Cash System”  was published under anonymous blogger “Satochi Nakamoto”. The general idea of the 9 pages piece explained cryptocurrency as a system that can execute all financial transitions online without going through the banking system by inventing a cryptic system, prohibits the doubling of the same transaction.

It is obvious that the banking system holds a lot of complications, despite modern technology. The reasons are infinity: tax system, terrorism, money laundering, high cost of money transfer, long and complicated phase before money delivery and insolvency of third world countries leading them to restrict money transfer in many cases. In other words, Satoshi Nakamoto tried to find a solution for the dinosaur banking system.

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Cryptocurrency Insider Mechanism

Cryptocureny as ‘Bitcoin’ using what is called ‘Block Chains’ in case the coin holder decides to transfer it to another. ‘Block Chains’ are a ledger of cryptocurrency deals arranged in data batches called “blocks”. That occurs through cryptographic algorithmic equations called “chains”. In other words these chains are like serial numbers for every transaction, which enables “miners” to monitor the process.

The cryptocurrency trading process include four parties; the issuer (as Bitcoin), the currency buyer (transferor), the new buyer (transferee) and between the transferor and the transferee there is the “Miner”. The word “Miner” came from the verb “mine” like gold mining or coal mining. Miners do not represent any central bank or governmental authority, they are private parties getting paid from the ‘transferor’ upon the agreement of the ‘issuer’ in order to ensure the credibility and validity of the transaction.

Today, thousands of transactions are taking place per second for transferring cryptocurrencies and soon it will be millions and billions a second. Unlike FOREX brokers, investment banks and central banks that have back office to follow clients’ transactions , ‘The cryptocurrency issuer’ can’t monitor every single transaction; as a result, they have agreements with private technological companies, the miners, which are responsible to monitor these peer to peer transactions.

During the usual bank money transfer, transaction details revealed to banks only to the transferring parties, the cryptocurrency’s code (chain) is revealed to any ‘Miner’ wishes to revise it. As central banks have the monitory over every money transfer transaction, ‘Miners’ also fulfill the role of central banks in monitoring the transactions made by cryptocurrency’s holder. The question is; since it is decentralized process and everyone can watch any process, which miner has the priority to revise the money transfer transaction so that it can benefit from the reward? The answer is THE FASTEST miner who can hunt the flying transaction FIRST.

Cryptocurrency Legal Framework

Bitcoin was the first cryptocurrency issued in 2009. It is owned by a company called Saint Bitts located in Saint Kites Island. According to Bitcoin issuer, the Bitcoin will issue no more than total of 21 million unit of it.

However, some banks are reluctant; some other central banks are resilient enough to accept dealing with the facts on the table. The Bank of Japan was the first bank to take the initiative and accept Bitcoin as a yet legalized mean of payment, with some concerns regarding the security of the block chain system. The surprise here is that the People’s Bank of China allows Bitocin wallet brokers to work onshore and trading Bitcoin for Yuan and to place Bitcoin’s ATM machines in public places, but with some restrictions on transferring money outside the mainland. Other countries like Switzerland, Netherlands, France, Portugal, Argentina, Thailand, and even some African countries start to accept cryptocurrency. Nevertheless, most banks are discussing Bitcoin matters seriously; no country set the appropriate legal framework for it.

Bitcoin Transactions Processing

You might have heard a lot of stories about people that made fortune after  bought Bitcoins and forgot about it, like the man who bought a pizza in Italy for 9 Bitcoins and now the shop owner that sold him the pizza became so rich for, or the guy that bought Bitcoins for $27 and the value rose to $800 000. Believe it! It started with $0.01 and now it’s  worth $1800. But how can we trade Bitcoin?

Now, if you want to trade FX or stocks it is very simple. You only have to make one click from the computer mouse; however, the cryptocurrencies trading system is still not complete. The reason FX and stocks are dynamics is becouse they can performed instantly by the clearance authority. Clearance authority will let you do transactions instantly, and clear the ledgers between buyers and sellers by the end of the year. Bitcoin dynamic is still not resilient yet, it will incur you some effort. Firstly, in order to buy you have to open a wallet account with one of the granted mediators, second you can now buy or sell the cryptocurrency from other peer dealing with the same mediator; nevertheless, it is not done by one mouse click. You have to offer your coins for selling if you want to sell, or search for seller if you want to buy. After that you have to contact the other peer to conduct the deal. In addition, you can transfer coins directly through a mobile app “peer to peer” to a shop or someone holds the same app on his mobile and will exchange it for dollars or any other agreed merchandise. Recently, two FX brokers started to put some cryptocurrencies on their trading platforms. This feature gives you the choice to speculate on the cryptocurencies with the marginal system without own it.

Analyzing Bitcoin

Here is the most important part. As we are looking for true qualitative and quantitative methods to analyse this asset, it is important to classify “cryptocurrency” under one of four major classes of financial markets which are (stocks, fixed income, currencies, and commodities). Definitely no one needs time to discover that it does not belong to the fixed income class; moreover, it is not listed on the stock exchange (as currency not company). Yet it is called ‘currency’ or ‘coin’, we cannot consider it blindly as FX asset. Why? Simply because when we analyze the usual FOREX currencies, we need some fundamental data as the country’s GDP, CPI or the latest central bank minutes.

Apparently cryptocurrencies lack those things. In order to find out the answer we should see how people are using it. For instance, at the beginning, majority of users were gamblers, specially when the price was under 1 US dollar. By that time, stores owners liked that idea and started to adopt these currencies as mean of payment. Eventually it became widely used by speculators and merchandise traders in addition to safe haven seekers that turned to assets like Bitcoin as an absolute store of value just like gold.

From that point we can compare cyrptourrencies to other classical safe havens assets like Gold or USD. By Comparing Bitcoin chart to Gold chart you can find out that Bitcoin had pulled the rug from Gold as a safe haven.

XAU/USD chart from 2009-2017
BTC/USD chart 2009-2017

From 2009, the starting date of Bitcoin to mid 2011, gold was bullish and Bitcoin had no big momentum by that time, but then in phase 2, from the end of 2012 to 2016 gold was bearish while Bitcoin surged constantly. Despite the fact that the first two phases have negative correlation between gold and Bitcoin, the third phase started to make both assets moving in the same direction slightly, or at least gold was choppy while the Bitcoin climbed.

DXY chart 2009/2017

Comparing BTC/USD to the dollar index, from 2009 to 2014 as the Bitcoin was stagnate, and no major movement over it, the DXY acted the same. Starting from 2015 the Dollar and Bitcoin have positive correlation.

I should mention that some cryptocurrencies companies have been listed on NYSE as GrayScal, which was listed in 2015 at $49 a share and today trades at $190. We can realize easily that the listed companies’ charts are correlated to the currency price, same as the correlation between the OSX index and oil price. With market capitalization of $28B for Bitcoin, this new industry looks prominent as much as the renewable energy industry or it may even lead the financial sector in the future .

Bitcoin Inv. Chart 2015-2016

An important question may arise, how could Bitcoin price be sometimes volatile, despite it is basically a store of value and banks do not clear short transactions? The answer is found in this article earlier, I have said that there are current brokers offering a marginal trading to the BTC upon CFDs. The Contracts For Differences (CFDs) are contracts that offer you to trade the asset without owning it. That kind of contracts can explain that some banks do not accept clearing process of Bitcoin short trades.

Conclusions

  • The most important is the economic nature of cryptocurrency. It is considered a new type of asset, which has a common characteristics between commodities and Currencies. It is affected by major events and used as a store of value.
  • Due to its special nature, Bitcoins are correlated with the USD and do not necessarily have positive correlation with gold.
  • Bitcoin is on its way to be legally recognized completely.
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