Part of our special report: A Bitcoin for Your Thoughts

To call Bitcoin a currency is an insult to national and multi-national currencies everywhere. Bitcoin is not a currency. That is my opinion, though not shared by all even in my office.

Besides the obvious fact that it has no Central Bank, or even known central issuer, Bitcoin has no army to back it up, no government agency to oversee its production and no Secret Service to ferret out counterfeiters. Where government bodies can bring instability to economic policy, key government agencies and departments bring stability by preserving and protecting the integrity of everything from the banks to the genuineness of the paper currency.

So what is this phenom known as Bitcoin?  Is it a commodity?  Is it a security?  If it is a security, what is it backing up?

There is nothing backing it up. There is no gold, no power to tax, no army and no intrinsic value, a point former Fed chair Alan Greenspan made this week as well in a Bloomberg article.

So what is its value?  Why does its price keep going up?  The first thing you have to look at when you have a market is who are the natural participants with an economic interest in the security, commodity or derivative. Since there is no country issuing them, or company, or anyone in particular, there is no natural long hedger.

I will make the argument that many of the individuals who have “invested” in bitcoins are not natural long hedgers. I contend they are political hedgers, using bitcoins as a way to hedge their default or debasement risk of their home currencies. The could just as easily use gold or farmland to hedge this risk.

Short hedgers could include people who own or are mining bitcoins. But there is no credible futures market yet for this product, as I understand it.

I contend that the natural participants of the Bitcoin market are money launderers. They need to move physical cash into bank accounts or sell or barter goods without being detected by banks, regulators or investigative bodies.

One way to turn cash into something else is very simple. You buy a server and you program that server to mine for bitcoins. Once you have the bitcoins, then you sell them to someone else and have the cash in the bank. I am told this is more difficult than it sounds, but I don’t underestimate the capabilities of the criminal element.

I believe that one of the reasons that the price of bitcoins has appreciated so is that speculators have rightly figured out who the natural players are and are methodically increasing the marginal cost of the money launderers using bitcoins to a level of price and price volatility that is equivalent to the prevailing prices for laundering cash.

Now, I only know what I know about money laundering from the movies and from taking Anti-Money-Laundering testing as part of my Series 3 registration. I am guessing in this age of the Patriot Act and all the pressure on the banks from regulators that the cost of laundering big money is pretty high.

Is it 25 percent?  Maybe 50 percent?  Who knows. But the market is showing that the risk to a person holding bitcoins, even for a day, or hours, is substantial.

This was not the case when bitcoins were priced in dollars, or tens of dollars. Now it is hundreds of dollars of movement per day. I am sure someone better at volatility than I could figure out what the implied volatility of the Bitcoin market is. That number will give us an idea what the cost of laundering big money is.

I know I am being harsh here and don’t want to rain on the innovation parade. There are uses for bitcoins that legitimate businesses are finding. I do think many of those who use it legitimately now fall into the “marketing” camp. It is a hot subject and liable to create buzz for a company or online site.

From my perspective, I believe bitcoins have been used to move large amounts of money across international borders. It has been linked to drug purchases online, but that is money laundering. No one wants to be found out to be buying or selling drugs, so they launder the money using bitcoins so they are not discovered. There are some indications it is used for gun sales without background checks, which is again money laundering.

The value of bitcoins comes not from the limited supply they have, though that is a factor in any market. The value comes from the marginal utility of bitcoins to launder money. And the value will keep going up, and stay volatile, as long as the cost of other means of laundering money is higher.

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