Bitcoin Hysteria – Digital Currency Overview

Euphoria has swept Bitcoin to unreal levels over the past few weeks. Bitcoin, one of many digital currencies, shot past 11,000 in the final week of November after eclipsing 10,000 just hours prior. The cumulative value of all cryptocurrencies throughout the world are estimated to be more than $300 billion, an enormous increase from the $18 billion at the beginning of the year.

The commodity futures trading commission granted the Chicago Board Options Exchange (CBOE) to issue Bitcoin futures which will allow traders to bet on the price of the digital currency via a trusted exchange. Traders will be allowed to bet on the appreciation of the cryptocurrency or the demise of it by buying and selling the futures.

What took the equity markets decades to establish, the cryptocurrencies market is trying to build in mere months. Bitcoins emerged in 2008 designed by a programmer or group of programmers under the name of Nakamoto, whose real identity remains unknown. New Bitcoins can only be created by solving complex math problems embedded in the currency keeping total growth limited.

Many believe that the development of digital currency is just the beginning of a globally accepted process available sometime in the near future. Bitcoin could merely be a stepping stone to an eventual acceptance of digital currency. Bitcoin currently accounts for roughly 55% the total digital currency market, down from 87% of the total market at the beginning of year.  Hence, Bitcoin has incredibly fast growing competition. Bitcoin is currently one of over 1000 other digital currencies in the marketplace. Other popular cryptocurrencies include Ethereum, Ripple, Litecoin, NEM, Dash, and IOTA, to name just a few.

Digital currencies are being examined as a store of value and a method of making monetary payments. Gold, an accepted store of value, and currencies issued by countries have been established internationally for centuries and are now challenged by the cyptocurrency concept.

One factor driving Bitcoin’s growth has been the emergence of a broader cryptocurrency ecosystem. Bitcoin serves as the reserve currency for the cryptocurrency economy in much the same way that the dollar serves as the main anchor currency for international trade. Bitcoin has been recognized as the first truly decentralized electronic payment network.

A looming regulatory crackdown is affecting the digital currency as well. Bitcoin has already been hit by a crackdown from Chinese officials who have been severely restricting the use of cryptocurrencies. In the United States, there’s little risk of a direct crackdown on Bitcoin, but there’s a real risk that the Securities and Exchange Commission will crack down on the ICOs (Initial Coin Offerings) that have pushed Bitcoin’s price upward. An unregulated means by which funds are raised for new cryptocurrency bench ICOs are used by startups to bypass the rigorous and highly regulated capital raising environment.

Bitcoins exist as software, not physical currency, and are not regulated by any country or banking authority. Even though U.S. Senate hearings disclosed that Bitcoin could be a means of exchange, it gave no assurance that it would actually become an accepted medium of exchange. Government regulations would need to be created and then enforced in order for Bitcoin to become accepted by other government entities. The currency can be traded without being tracked, thus raising the potential for illicit activity, such as involving weapons, drugs, and prostitution. Even though Bitcoins are not illegal, it is not legally recognized by governments as a currency.

Bitcoin Hysteria – Digital Currency Overview (continued)

Some believe that the price appreciation of Bitcoin has been solely a result of speculation and hasn’t yet been used as a store of value or as a medium of exchange to any extent. Some compare Bitcoin to the tulip craze in Holland of 1637, when speculators pushed the price of tulip bulbs to incredible levels, followed then by a collapse in the tulip bulb market. Bitcoin has also surged on speculation that perhaps one day digital money will eventually become a legitimate global currency and even replacing currencies from certain countries.

Bitcoins are mined by powerful computers that calculate complex, mathematical functions. Total Bitcoin quantity is capped at 21 million and currently there are about 12.4 million that exist worldwide.

The growing mobile payment industry could be a big benefactor to the acceptance of Bitcoin as new and creative applications are being devised to accept digital currency. Bitcoin transactions are very popular among mobile users, where rather than using a credit card or cash to make a purchase, all you need is your phone.

In 2014, the value of Bitcoins fell by over fifty percent following remarks by China and Norway to not recognize the digital currency as legal tender. The government of Norway ruled that Bitcoin does not qualify as real currency but rather qualifies as an asset, producing taxable capital gains. Norway said that Bitcoins don’t fall under the normal definition of money or currency.

More and more nations have been taking an official stance as the popularity of Bitcoins has evolved. The European Banking Authority has warned about the risks of trading digital money and subject to losses where consumers are not protected by any government entity or authority.

As digital currency evolves, some believe that it will eventually be accepted as a legitimate currency. But for the time being, others believe that its time hasn’t arrived yet. Various studies have recently emerged with different opinions, such as a Stern School of Business study conducted by David Yermack, which concluded that Bitcoin behaves more like a speculative investment than a currency and has no currency attributes at all.

Sources: Bloomberg, Reuters, cointelegraph.com

Macro Overview

Both chambers of Congress have passed tax reform plans that will invoke among the most significant changes to the tax code since the Tax Reform Act of 1986. Versions of the Tax Cut and Jobs Act passed by the House in November and the Senate in early December will be modified into a single bill following Congressional deliberations.

Enactment of the tax bill would cut taxes by more than $1.4 trillion over 10 years, as estimated by the Joint Committee on Taxation. Other projections also include a rise in the federal deficit, should economic growth not be sufficient to make up for the cost of the tax cuts.

Passage of the tax reform bill may eventually lead to higher inflation because of possible growth in the federal deficit and an expanding economy. Economic expansion produces inflationary pressures that can increase wages and asset prices such as homes and stocks. In addition, tapering of fiscal stimulus in Europe by the European Central Bank (ECB) may also add to international inflationary pressures, which has been one of the ECB’s primary objectives.

Equity markets rose in November with the Dow Jones Industrial Index climbing past 24,000 and the S&P 500 Index eclipsing the 2600 level, as the likelihood of tax reform passage became more apparent. Companies with strong balance sheets have been out performing those with weak balance sheets, as the market prepares for possible tax ramifications of companies deducting certain interest expenses. Markets expect the Fed to raise short-term rates again in December as improvements in the economy and labor markets materialized further. The unemployment rate dropped to 4.1% in October, the most recent data available from the Labor Department, the lowest rate since December 2000.

The internet will undergo deregulatory efforts with the repeal of an Obama administration rule set in place to regulate the internet with regulations similar to the utility industry. The FCC repealed Net Neutrality in November with the intent of increasing competition and alleviating regulatory oversight.

The Federal Reserve will have a new chief starting on February 3, 2018 with Jerome Powell replacing Janet Yellen. Senate confirmation hearings in late November buoyed markets as Jerome Powell expressed that the steady pace of monetary tightening under Yellen would continue under his watch. Mr. Powell is favored by the banking sector and financial markets because of his hands-on experience over the years.(Sources: Fed, Labor Dept., Dow Jones, S&P, Congress.gov/bill/115th-congress/house-bill/1)

What A Flattening Yield Curve Means – Bond Market Update

The anticipation of Fed rate hikes has gradually raised short-term rates this year, with the demand for longer-term bond maturities increasing. The result has been a flatter yield curve, where short-term rates have risen and long-term yields have dropped. A flattening yield curve implies that longer-term economic growth may be subdued or not expected to be very extensive.

At the end of November, short-term rates such as the 2-year Treasury yield had risen to 1.75% from 1.22% at the beginning of the year. The longer-term 30-year Treasury bond yield fell to 2.77% on November 30th from 3.04% in January.

As promised, the Fed has started to curtail its buying of Mortgage Backed Securities (MBS). Through September, the Fed was buying an estimated 20-25% of the roughly $110 billion of MBS sold each month. In October, the Fed scaled back its purchases by $4 billion and is scheduled to reduce purchases by another $4 billion every quarter. As the Fed buys less and less MBS, the market will need to slowly absorb the additional paper made available by the Fed’s lack of buying. As this occurs, it is expected that MBS prices will gradually fall and yields will gradually rise. (Sources: Federal Reserve, Bloomberg, Treasury Department)

Itemized Deductions By Income Groups – Financial Planning

One of the most coveted tax tools proposed for elimination are various deductions. IRS data shows that approximately 70% of taxpayers take the standard deduction rather than taking itemized deductions. Taxpayers, regardless of their income, have the option of using either one. According to the IRS, over 30% of households choose to itemize their deductions in tax year 2013. Data also shows that households with incomes greater than $75,000 made most use of these deductions, validating that higher income households tend to itemize deductions. The same IRS data revealed that only 6% of tax returns with under $25,000 in income chose to itemize, while over 93% of tax returns with over $200,000 in income itemized. Households with higher incomes are more likely to pay more in state and local taxes, take larger mortgages, and donate to charities. All of these can lead to sizeable deductions on a tax return. The Tax Foundation concludes that itemized deductions mostly benefit wealthy taxpayers and is the reason why many recent tax reform proposals have sought to limit or eliminate them. (Sources: IRS, Tax Foundation)