Tag Archives: bitcoin

The Blockchain Beyond Bitcoin

The rapid emergence and commercialization of blockchain technology is undoubtedly one of the key technological trends at the moment, not just within crypto currencies, but as a disruptive technology across many industries and economic functions.

At a high level, a blockchain is a distributed and public digital ledger of transactions that is updated across a peer-to-peer network, and that uses cryptography to record and update the chain of blocks that make up the ledger. Within a blockchain structure, there is no central authority.

What is a Block Chain?

The essence of a decentralised blockchain network is actually explained quite simply in the introduction to the whitepaper of the world’s first implemented blockchain, Bitcoin, i.e. Sataoshi Nakamoto’s now famous Bitcoin whitepaper which was titled “Bitcoin: A Peer-to-Peer Electronic Cash System”.

In the Bitcoin peer-to-peer network, as devised by Nakamoto, network transactions are processed by cooperative nodes on the network and then stored in an ongoing chain of updates that cannot in practice be altered. The processing works by taking a number of transactions, gathering them into a block, and then hashing them, while also referencing the previous block of data.

In general, hashing refers to the process of converting a string of data into a fixed length value. The hashing function takes in the input string and outputs the hashed value. The Bitcoin protocol uses a block hashing algorithm where transactions are timestamped, with each hash output containing its own timestamp and the timestamp of the previous block. This allows the blocks to be hashed into an ongoing chain of blocks. Hence the term block chain or blockchain.

Within the Bitcoin network, the hashing is done by competing computing nodes on the network which are known as miners, and the hashing is designed so that significant mathematical effort (and CPU power) are required to produce the correct hash that will satisfy hash formatting rules, but that will also be easily identifiable as a valid block by all other nodes. The system of calculations that produce the blocks that can pass this validity check is referred to as a proof of work (PoW) system.

The mining process is therefore essentially adding new transactions to the blockchain with the inputs to the hash function being the transactions on the network which have not yet been validated or confirmed. Once a new block is accepted, all miners will switch to working on validating the next block.

Although the network is decentralised, the nodes on the network don’t need to trust each other or coordinate with each other. They can all examine the latest block created and accept its validity, therefore accepting that the longest chain is the valid chain. All the nodes or participants in the network can therefore reach consensus even though they don’t know each other and don’t communicate with each other. In the Bitcoin network, the miner which successfully solves the hash of a new block will receive an incentive for their work in the form of new bitcoins.

This continual chaining of blocks means that the resulting blockchain is irreversible and permanent, with every transaction in the history of the network being recorded in perpetuity. A properly maintained blockchain is therefore a public record that cannot be altered or tampered with.

Grasping this essential nature of a blockchain should help explain why Blockchain as a technology is variously described as a “public ledger”, a “distributed ledger”, or as a “globally decentralized public accounting ledger”. Any venture that promotes itself as using blockchain should be in some way using the technology described above or a variant of it.

The Emerging Competition to Bitcoin

Since the launch of Bitcoin nine years ago in January 2009, the blockchain technology and design concepts inherent in Bitcoin have served as the foundation for many other cryptocurrencies and blockchain innovations. There are now over 1500 exchange-traded cryptocurrencies (coins and tokens) listed on the crypto coin tracking site www.coinmarketcap.com which back these mostly blockchain ventures.

As in any competitive market, many of these coins and the companies backing them will most likely not survive over time and will disappear. However, in addition to Bitcoin (currently valued at approximately $170 billion), there are multiple coins alternative to Bitcoin (alt coins) which use block chain models, and which the ‘market’ continues to put a significant value on, based on the current trading prices of their coins /tokens and the market capitalisations of these coins / tokens.

Litecoin (currently valued at over $12 billion) used much of the same design as Bitcoin when it first released in October 2011, while introducing some coding changes such as a shorter block generation time and a different hashing algorithm.

Bitcoin Cash (valued at over $20 billion) was created on 1 August 2017 via a hard fork when the Bitcoin blockchain split into two separate chains. While the block size in Bitcoin is 1 MB, Bitcoin Cash has an increased block size of 8 MB. Bitcoin Cash allows for processing of more transactions per second than Bitcoin, which should translate into faster payments. In the short time since its launch, Bitcoin Cash has seen widespread adoption by a supportive community of developers as well as encouraging take-up by merchants and listings on many cryptocurrency exchanges. It is also supported by some high-profile names in the Bitcoin community such as Craig Wright, Roger Ver and Calvin Ayre.

Ethereum (valued at approximately $80 billion), which launched in 2015, is a distributed public blockchain system and platform that significantly extends the blockchain concepts first used in Bitcoin, and in addition to transaction processing, it also supports smart contract functionality.

Smart contracts are self-executing contracts. In technical terms, smart contracts are small software programs that live and run on a blockchain and that are replicated across the blockchain ledger. In terms of function, smart contracts are agreements which are coded so that they will only be triggered or executed when the terms of the agreement are validated. The contract logic of Ethereum smart contracts runs in a run-time environment called the Ethereum virtual machine.

The Ethereum network, co-founded by Vitalik Buterin, uses a cryptocurrency called Ether, abbreviated to ETH. Ethereum also currently uses proof of work (PoW) to prove the validity of blocks and rewards miners with ETH for processing new blocks. ETH is also used to pay for the fees levied to run Ethereum smart contracts. Ethereum will in the future move to a Proof of Stake (PoS) algorithm for awarding and allocating new blocks. Proof of Stake is based on assessing the validator’s economic stake in the platform, for example, does it hold the platform’s currency (e.g. ETH).

The Ethereum platform also supports an open source software protocol that allows software developers to build their own distributed blockchain applications or Decentralised Applications (DApps). Over 1100 DApps have already been developed using the Ethereum Platform. For example, Golem, which is a project that aims to link worldwide computers together to harness their idle processing power, is an Ethereum based DApp.

As of the time of writing, Bitcoin Cash was processing over 20,000 transactions per day. The average transaction fee on the network was 0.217 US dollars. The average time between blocks (block time) for Bitcoin Cash was 10 minutes. Similar processing statistics for Bitcoin showed that the Bitcoin network processed 215,000 transactions during the same period, with an average transaction fee of 3.04 US dollars, and a block time of 8 minutes 5 seconds. During the same time, the Ethereum network processed 835,000 transactions with an average transaction fee of 0.865 US dollars, and a block time of 15 seconds.

A relatively new blockchain platform called Cardano (currently valued at more than $9 billion) is also being valued by the market as having significant potential. Like Ethereum, Cardano is an open source decentralised public blockchain with its own cryptocurrency called ADA. The Cardano platform is also developing smart contracts and decentralised applications (DApps).

Purchase Precious Metals at BullionStar using Cryptos

BullionStar is committed to offering customers flexibility and choice when transacting on the BullionStar website and in the BullionStar shop and showroom in Singapore. As such, BullionStar facilitates the use of Bitcoin as a payment currency in addition to 6 major national currencies (Singapore Dollars, Euros, US Dollars, Japanese Yen, Australian Dollars and Swedish Krona). This ability to use Bitcoin to buy gold bars, gold coins, silver bars, and silver coins has been available to BullionStar customers since 2014.

All of the features of BullionStar's website are also fully integrated with Bitcoin. When selected from the Currency drop-down menu at the top right hand side of the BullionStar website homepage, Bitcoin becomes the default transactional currency within the website, and all product prices, spot prices, chart data, and account history will be displayed in Bitcoin. When logged into their accounts on the BullionStar website, customers can view their vault portfolios and cash balances and account history all in terms of BTC.

Bitcoin is fully integrated into BullionStar's website functionality

Benefits of Block Chain

Overall, some of the benefits of using blockchain technology include the following:

  • A blockchain, as long as it’s up and running, will continue to exist, so is a permanent record independent of any central authority. As its decentralized, there is no single point of failure, and the data can’t be lost because it is replicated across nodes.
  • Transactions that have been committed to a public blockchain are in practice irrevocable, which means that they cannot be changed, tampered with, or deleted, i.e. they are immutable.
  • Transactional data sent through a blockchain is encrypted and secure from interception
  • Blockchains, as distributed and decentralized platforms, offer dis-intermediation from often inefficient and costly intermediaries. They therefore offer efficiency improvements and cost savings compared to the frictions and costs associated with intermediaries.
  • Transacting currency across a decentralised blockchain between accounts, such as over the Ethereum platform, is far faster than over a centralized legacy bank transfer system.
  • Blockchain platforms that support smart contracts offer the potential to radically alter a whole range of industries that up until now have relied on the centralized execution of agreements and the obligations and terms of those agreements.
  • A public blockchain is a persistent and permanent ledger of transactions and data, accessible for anyone to see and to audit. It therefore enhances transparency, as well as hinders censorship.

Applicability of Block Chains

While the implementation of blockchain applications to the world’s industries is still in its infancy, the potential to alter existing economic systems appears far reaching, such as in financial services, real estate, legal services, government services, supply chain management, and energy markets.

For example, in the investment asset and property management sectors, ownership rights, title deeds and transactions could be recorded in blockchain ledgers, potentially altering the core processes of the asset management and property law sectors.

In the government sector, blockchain applications could be applied to electoral registers, voting records and polls, which is especially promising as blockchain data once committed can’t be altered or hacked. This would also increase transparency, trust and confidence in electoral and voting systems. Block chains also have potential to be used for digital identity and authentication functions such as passports, birth certificates, and other forms of government issued identification.

Blockchain records and transactions could also improve transparency in the world of corporate governance, providing transparent records of board level decisions and voting records.

The legal areas of intellectual property, patents, and music royalties are also strong candidates for adopting blockchain transaction and keeping records of ownership as well as the utilization of smart contracts to collect fees. Blockchains and smart contracts can also aid global supply chain management, such as tracking shipments and inventories and re-ordering supplies.

Other areas where smart contracts are seen to be beneficial include online gaming, online gambling, prediction markets, the sharing economy such as ride sharing and accommodation sharing, the trading of computer processing power, decentralized data storage, and decentralized securities exchanges. Overall, smart contracts are in theory applicable to anything that can be programmed, which covers a wide range of agreements and documentation in nearly every industry around the globe.

The Role of Gold as Turmoil hits wider Financial Markets

As market turmoil hits both equities and cryptocurrencies, the heightened volatility in these assets underscores gold’s unique role as a safe haven, store of value and portfolio diversifier.

Stock Market Selloffs

With major US stock indices falling again sharply on Thursday (DJIA - 4.02%, NASDAQ - 4.08%, S&P -3.41%), last Monday’s equity market selloff and spike in volatility looks set to be a more prolonged affair than a one-off plunge and recovery. The Dow’s Thursday close of 23860 is 2756 points, or 10.3% lower, than the all time high of 26616 from 26 January, and the Dow is now officially in correction territory. This week also saw two records added to the history of stock market selloffs, Monday’s biggest ever points drop in the Dow, and Thursday’s second biggest ever Dow points drop.

Similarly the S&P 500 index closed on Thursday at 2581 and is now 292 points, or 10.1% lower than its all-time high of 2,872.87 from 26 January, again in correction territory.

The NASDAQ composite, which also reached its all-time high of 7505 on 26 January, is virtually in a 10% correction zone below 6755, as it closed just a few points over this level at 6777 on Thursday.

Finally, the CBOE Volatility Index (VIX), the widely used measure of stock market volatility - which is also known as the investor fear gauge - had spiked up massively late Monday and into Tuesday to the 35-40 range, and critically was again seen approaching those levels at Wall Street market close Thursday.

Equity market indexes across the globe, as normal taking their cue from Wall Street trading, have also been falling in tandem, with markets in Europe, Asia and the Americas all lower on the week.

Whatever the reasons for the shift change in market sentiment, from macro factors to algorithmic trading, these abrupt index plunges and the rise in volatility have spooked investors across the globe and have led to panic selling and active profit-taking. With a low volatility environment less certain than before, market consensus on ever-increasing stock prices may be beginning to unravel.

Clouds over Cryptocurrencies

In cryptocurrency markets, the price euphoria seen in December and early January led by Bitcoin and some other large alt coin rivals has also given way to deep corrections and unclear price direction.

Until earlier this week when Bitcoin rallied back to above $8000 from below $6000, Bitcoin’s price had been on a consistent downward trajectory for nearly a month. From its intermediate high of US $17,000 on 7 January, in less than 30 days, the price had collapsed to below US $ 6,000, an approximate 65% drop. From the ultimate high of just over $20,000 on 17 December to the recent low of below $6000, Bitcoin’s price collapse exceeded 70%. Similar price movements were seen across the board in other crypto coin prices, both large and small cap.

Coupled with Bitcoin’s equally sharp price gains in late 2017, the short-term price movements of Bitcoin, both up and down, are hugely volatile. As recently as a year ago in early February 2017, Bitcoin in US dollars was still trading in the $1000 range. It was only in May 2017 when the price first breached the $2000 mark and August when it initially hit the $3000 range. As its meteoric rise continued, by late October the price had again doubled to $6000, and it was just mid-November 2017 (less than 3 months ago) when the Bitcoin price first traded in the $8000 range, a similar price range to where it now finds itself back at now.

Mid-November is also arguably the point at which Bitcoin’s dizzying ascent really got going, shooting up to over $11,000 before the end of November. It was at this point that hundreds of smaller alt coin prices started to really explode upwards also, taking the broad cryptocurrency market and the overall sector MarketCap much higher.  Within a week between 1 December and 8 December, the Bitcoin price had again exploded to over $18,000, and the ultimate peak of $20,000 was reached less than 10 days later on 17 December.

After this, a series of lower highs and lower lows saw the Bitcoin price oscillate wildly in the $12,000 - $18,000 range before its prolonged fall from 7 January onwards to below $6000 on Tuesday 6 February, and its subsequent bounce  to $8000. This high price volatility must raise the question of Bitcoin as store of value, and to what extent it is primarily a payment system versus a dependable store of value.

Gold's Attraction in Market Turmoil

Investors in financial and other asset markets prefer predictability and stability. Hence investor apprehension at the growing uncertainty and heightened volatility in global stock markets and the recent pump and dump chart patterns of many cryptocurrencies.

But it is during market turmoil that gold’s safe haven qualities come to the fore. Since gold has no counterparty or default risk it is a universally known and universally used safe haven for preserving wealth during market crises. Gold's high liquidity also adds to its safe haven appeal. During financial market turmoil, gold's price therefore generally reflects this movement out of risk assets and into the safe harbour that gold provides. The below chart plots a relatively comparison between the US dollar price of gold and the S&P 500 index, over the week beginning Monday 5 February, showing gold's outperformance as the US stock market suffered a series of selloffs.

USD Dollar Gold Price in terms of the S&P 500 Index, Week from 5 February 2018. Source: BullionStar Charts

Gold is also one of the traditional and best-known stores of value, some others being land and property. A reliable store of value asset will allow you to park your wealth and retrieve it at a later time knowing that it will still have value and will have retained the value that it had when you converted some of your savings or wealth into that asset. A reliable store of value will also adjust for inflation and retain its purchasing power relative to inflation. Physical gold in the form of gold bars and gold coins does just that and retains its purchasing power over long periods of time precisely because the gold price, as an inflation barometer, adjusts to reflect expected inflation.

Finally, gold can also reduce the volatility of a portfolio of investment assets such as stocks and bonds. By adding an investment in gold, the resultant portfolio displays less volatility of returns, and can also exhibit higher expected returns. This is due to the gold price having a low to negative correlation with the prices of securities such as stocks and bonds.

Bitcoin backwardation, gold contango

People often refer to bitcoin as digital gold because of the similarities between the two assets. One big difference between gold and bitcoin is currently playing out in their respective futures markets. Since bitcoin futures were introduced last December by the CBOE, futures prices have often been inverted, or in backwardation. This sort of phenomenon rarely happens in gold markets, which trade normally, or in contango. Let's explore why inversion seems to be relatively common with bitcoin and whether this will continue to be the case in the future.

Backwardation or inversion is when future prices for a commodity lie below its current price. For instance, at lunch-time on January 16 (EST), when the current price for bitcoin was $12,170 on the Gemini bitcoin exchange, the March 2018 contract on the CBOE futures exchange was being bid at $12,000, a discount-to-spot of $170 or 1.4%.

At that very same point in time on January 16, gold's spot price was at $1334 whereas the March futures contract was trading at $1336.90, a premium-to-spot of $2.90 or 0.2%. This is contango, or a normal-yielding market. I’ve illustrated both markets below.

A comparison of the spot prices of bitcoin and gold to their futures prices on Jan 16, 2018

In theory, the future price of a durable and easily storable commodity—say like gold, silver, and bitcoin—should always lie above the current price, or in contango. This is because storables incur holding costs, and a higher futures price is the market's way of paying for those costs.

Contango as the fee for hoarding gold

To see how this works, let's trek through an example. Say that you are jeweler. It is January and gold is trading at $1300/ounce, which you think is a fantastically cheap price. However, you can't take possession of the gold right now because you have no space for it—your vault is already full. Three months from now, at the end of March, your existing inventory will have run down and you'll have room for the stuff. Can you lock in today's price while having someone else hold the metal for you until then? Say you strike a deal with a counterparty. They will buy the gold at today's price of $1300 and store it in their vaults on your behalf, only delivering the stuff to you at the end of March.

Your counterparty won't provide this service for free, they have to be compensated for the burdens of carrying the product for you. These costs include the interest payments on the loan required to buy the gold, vaulting fees, and insurance. So if gold is currently trading at $1300, and the total cost of carrying it till March is $10/ounce, then the contract you strike with the counterparty will be priced at $1310. Of this amount, $1300 allows the counterparty to pay off the face value of the loan they originally took out to buy an ounce of the yellow metal, the remaining $10 covers them for the cost of storing it, insuring it, and paying interest.

With the futures contract trading at $1310 and the current price at $1300, we say that the market is in contango. Contango is the fee—in this case $10—that buyers of gold-in-the-future pay to counterparties in order to induce these counterparties to hoard the metal on their behalf for a period of time.

As the chart below shows, gold has spent most of the last ten years in contango. The spread, or difference between the spot price and the futures price (from 2 months out to 20 months out) almost always lies above 0%.

Source: www.goldchartsrus.com

There have been two exceptions on the two and four-month spread (the red and pink lines), one in 2014 and another in 2016. I described the 2014 episode here. But  inversions like these will only ever be fleeting, the dominant pattern in gold markets being a normal market characterized by futures prices trading above spot prices. (If you want to get into the specifics of the relationship between gold spot and future prices, Koos Jansen has written an in depth treatment here).

Backwardation as a negative fee

Compared to other commodities, gold compresses a lot of value into a small amount of space. Which means it is relatively cheap to store. For instance, ten bushels of wheat—which is worth around $40—would require an entire closet as storage space. To store $40 worth of value in the form of gold, a gram would be sufficient for the task. If we look at the data, with gold trading at $1334 and the March contract was $1336.90, the cost of storing gold in a vault, insuring it, and financing it until March is just $2.90.

Bitcoin's $170 backwardation on January 16 meant the opposite. Counterparties who were offering to store bitcoin through to March were so desperate to provide this service that they were willing to pay a fee to do it rather than charging a fee. That anyone would take on the task of storing bitcoins for free, let alone paying to take on the burden, is especially odd given that the cost of securely "hodling" bitcoin is probably not that much less than storing gold. Commercial storage of bitcoin involves depositing private keys in vaults, much like how people keep the yellow metal safe. Consider this recent Times article that describes how the Winklevoss twins, who own a big bitcoin stake, have cut up printouts of their keys and scattered the pieces in safes all around the U.S., so if one safe is broken into the thief would still lack the full key. It is difficult to find insurers that offer bitcoin insurance products, this rarity presumably translating into fairly high insurance costs. And like gold, the financing necessary for purchasing bitcoin incurs interest expenses. So in theory, the price of bitcoin in March should permanently lies a hundred or so dollars above the spot price in order to cover these carrying costs, not below the spot price.

There are two theories for why bitcoin might be spending a disproportionate amount of time in backwardation.

1. Undeveloped market for short-selling

Imagine that a crowd of large Wall Street traders suddenly want to sell bitcoins short, but they can't because their stringent investment mandates prohibit physical bitcoin positions. So they express their short bias by selling CBOE futures contracts which—because they are listed on a legitimate exchange—do not contravene these traders' mandates. Bitcoin futures, which had been in contango, are abruptly driven into backwardation, a discount-to-spot.

Normally an arbitrageur would correct this discrepancy. If an arbitrageur is holding some bitcoins, the $170 discount means that the market is rewarding her not to store those bitcoins. She purchases futures at $12,000 and sells some of her bitcoins at $12,170, earning a risk free $170 profit. As long as this backwardation continues, she can keep earning profits by selling her bitcoins and buying futures until she has run out of bitcoins to sell. At which point she will try to borrow bitcoins from other people and sell them. The combined effect of her constant selling of physical bitcoins and futures buying should eventually drive the market price from its inverted state back into contango.

But if our arbitrageur can't borrow enough bitcoin to counterbalance Wall Street's demand to sell bitcoin short, say because lending markets are still undeveloped, then there is no way for her to fix the anomaly. Markets are stuck in backwardation. Both Kid Dynamite and Jayanth Varma have posts explaining the difficulties of arbitraging bitcoin in more detail.

An undeveloped market for borrowing and lending bitcoins is not innate to bitcoin. Presumably if bitcoin markets develop, these sorts of inefficiencies will be addressed and bitcoin—like gold—will trade more normally. That being said, bitcoin does have one innate property that can lead to backwardation: forks.

2. The omnipresent threat of forks

The second explanation for bitcoin backwardation is the ever-present threat of contentious forks.

To help understand how forks affect bitcoin futures prices let's first look at how S&P 500 futures work, because there is an important similarity between the two assets. While storing gold is a drag, there is an upside to storing the S&P 500. The person who does the storing gets to enjoy dividend payments! As long as dividend payments are higher than the cost of paying interest on the loan originally used to buy the S&P 500 (there is no vaulting or insurance costs on equities), then it is possible to come out a net winner by carrying the S&P 500 through time.

Over the last ten years or so, S&P 500 futures have generally been inverted, with futures prices trading below spot prices. The reason for this is that short-term interest rates have generally been lower than dividend yields. Those who store equities through time on behalf of buyers of S&P 500 futures accept a discount-to-spot because the dividends they earn make up for it.

Although bitcoin doesn't pay dividends, it does throw off an unusual set of rewards—forks. When a fork occurs, anyone who held x bitcoins now gets x newcoins in addition to their existing x bitcoins. Forks occur because participants in the Bitcoin network disagree about certain technical features of the code that runs the network. One set of actors continues to use the original code while the other modifies it, this modification leading to the creation of newcoins.

A futures market like the CBOE must define what sort of bitcoins are sufficient to settle a bitcoin futures contract. In the case of a chain split, this gets complicated. Is someone who owns a futures contract entitled to get just 1 bitcoin from the seller of a futures contract, or are the entitled to 1 bitcoin and 1 newcoin? The short answer is that the CBOE defines a 'bitcoin' in such a way that it does not include newcoin. So in the event of a fork, a futures seller who is storing a bitcoin in order to deliver it to a futures buyer gets to keep the newcoins for free.

Any newcoin that is created will hive off or steal a chunk of bitcoin's original value—after all, you can't get something for nothing. Thus, in the event of a fork, those who have bought a futures contract are now entitled to an inferior bitcoin, one that has had the value of a newcoin ripped out of it. Conversely, anyone who has been storing bitcoin on behalf of someone else no longer needs to deliver the full bitcoin when the futures contract expires; the terms of the futures contract stipulate that they get to retain a chunk of the original bitcoin in the form of a newcoin.

So to protect themselves against the potential for lost newcoins, those buying bitcoin futures will always demand a lower futures price than they would otherwise demand in a world in which bitcoin could not be forked. If the threat of a fork is deemed large enough, bitcoin futures will actually go into backwardation.

Think of it this way. Backwardation means that those storing bitcoin on behalf of others will not only do so for free, but will even pay to have the task thrust on them. This may sound odd, but if part of the calculus of storing bitcoins is that all free and valuable newcoins can be retained by the person who does the storing, then it makes sense that people will eagerly pay a fee for the right to store someone else's bitcoins.

An example: backwardation and the failed Segwit2x fork

We can see an example of a fork-induced backwardation happening back in the fall of 2017, when a proposed change to Bitcoin's source code called Segwit2x was on the verge of leading to the creation of a newcoin. Bitmex, a fledgling futures exchange, stressed to its users at the time that its December 2017 bitcoin futures contract would not include the Segwit2x newcoin.

Through late October and early November, Bitmex's December futures contract fell to an ever deeper discount relative to the spot price of bitcoin. You can see this in the chart below. This inversion occurred in conjunction with growing odds that the upcoming newcoin's debut would be a success and that it would 'steal' quite a bit of value from each already-existing bitcoin. A futures buyer who wanted to take delivery of one bitcoin in December 2017 needed to adjust for the fact that this bitcoin could have a large chunk ripped out of it by Segwit2x. Driving Bitmex's futures contract into backwardation was the market's way of making this adjustment.

The Segwit2x fork drove bitcoin into deep backwardation

The Segwit2x fork was abruptly cancelled on November 8, and Bitmex's December 2017 contracts immediately reverted to contango. Since the cancellation of Segwit2x meant that existing bitcoins would not have any value sucked out of them, there was no need for futures buyers to protect themselves.

To sum up...

Because bitcoin is a young and inefficient market, borrowing bitcoins in size may be challenging. And that may explain at least some of the observed backwardation in bitcoin futures prices. But even if the market matures, Bitcoin will always be subject to the threat of contentious forks. This permanent threat gives rise to a set of forces that will always pressure the future price of bitcoin down relative to spot price. When the odds of a fork are low, these forces will not be sufficient to drive futures prices into full backwardation—they will simply push them down until they are relatively flat relative to the current price. But as the odds of a fork grow, all-out backwardation will be the result.

As for gold, there is no way it can be forked. Thus gold futures should spend far more time in contango than bitcoin futures should.

Bitcoin isn’t Digital Gold, it’s Digital Uselesstainium

This blog post is a guest post on BullionStar's Blog by the renowned blogger JP Koning who will be writing about monetary economics, central banking and gold. BullionStar does not endorse or oppose the opinions presented but encourage a healthy debate. 

People often like to describe bitcoin as digital gold, but that analogy isn't a very good one. Bitcoin is categorically different from the yellow metal. If we had to choose a metal as an analogy for bitcoin, that metal would be boring grey in colour (and thus lacking ornamental purpose), useless for industrial purposes, but scarce. As far as I know no such material exists, so let's come up with a name for this imaginary metal: uselesstainium. Bitcoin is digital uselesstainium.

Before bitcoin fans get angry with me, I should confess that I got the idea for uselesstainium from a 2010 discussion board post by Satoshi Nakamoto, the creator of bitcoin. Below are his thoughts on a scarce metal that is "boring grey" and "not useful for any practical or ornamental purpose":

Let's dig more into the difference between gold and this stuff we call uselesstainium. There are two reasons to value something: 1) because you want to use it, or 2) because you expect to pass it off in the future. Pass-it-off demand may be for short-term purposes, like money—you only expect to have a dollar bill in your wallet for a day or two before spending it on. Or it may be for the long-term, like a speculative asset that you intend to keep for a few years before selling to someone else. Either way, pass-it-off demand means that the item's value to you depends on what *the next person* is willing to provide, not on its use-value.

The demand for gold is made up of both types of demand. A portion of those active in the gold market value it as jewellery or a collectors item, or because it can be used to make circuitry or in satellites. The other portion likes the metal for its pass-it-off purposes, say they expect that someone else will pay twice the price next year.

Because it is an ugly grey colour and thus unsuitable for collectors or jewellery wearers, and it can't be used in teeth nor for industrial purposes, uselesstainium has no use-value. If it is going to be valued at all, then pass-it-off demand will have to be wholly responsible for generating that value.

Gold and a fat-finger trade

Thanks to this difference, the prices of gold and uselesstainium will act very differently. Let's say the two metals are each trading at $1000/oz. Each of them suddenly suffers from a freak $100 drop in price. No event has occurred to cause it, nor have people's tastes change, nor has the technological backdrop been altered. It's a fat finger event.

In this context there is *no* fundamental reason for uselesstainium to return to $1000. With gold, however, strong market forces will emerge to help fix the mistake and push the price up towards $1000.

Gold is a good conductor of electricity. And unlike copper and other metals it doesn't corrode, which means that gold electrical connections are superior to most. However, an ounce of gold is much more expensive than an ounce of copper or any other metal. When gold was at $1000, manufacturers of printed circuit boards (PCB) will have made a tradeoff between gold and other materials subject to the preferences of their customers, choosing the optimal amount of gold for the parts of the board that are too delicate to suffer from corrosion while directing copper, silver, and other materials to the rest.

But with gold now at $900, the yellow metal has become marginally more competitive than other metals. At these prices, PCB customers can afford to ask for a bit more gold on their boards. This demand will help drive gold back up to $1000. The PCB market won't be the only market to demand more gold. Collectors, jewellers, dentists, and many others will all find gold a little more advantageous than before relative to alternative materials and will step up their buying. Their combined purchases will help counterbalance the mistaken fat finger trade.

Speculators who are attracted to gold solely for its pass-it-off value will contribute to this rebound. Because they are constantly trying to anticipate the needs of future buyers, including those in the PCB market, speculators will purchase as much gold as they can from the fat finger trader based on their informed opinion that they can resell it to board manufacturers at a higher price.

Uselesstainium and a fat-finger trade

When uselesstainium falls to $900, no equivalent forces exist to drive the metal's price back to $1000. Remember, because uselesstainium has no industrial value the only basis for valuing it is by trying to guess what price it can be passed off to others. Whereas a gold speculator can try to anticipate the needs of participants in the PCB market, a uselesstainium speculator can only sell to other speculators. This means that she must try to anticipate what other speculators are likely to pay, while at the same time these potential buyers are in turn trying to anticipate what she will pay.

This sort of expectations game was beautifully described by the economist John Maynard Keynes back in 1936 as a beauty contest. Presented with a row of faces, a competitor has to choose the prettiest face as estimated by all other participants in the contest:

"...each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees."

Confronted with a sudden $100 crash, there is no inherent reason for a uselesstainium trader to anticipate that average opinion anticipates average opinion to move the price back up to $1000. A move up to $1100, or down to $700, or a collapse to $0, are all just as likely. In a beauty contest, there is no right or wrong price for uselesstainium.

Bitcoin is digital uselesstainium

Since there is no use-value to anchor uselesstainium's price, we'd expect it to be far more volatile than gold. Likewise with bitcoin, which is both rare and demanded solely for pass-it-off purposes. Let's take a look at a chart of the relative volatility of bitcoin and gold to see what it shows.

What you see in the above chart is the median daily change for each asset plotted over a moving 200-day period. By using the median rather than the average I am stripping out some of the large gut-wrenching changes that assets experience, in an effort to give a sense of what happens on a day-to-day basis.

Gold's median change since 2011 (the black dashed line) is around 0.5%. This means that on a majority of days you should expect a gain or loss of around 0.5% if you hold the yellow metal. Over the same time range, bitcoin's median change (the dashed red line) is about 1.7%, which means that an owner of bitcoin must generally deal with moves of +/-1.7% each day, more than three times what a gold owner must bear.

Bitcoin's rolling 200-day median return (the solid red line) is much less stable than gold's. It almost fell to the same level as gold in late 2016, hitting a low of around 0.75%, but has quickly moved back above 3%, a level last seen in 2011 and again in 2013-14. The volatility gap between gold and bitcoin—the distance between the two solid lines—is currently at its widest since 2012.

Bitcoin will always be an incredibly volatile asset because it exists entirely on pass-through demand. Like uselesstainium, it is a pure Keynesian beauty contest. If all contestants in the bitcoin price-setting game come to believe that the average contestant believes that the average contestant believes bitcoin is worth $0, then that belief will self-realize itself and bitcoin will fall to $0. If they all become 100% sure that it should be worth $100,000, then it will jump to $100,000. These sorts of price implosions and explosions can't happen with gold because its usefulness inspires economic behaviour that counterbalances beauty contest dynamics.

Now it is possible that bitcoin inherits some useful properties and therefore shifts from being a form of digital uselesstainium to a form of digital gold. Bitcoin advocates will often mention time-stamping as a service. People can take a digital representation, or hash, of a document and put it on the bitcoin blockchain by spending a small amount of bitcoin. Once accomplished the owner of the document will be able to publicly prove that they were the owner of that document on that date. Bitcoin time-stamping would in theory compete with other alternatives, like real-life notaries or the post office. In the event of a bitcoin price crash, anyone who wants to get cheap time stamping services may step in as buyers of bitcoin, in the same way that PCB makers support the gold market.

However, time stamping is still in its infancy. Certainly other uses for bitcoin apart from time stamping may eventually be found, but until then bitcoin remains digital uselesstainium, not digital gold. Plenty of money can be made betting on uselesstainium, and much can be lost. But no one should be buying uselesstainum—whether it be the digital type or physical—unless they are comfortable playing in a pure Keynesian beauty contest.

This blog post is the second in a series of guest posts on BullionStar's Blog  by the renowned blogger JP Koning who will be writing about monetary economics, central banking and gold .

28 Reasons to Buy Physical Gold

Throughout human history, gold has constantly emerged as an unparalleled form of savings, investment and wealth preservation. Due to its unique characteristics and features, gold has inherent value and cannot be debased. When holding physical gold, there is no counterparty risk or default risk. Wealth in the form of gold can also be held and stored anonymously.

From its ability to retain its purchasing power over time, to its safe haven status in times of financial turmoil and uncertainty, to gold's ability to diversify investment risk, there are many and varied reasons to own physical gold in the form of investment grade gold bars and gold coins.

1. Tangible with Inherent Value

Physical gold is real and tangible. It is indestructible, impossible to create artificially, and difficult to counterfeit. Mining physical gold is arduous and costly. Physical gold therefore has inherent value and worth. In contrast, paper money doesn't have any inherent value.

2. No Counterparty Risk

Physical gold has no counterparty risk. When you hold and own gold bars and gold coins outright, there is no counterparty. In contrast, paper gold (gold futures, gold certificates, gold-backed ETFs) all involve counterparty risk.

3. Scarcity

Gold deposits are relatively scarce across the world and difficult to mine and extract. New supply of physical gold is therefore limited and explains why gold is a precious metal. Gold's scarcity reinforces it's inherent value.

4. Cannot be Debased

Because of its physical characteristics and features, gold cannot be debased, and gold supply is immune to political meddling. Compare this to fiat money supplies which are constantly being debased and destroyed via deficit government spending, central bank quantitative easing and financial system bailouts. On a survivorship scale, gold has far outlived all fiat currencies by thousands of years.

5. A 6000 Year History

Gold has played a central role in society for thousands of years from the early civilizations of ancient Egypt, right up to the contemporary era. Gold has facilitated international trade throughout history, has been directly responsible for the economic expansion and prosperity of numerous civilizations throughout history, and has even been, due to gold exploration and mining, the direct catalyst for the growth of some of today’s best-known cities such as San Francisco, Johannesburg, and Sydney.

6. Store of Value

Gold is a preeminent store of value. Physical gold, in the form of gold bars or gold coins, retains its purchasing power over long periods of time despite general increases in the price of goods and services.

In contrast, fiat currencies such as the US Dollar are not stores of value and their purchasing power consistently becomes eroded by inflation or the general increase in the price level. Fiat currencies have a long history of either becoming totally worthless and going out of circulation, or else becoming completely debased, such as the US dollar, while remaining in circulation.

Since the creation of the US Federal Reserve in 1913, the US dollar has lost over 98% of its value relative to gold, i.e. the US dollar has lost over 98% of its purchasing power relative to gold.

Since 1913, the US Dollar has lost more than 98% of its value, while gold has retained its value.

7. Long- Term Inflation Hedge

Physical gold’s ability to retain its purchasing power over time is sometimes referred to as the “Golden Constant”. This reflects the fact that gold’s purchasing power is constant over long periods of time. This ‘constant’ exists because the gold price adjusts to changes in inflation and future inflation expectations. Therefore, physical gold is a long-term hedge against inflation.

8. A 2500 Year Track Record as Money

Because of its ability to retain value and act as a store of value, physical gold has been used as money for over 2500 years. Gold coins were first issued in the Lydian civilization in what is now modern Turkey. Subsequently gold was used as a stable form of money in Persia, ancient Greece, ancient Rome, the Spanish and Portuguese Empires, the British Empire, and right through to the various international gold standards of the 20th century.

It was only in August 1971 that the US famously suspended the convertibility of the US dollar into gold, a move which triggered the debt fueled expansion that is still having repercussions within today’s monetary system.

To put gold’s monetary importance into perspective, for 97% of the last 2500 years, gold has been chosen by numerous sophisticated civilizations as the form of money par excellence and an anchor of stability, precisely because of its ability to retain its value.

9. Safe Haven

Physical gold acts as a safe haven asset in times of conflict, war and geopolitical turmoil. During the financial market stresses and heightened uncertainties caused by wars, conflicts and turmoil, the counterparty risk of most financial assets spikes. But since physical gold does not have any counterparty risk, investors rush to gold during these periods so as to preserve their wealth. This is analogous to sheltering in a safe harbor. Gold can thus be seen as a form of financial insurance against catastrophe.

10. Portable Anonymous Wealth

Gold bars and gold coins combine high value with high portability. In times of conflict and war, gold bars and gold coins are ideal for transporting wealth and savings across borders and within conflict zones in an anonymous fashion.

11. Universal Acceptance

Gold is universally accepted as money across the world, with the highly liquid global market always providing ample sales opportunities for gold bars and gold coins. This means that whichever city you are in across the world, you can always sell or trade your gold bars and gold coins.

12. Emergency Money

Military personnel are often issued with gold coins that they carry with them in conflicts zones as a form of emergency universal money. For example, the British Ministry of Defense often issues RAF pilots and SAS soldiers with Gold Sovereign coins to carry on their persons during combat missions and activities, such as in the Middle East.

Worthless paper Currencies vs the Inherent Value of Owning Physical Gold

13. Outside the Banking System

In the current era of global financial repression, physical gold is one of the few assets outside the financial system. Gold is not issued by any monetary authority or central bank or government. Because its not issued by any government or central bank, gold is independent of the banking system. Fully owned physical gold, if stored in a non-bank vault or held in one’s possession, is outside the banking system.

14. No Default Risk

Unlike a government bond, there is also no default risk with gold because it is not issued by any authority that could default. Gold bars and gold coins are no one else’s liability. Physical gold cannot go bankrupt or become insolvent. Therefore, there is no need to have to trust any other party when holding physical gold.

15. Portfolio Diversification

Adding an investment in gold to an existing portfolio of other investment assets such as stocks and bonds, reduces the volatility (risk) of the investment portfolio and can increase portfolio returns. This is because the gold price has a low to negative correlation with the prices of most other financial assets, because gold is less influenced by business cycles and macro-economic cycles than most other assets.

Numerous empirical studies by financial academics, as well as industry bodies, such as the World Gold Council, have validated gold’s role as a strategic portfolio diversifier. Optimal allocations to gold in multi-asset portfolios have found to be in the 5% to 10% range.

16. Currency Hedge

There is generally an inverse relationship between the gold price and the US dollar, in that the gold price generally moves in opposite directions to the US dollar. Therefore, holding gold can act as a currency hedge of the US dollar, and help manage the currency risk of portfolios denominated in US dollars.

17. Gold's Metallic Properties

Gold has many and varied metallic properties. These properties provide gold with many technological and commercial applications and uses, which in turn contribute as additional demand drivers in addition to the investment and monetary demand for gold.

Gold is highly ductile (can be drawn into very thin wire). It is also highly malleable (can be hammered and flattened into very thin film). Gold is a very good conductor of electricity and heat. Gold does not corrode or tarnish. It is chemically unreactive and non-toxic to the human body. Gold has a high luster and shine, and an attractive yellow glow.

These properties explain gold’s use in electrical and electronic wiring and circuits (e.g. computers and internet switches), its use in the medical and dental fields, gold’s use in solar panels, space travel, and gold’s traditional uses in jewelry, decoration, and ornamentation. With new technological uses being found for gold all the time, gold's demand pattern is diversified and underpinned by its commercial importance.

18. Physical gold - A tiny fraction of Paper Gold

The London wholesale gold market and the US-based COMEX gold futures market generate huge trading volumes of paper gold that dwarf the size of the physical gold market. However, these markets only trade derivatives on gold (futures and unallocated positions), representing fractionally-backed and unbacked claims on gold that could never be convertible into physical gold by claim holders.

In a scenario under which these paper gold markets became unsustainable, the prices of paper gold and physical gold would diverge, with the paper gold markets ceasing to trade and collapsing, and only physical gold retaining any real value. Physical gold is therefore an insurance against the collapse of the world's vast paper gold markets.

19. By Definition - Not an ETF

Physical gold Provides all the benefits that gold-backed Exchange Traded Funds (ETFs) do not. ETFs provide exposure to the gold price, not to gold. Holding physical gold is by definition direct exposure to gold. With most gold-backed ETFs, you cannot convert the units into gold and take delivery of the gold, and in many cases, the locations of the vaults are not even known. If holding physical allocated gold bars or gold coins in a vault, such as with BullionStar in Singapore, you can always take delivery.

Gold ETFs have many counterparty risks since there are many moving parts in an ETF such as a trustee, a custodian, and a sponsor / issuer. Physical gold has no counterparty risks. When you hold a gold-backed ETF, the quantity of gold backing the ETF declines over time due to management fees being offset against the gold holdings. When you hold physical gold, you always remain with 100% of the actual gold you first purchased. There is no erosion of holdings.

20. Anonymous Storage

Gold can be stored anonymously, either in your possession within your house or property, or in a vault in a jurisdiction, such as Singapore, that has no reporting requirements. Since gold has a high value to weight ratio, storing gold does not take up much space.

21. Independent of Internet

Owning physical gold is not reliant on having internet access and access to electronic wallets and cryptocurrency exchanges. Furthermore, gold cannot be stolen by hacking an electronic address or by transferring or deleting a number in a computer.

The Benefits of Owning Gold Coins and Gold Bars

22. Real Gold is Measured by Weight

Physical gold is measured in weight, not through a number set by a politician or central banker. When you buy a 1 Kilo gold bar, or a 10 Tola gold bar, or a 1 troy ounce gold coin, or a 5 Tael gold bar, you will always have that gold bar or gold coin, irrespective of the fluctuations of fiat currencies.

While thinking of the value of physical gold in terms of a fiat currency might be convenient, a better way is to think of a gold holding in terms of weight.

23. Coins and Bars - Build a Collection

Buying investment gold bars and bullion gold coins allows you to build a diverse collection of bars and coins that are at the same time a fascinating pastime and a form of investment and saving.

Bullion gold coins from the world’s major mints are beautifully illustrated and often have a connection to history. Investment gold bars from the world's major gold refineries are distinctively different from each other and you can vary a collection by cast or minted bars, and a selection of weights.

24. Physical Gold Feels like Real Wealth

Physical gold feels like real wealth. When you hold ten 1 ounce gold coins in your hand, you intrinsically know that you are holding real wealth, gold that is scarce and that has been costly to produce.

25. Gold as Loan Collateral

Gold can be used as loan collateral. Since gold is highly liquid and valuable, it can be lent and used as a form of financing, and as a way of generating interest. The wholesale gold lending market between central banks and bullion banks is highly active. Likewise, retail gold holders can also in various ways lend their gold to receive financing or interest, with new innovations to do this arising all the time.

26. Central Banks hold Gold

Although the world’s central banks like to downplay the importance of gold because it competes with their fiat currencies, most central banks continue to hold substantial amounts of physical gold bars and gold coins in vaults around the world. They hold this gold as a reserve asset on their balance sheets, and they value this gold at market prices.

Like private gold investors, central banks hold physical gold because it is highly liquid, it lacks counterparty risk, and because gold is a safe haven or ‘war chest’ asset that acts as a financial insurance in times of crisis. Central banks also hold gold for the unpublished reason that if and when gold re-emerges at the centre of a new monetary system, these very same central banks will not be caught out having no gold.

27. Gold for Gifting

Gold coins and small gold bars make great gifts and presents, and gold is a traditional form of gifting in many societies around the world. Gifting a gold coin or small gold bar to mark a birth, or anniversary, or a wedding or other special occasion, is an ideal present that will be highly appreciated by the recipient.

28. Gold for Inheritance

Gold bars and gold coins are a great form of inheritance for your children and family members. Because gold is real, tangible, valuable, and has a highly liquid trading market, it is an ideal asset for inter-generational wealth transfers. Because physical gold is fabricated in convenient weight denominations, such as troy ounces and kilograms, it can be distributed equitably among recipients, and specified equitably in wills and trusts.

Hyperinflation in Zimbabwe – It’s back, but maybe not for long

When a nation adopts a foreign currency it will typically face significant hurdles when it tries to rid itself of that currency, or de-dollarize. But Zimbabwe’s autocratic ruler Robert Mugabe has appeared to have done the impossible. After dollarizing ten years ago, over the course of the last year or two he and his cronies have managed to throw off the U.S. dollar and re-introduce a Zimbabwean replacement.

We can see evidence of this new currency in Zimbabwe's stock market. Below I've charted the country's main equity index, the Zimbabwe Industrial Index, going back to 2011. What an incredible rise over the last year, right? Beware; these returns have nothing to do with real economic growth. Zimbabwean equities have switched from being claim on an a stream of cash flows denominated in U.S. dollars to a stream denominated in Zimbabwe's new currency. Because investors expect inflation of the new currency to drive up future cash flows, they have responded by bidding stock prices up. In real terms (i.e. U.S. dollar terms), stock prices are probably flat–and may have even declined.

Dollarization and de-dollarization

Let's back up a bit. For those countries that mismanage their currency, the penalty box has typically been some form of dollarization. The citizens of a nation grow so tired of the hyperinflating currency that they opt for an alternative, whether that is euros, dollars, or some other medium of exchange.

Dollarization is usually only partial, the mismanaged currency continuing to circulate–albeit to a lesser extent–in conjunction with a stable alternative. Zimbabwe is unique in being one of the few countries to fully dollarize. By late 2008 the hyperinflation of the Zimbabwe dollar had become such a burden that Zimbabweans–without the permission of the Mugabe regime–threw their local currency notes into the gutters and adopted the U.S. dollar as their sole medium of exchange and unit of account.

Zimbabwe 100 trillion notes and gold bullion
Do you prefer to own 200 trillion dollars or do you prefer to own gold?

In 2016-17, the reverse has happened. Before I go into how the new Zimbabwean currency was introduced, it should be emphasized how difficult it is to replace an existing currency with a new one. Currency usage is locked in place by tradition and broad acceptance. Even when a national currency is doing very poorly, any single individual will be loath to be the first to desert it for a more stable alternative. Money is only useful when many people are using it, and since any new money lacks a base of users, it faces the paradox that it cannot ever get jumpstarted. In the case of modern Zimbabwe, the communal benefits of using the U.S. dollar as the "language of trade" are significant, so any alternative should have faced a huge hurdle in gaining acceptance.

The birth of Zimbabwe’s new currency

That the new Zimbabwean currency managed to make it past this hurdle is a testament to the powerful combination of subterfuge, brute force, and good old Gresham's law that overpowered the staying power of the U.S. dollar. What follows are the steps that led to this switch.

After the 2008 dollarization rendered it useless, the Reserve Bank of Zimbabwe (RBZ) sneakily got back into the money printing game in 2012 or 2013. Creating a new national currency from scratch would have been politically impossible; the population was still furious with its leaders' previous monetary mistakes. So instead the central bank began issuing a U.S. look-alike. Domestic banks had the option–and later were required–to open U.S. dollar accounts at the RBZ. These accounts weren't available to the public but could be used between banks to settle domestic payments flows. At first, the RBZ's U.S. dollar deposits were as good as the real thing. Banks could easily convert them into U.S. paper currency.

As time passed, Robert Mugabe's government drew down on the RBZ's resources in order to fund a massive spending campaign. This depletion of the RBZ's hard currency reserves eventually forced it to renege on its promise to commercial banks to redeem in dollars. Regular Zimbabweans only got their first sign of trouble in early 2016. Since commercial banks could no longer rely on the RBZ to convert its U.S. deposits into real U.S. cash, the banks had no choice but to pass their inability to get cash on to their customers. The ability of the public to withdraw cash from U.S. dollar accounts was steadily cut back until they could only take out $50 per day, leading to massive lineups at banks across the nation. With the convertibility promise having been betrayed, dollars held in the banking system ceased to be equivalent to U.S. dollars. They began to trade at a 5-20% discount to genuine U.S. cash in the black market.

In November 2016 the RBZ introduced the bond note, its first issue of paper money since the old Zimbabwe dollar had expired worthless in 2008. (For more details, read my post on the topic here). As in the case of the accounts at the central bank, bond notes were supposed to be redeemable on demand into U.S. dollars. But this redemption promise proved to be a sham–and bond notes quickly began to trade at a discount to U.S. paper money.

Gresham’s law makes an appearance in Zimbabwe

Having duped the population into accepting RBZ-issued dollar notes and deposits, the government proceeded to declare its new currency legal tender. This meant that any creditor who had lent out U.S. dollars was obligated by law to accept payment in bond notes at par. At the same time, the authorities required retailers to treat all payments media as equivalents–they could neither discount the inferior currency nor accept the superior currency at a premium, the penalty being seven years in jail.

Which gets us to Gresham's law. A rule going back to medieval times, Gresham's law tells us that when a government dictates the exchange rate between different types of money, the 'good', or undervalued money will be chased out by the 'bad', or overvalued money.

To see how Gresham's law has played out in Zimbabwe, consider a Zimbabwean street hawker who prior to 2016 had been selling oranges for $1 per bag. The new Zimbabwean currency is introduced. Because this new currency is inferior to the U.S. dollar, the street hawker continues to charge $1 per bag for those paying with genuine dollars but requires everyone paying with new currency to pay an extra 50 cents, or $1.50. With this new dual-pricing scheme, some customers will continue to pay with U.S. dollars, others will pay with bond notes. Both types of money circulate together.

Zimbabwe 100 trillion dollar notes with bread, eggs and milk
In 2008, on the first day of issuance, a 100 trillion dollar note reportedly could buy 3 eggs in Zimbabwe but only 1 egg the day after

When the government announces that all currencies must be treated as equals, the street hawker can no longer charge an extra 50 cents to those paying with Zimbabwean currency. To meet the letter of the law, he sets his price at a flat $1.50 per bag of oranges, irrespective of the type of currency used. However, this undervalues the U.S. dollar. After all, $1.50 in U.S. cash should be capable of buying a bag-and-half of oranges, not just one bag. The result is that none of the street hawker's customers will ever pay with U.S. dollars, preferring to hoard them and proffer Zimbabwean currency as payment instead.

This parable of the street seller has occurred all over Zimbabwe over the last twelve months. Thanks to the government's edict that all currencies be treated as equals, U.S. dollars have been driven entirely from circulation. No one wants to use them because they are undervalued. As a result, bank money and bond notes have become the main media of exchange in Zimbabwe. Zimbabwe has dedollarized.

Hyperinflation 2.0

Prices are on the rise. I used the stock market as an illustration of this in my introduction. Consumer goods have been slower to adjust, but earlier this month Equity Axis–a local financial research firm–reported that the prices of basic goods have gone up by between 50- 100% over the past eight weeks. On the streets, illegal currency traders will buy $1 worth of bank money for just 54 cents in genuine cash, according to recent reports.

Comparing the price of bitcoin in Zimbabwe against its international price also gives some clues into how far the new currency has tumbled. Last week bitcoin traded at $13,185 on the Golix, a Zimbabwean bitcoin exchange, but only $7190 on U.S. exchanges. We need to take the price of $13,185 with a grain of salt, because Golix is a very illiquid exchange. In any case, the ratio between the two bitcoin prices implies that a Zimbabwean bank dollar is only worth 54 cents in genuine U.S. dollars ($13185/7190), confirming the unofficial street price in the previous paragraph. Put differently, in just one year Zimbabwe's new currency has lost almost half its value.

Economist Steve Hanke, who helps maintain the Hanke-Krus World Inflation Table, has used interlisted stocks on the Harare and London stock exchanges to infer that Zimbabwe’s inflation rate has soared to 77%. (I described this technique in more detail here). When inflation exceeds 50% per month and lasts for at least thirty consecutive days it qualifies as hyperinflation, which means that Zimbabwe’s current currency collapse will be added to the Hanke-Krus table.

Going forward…

Given that Mugabe and his cronies have already shown a penchant for destroying currencies, as long as they are in power it seems unlikely that the current inflation will stop. As I was writing this post, however, the situation in Zimbabwe has dramatically changed. On November 14, the army announced that it had placed Mugabe under house arrest. We don’t know if he will be permanently removed from power or if the situation is just a temporary one. If a new government can be established, and the international community mobilized to support it, it is possible that the collapse in the new currency will be halted, perhaps even reversing back to par. For instance, a large enough IMF loan might allow the RBZ to uphold its original promise to convert bond notes and deposits into genuine dollars on a 1:1 basis.

The market may already be pricing in an improvement in the odds of the Zimbabwean currency being stabilized. Over the two days the Zimbabwe Industrial Index has plunged by over 100 points or 20%, as the chart at top illustrates. This correction may be partly due to operating uncertainties faced by listed firms given the lack of visibility surrounding future leadership. But the largest chunk of the decline is surely a pure monetary phenomenon. Since all stock prices are quoted in Zimbabwean money, a massive increase in the purchasing power of money will cause stock prices to fall.

Many outside the country have no doubt been anxiously watching Zimbabwe's monetary experiment, especially in Europe. In the same way that Zimbabwe was part of the U.S. dollar-zone, most European nations are part of the Eurozone, in some cases reluctantly so. Zimbabwe offers these nations a blueprint for quickly exiting the monetary union. That may be one reason why the President of the European Central Bank, Mario Draghi, was so quick to shoot down Estonia's recently mooted state-backed cryptocurrency, the Estcoin. By nipping it off at the bud, he ensured he wouldn't have a home-grown bond note problem.

This blog post is the first in a series of guest posts on BullionStar's Blog  by the renowned blogger JP Koning who will be writing about monetary economics, central banking and gold .

Buy and Sell Gold and Silver with Bitcoin

Given the very strong price appreciation of leading cryptocurrency Bitcoin recently, Bitcoin holders who are thinking of diversifying or taking some profits on their Bitcoin positions may be interested to know that in addition to transacting in US Dollars, Singapore Dollars, and Euros, BullionStar also accepts Bitcoin as a payment option for its precious metals products, and has done so since May 2014.

2017 Year-to-Date: Bitcoin Price in US Dollars
2017 Year-to-Date: Bitcoin Price in US Dollars

Using the BullionStar website, customers can quickly and efficiently purchase gold bars and gold coins, as well as silver bars and silver coins using Bitcoin. Customers can also sell gold and sell silver to BullionStar and receive settlement proceeds in Bitcoin.

The maximum transaction size for a purchase order using Bitcoin is currently set by BullionStar at BTC 200 per transaction. There is no minimum transaction size for a purchase order using Bitcoin. For sell orders that settle in Bitcoin, the standard maximum transaction size is currently 30 BTC per transaction, but this can be higher upon discussion with BullionStar.

Bitcoin as a currency is also fully integrated into the BullionStar website. Once you select Bitcoin as the default currency from the Currency drop-down menu at the top right hand side of the BullionStar website homepage, Bitcoin becomes the default transactional currency within the website, and furthermore, all spot prices and associated charts and all product prices on the website will be displayed in terms of BTC.

If logged into your Account, your ‘My Vault Balance’ and ‘Cash Balance’ will also be displayed in BTC. Account history and “My Vault Portfolio” are also displayed in BTC once Bitcoin is selected as the default currency option.

Buying Gold and Silver using Bitcoin

To purchase precious metals on the BullionStar website using Bitcoin:

1, Select Bitcoin in the currency drop-down menu at the upper right hand side of the BullionStar homepage. This will display all product prices in Bitcoin, and will also automatically populate Bitcoin as the default payment method in the online Checkout tool.

Bitcoin currency
Select Bitcoin in the Currency Dropdown menu

2. From the ‘Buy Gold and Silver’ menu option, select the precious metal products you wish to buy. Product prices will be displayed in Bitcoin (BTC).

For example, if you are interested in purchasing a PAMP minted 1 ounce gold bar, select ‘Gold Bars’ from the drop-down menu and the price in Bitcoin of a 1 ounce PAMP gold bar will be displayed in BTC, which, at the time of writing was BTC 0.675530.

BullionStar Product Prices displayed in BTC
BullionStar Product Prices displayed in BTC

3. Fill in the quantity of the product you wish to buy. Then click the green “Add to Cart” button to add the selected product to your Shopping Cart.

4. Repeat Step 3 to add other products to your Shopping Cart, or if finished shopping, select the green ‘Checkout’ button towards the top right hand side of the screen.

5. In the subsequent Checkout screen, Bitcoin will appear as the default payment method. Select your preferred ‘Delivery Method’ of either ‘Vault Storage’, ‘Shipping by Courier’, or ‘Personal Collection (Pick-up)’.

Checkout Screen with BTC as the default payment option
Checkout Screen with BTC as the default payment option

Ensure that the order total is less than or equal the maximum transaction size for a purchase order of BTC 200 per transaction.

Fill in your customer information, click the check boxes to indicate that you agree with the Terms and Conditions, and that you agree that the order is binding, then click the “Confirm” button to place your order.

6. After clicking “Confirm”, an order confirmation will appear on the screen. This order confirmation details your order number, the products ordered, the order date, your customer information, and the Bitcoin payment information, i.e. the payment amount in BTC and the unique Bitcoin address to which to send your payment to. An example of a Bitcoin payment amount and a Bitcoin address is shown in the screen below.

Bitcoin payment
Example of Bitcoin payment information on an order Confirmation

Your order confirmation is also sent to your email address.

Upon placing an order and hitting ‘Confirm’, you have 20 minutes in which to send your Bitcoin payment to the unique Bitcoin address that specified on your order confirmation.

7. As soon as BullionStar has received 6 block confirmations of your Bitcoin payment, which can take anywhere from 20 minutes to a few hours, you will automatically receive a payment confirmation update to your email address. BullionStar will thereafter process your order.

For those unfamiliar with the Bitcoin transfer confirmation process, block confirmation is Bitcoin’s way of verifying transactions.

When a Bitcoin transaction is made, it is then verified by Bitcoin miners and is grouped with other transactions into a new block on the blockchain, upon which it is confirmed. Then when subsequent blocks are added to the block chain, all previous blocks are reconfirmed, a process which generates additional block confirmations.

Generally, merchants and retailers who accept Bitcoin require 6 confirmations to ensure that a transaction has been fully validated.

Upon receipt for 6 confirmations, BullionStar will proceed to process your order.

Selling Gold and Silver using Bitcoin

To sell gold or sell silver on the BullionStar website and receive the proceeds in the form of Bitcoin:

1. Select Bitcoin in the currency drop-down menu at the upper right hand side of the BullionStar homepage.

2. Select the “Sell Gold & Silver to us” option from the main menu.

Select the product(s) and quantity you wish to sell.

Ensure that the total value of the sell order in BTC is less than or equal to BullionStar's current online maximum transaction size for a sell order of BTC 30 per transaction.

(Note: If you would like to place a sell order for an amount larger than BTC 30, please send an e-mail to support@bullionstar.com or call +65 6284 4653  to enquire whether we can settle your sell order in Bitcoins.)

Enter your customer information. The Payment Instructions box will be defaulted to Bitcoin. In the Bitcoin Address box, enter the Bitcoin address where you want to receive your Bitcoin payment to. Then submit your order by clicking “Confirm”.

Bitcoin Sell screen
Bitcoin Sell screen. Payment Instructions defaults to Bitcoin and Bitcoin Address box

For more information, see BullionStar's help page "Bitcoin as Payment Option and Currency".

To convert Bitcoins to traditional fiat currency, one straightforward option is to use a Bitcoin exchange such as Bitstamp in the USA or FYB-SG in Singapore. The steps to follow would be to open an account with a Bitcoin exchange, transfer your Bitcoins to your account wallet on the Exchange, sell the Bitcoins on the exchange, and then withdraw the proceeds of the sale in a currency such as US Dollars.

Those who currently do not hold Bitcoin but who might want to can also open and fund a Bitcoin account with one of the Bitcoin Exchanges, and then buy Bitcoin to hold in their Exchange account. This Bitcoin could then be subsequently used in a transaction on the BullionStar website to buy gold or buy silver.

BullionStar Charts: View and Create Bitcoin Charts

Note that historic Bitcoin prices are also available on the BullionStar Charts page, where Bitcoin is listed under the Currencies category along with 18 major currencies. The BullionStar charting tool allows you to chart the price of Bitcoin in terms of other currencies and in terms of precious metals, commodities, major stocks, popular stock indices, and in terms of the prices of BullionStar’s product range.

With a Bitcoin price history that goes back to January 2011, you can now use BullionStar charting tools to check and view the price action of Bitcoin for the last 6 and a half years.