In a report on Bitcoin, Merrill Lynch's commodity and derivatives strategist Francisco Blanch, has noted the similarities of digital currencies to gold but says it can take the next step up in money’s evolution if issues on safety, liquidity and return are addressed.
The report has looked at the history of trading commodities and how those gave rise to paper money, noting that Bitcoin could be the latest innovation that has seen people switch from salt to dollar notes.
Collateral damage
On this path to legitimacy, Blanch mentions that Bitcoin’s first and biggest hurdle is to be accepted as collateral as an asset, once that happens, it will take a huge step to global asset legitimacy.
"We are not aware of any major institution that takes cryptocurrency as collateral at the moment," Blanch said
Despite this though, Wall Street is warming to the digital currency as a potential investment product.
Worth its salt
Blanch begins his report with a brief history of commodities and their value as a currency explaining that practical needs, innovation and new discoveries have seen money evolve.
It seems logical then that because Bitcoin addresses some of the issues faced by paper money, it could become legitimized, but there are some of its own issues it needs to sort out.
Safety
Safety has always been a sore spot for Bitcoin and digital currencies, and it has been noted by Blanch too.
“The lack of a centralized decision-making process or authority creates risks such as a currency split," he says. "Also, risks such as hacking, identity theft or outright scams are a recurring problem."
However, in terms of its volatility, another hallmark of the digital currency, Bitcoin actually outscored silver on few occasions.
"Bitcoin's volatility is very high compared to the euro, the yen or even gold," Blanch said. "But it fell twice last year below the volatility of silver, the world's currency for 400 years."
Source: Bank of America Merrill Lynch Global Research
Liquidity
Unsurprisingly, for an asset that is practically on the margins of society, it is being outperformed by stocks, traditional currencies and fixed income when it comes to market liquidity, but Bitcoin’s trading volumes are hard to ignore.
"It is hard to ignore that trading volumes for major digital currencies like Bitcoin and Ethereum have skyrocketed in recent years," he said. “Noting that since 2012, daily trading volumes for Bitcoin have grown five times to $2 bln a day,” Blanch added.
Return
One area where Bitcoin does score high is its returns. The digital currency has more than doubled its value this year while rivals in the same sphere, such as Ethereum, are seeing more than a 1,000 percent growth.
However, linking it back to gold, Blanch believes that it is the difficulty in mining Bitcoin that is making it so valuable.
In a rather too simplistic assumption, Blanch believes things could be different: "This could change with the advent of quantum computers or through agreements among developers to adopt simpler protocols."
Truly is digital gold
Mining, as well as its increased difficulty, alongside an upsurge in interest, has seen Bitcoin climb in "a pattern similar to gold" and "over a much more compressed time period.”
Source: Bank of America Merrill Lynch Global Research
"There is no certainty that [similarity to gold] will continue and, most certainly, no way to predict it," Blanch said. "In our view, cryptocurrency returns will mostly depend on the faith placed by individuals, corporations, and financial institutions on this emerging technology,” Blanch concludes.