Sunday, May 12, 2019

The Five Myths of Bitcoin

Bitcoin has been around for a few years now. Has it lived up to its hype?

Bitcoin recently surged above $6,000 a coin.  This after years of extreme volatility where Bitcoin has gone up and down in value, sometimes thousands of dollars within a day - sometimes within an hour. The question remains, what is Bitcoin and has it lived up to its expectations?  A lot of what Bitcoin proponents claimed early on has proven not only to be overstated, but outright false.

There were a lot of promises made about Bitcoin, but they all turned out to be myths:

1.  Bitcoin will replace currencies.   It's been several years now, and yet no one is using Bitcoin as a currency.  Sure, many retailers claim to accept Bitcoin and there have been a few stunt buys involving Bitcoin, such as a few years back when a guy "bought a Tesla with Bitcoin."  When you scratch the surface on these stories, it turns out that the retailer is merely converting Bitcoin to a local currency using a Bitcoin exchange and then pocketing dollars.  Bitcoin has yet to become its own closed-loop ecosystem where transactions are consummated in Bitcoin and not immediately converted to other currencies.  Bitcoin is not a currency by itself.

2.  Bitcoin is more secure than other forms of money transfer.   This has turned out not only to be not true, but laughably so.  Accounts of hacking or outright theft at various Bitcoin exchanges have been repeated over the years.  Recently, a fellow had to sue a number of people who stole Bitcoins from his cell phone when they hacked into his cell phone account using the old SIM swap gag.  He lost tens of millions of dollars in Bitcoin in a matter of seconds.

Theft of Bitcoin has been a chronic problem with some Bitcoin exchanges actually going out of business as a result of either internal or external theft.  Putting your money into Bitcoin isn't secure at all.

Of course, you can put your Bitcoin money into an offline computer or even print out a piece of paper with a list of your Bitcoin codes on it.  The problem with this approach is that it negates the touted ability to easily move money around using Bitcoin.  Offline storage for Bitcoin is not readily accessible, thus you cannot easily spend the money and it no longer has hopes of being a currency or means of transferring money.

But even offline storage has its perils.   One fellow nearly lost his mind when he realized that a few dollars in Bitcoin that were on his hard drive on a computer he threw away were now worth millions of dollars.  In the early days of Bitcoin, it was easy to mine the Bitcoins and they had very low value.  But then they rose in value to be worth thousands of dollars each.  He threw away his computer, and now is trying to dig through a landfill to find it.  It is akin to throwing away a winning lottery ticket.  People have been known to kill themselves over things like this.

This scenario also illustrates another fault with Bitcoin - there is no way to replace lost or damaged bitcoins in the ecosystem.   Regular currency can be returned to the US Mint and new currency issued.  Even if totally lost, the amount of currency in circulation isn't decreased - if someone loses a billion dollars, it doesn't mean the US Government has a Billion less in ciruculation - at least not for very long.

Since Bitcoin has only a finite amount coins that can be created, it is a mathematical certainty that eventually all of them will be lost or damaged or otherwise rendered unusable and no replacements or new coins can be created.   This was touted initially as a feature - to prevent inflation over time - but it now appears to be a self-destruct mechanism for the currency.

Far from being secure, Bitcoin is showing itself to be particularly insecure.  Losses in Bitcoin theft this year alone exceed 80% of last year's losses. So not only is the theft and loss of Bitcoin a problem, it seems to be increasing over time.

3.  Bitcoin is a convenient way to transfer money.  In the early days of Bitcoin, it didn't take long to process transactions as the puzzles solved by the computers (to create the coins and process transactions) were rather short.  You could transfer Bitcoin in a matter of seconds across the planet. However, as it became harder and harder to mine the Bitcoins, it also takes longer and longer to decode these transactions.  As a result, it can take 20 minutes to an hour to consummate a Bitcoin transaction.

Arguably, this is probably easier than a wire transfer, but it still isn't at the level where you could use this in place of your Visa or MasterCard to make a purchase.  The idea that we'd all be buying our groceries and paying for our gasoline with Bitcoin has long ago gone by the wayside. If Bitcoin has any use in transferring money it's only in huge sums to make search transfer times worthwhile.

4.  Bitcoin is less expensive to use than other alternatives. The corallary problem with using Bitcoin is it can cost $20 or more to process a single transaction.  Obviously, you're not paying for your cup of Starbucks with Bitcoin if the cost of the transaction is 4 to 10 times more than the object you're paying for.  Again, perhaps early on in the Bitcoin universe it would have been possible to consummate these transactions quickly and inexpensively.  But today, the amount of computing power needed to process even one transaction is rather significant.

Even for large money transfers, the cost of doing any Bitcoin transaction is now competitive with wire transfers through traditional banks.  So there seems to be little advantage to using Bitcoin for the average person.  It is much easier to just log on to your Bank of America account and send a wire transfer that way.  It's about as quick and about as expensive to do, and probably more secure.

5.  Bitcoin is a good investment.  When the idea of using Bitcoin as a currency itself went by the wayside, Bitcoin proponents then pushed the idea of Bitcoin as a virtual investment. They stated it was like virtual gold based on the idea that its scarcity made it inherently worth something.

And some people have bought into this, particularly little people who spend $500 to $1000 buying Bitcoin, only to find out it's worth half what they paid for it a day later.

The problem with Bitcoin is that since it is so thinly traded - and it always will be so thinly traded because there's not very many of them - it jumps and drops dramatically in value depending on how many people are buying and selling the coins at any a given time.

In one celebrated occasion, someone with a "heavy thumb" mistakenly sold off a huge chunk of Bitcoin and tanked the value of the coin for several hours.  If you were consummating a transaction during that period, you might have lost your shirt.  And some argue that this may have been not a transaction error, but an attempt to manipulate the market price.

While there are number of people who are holding on to Bitcoin as an investment, most of the users are people doing illegal things such as selling drugs or children or weapons and using Bitcoin to consummate these transactions. Others uses include ransomware and other cons - fraudsters use Bitcoin because it is untraceable.  There really is no legitimate use for it, otherwise.

When a warlord in Africa uses 20 million dollars in Bitcoin to buy rocket launchers, it affects the Bitcoin ecosystem, as it is such a large purchase compared to the overall background amount of Bitcoin trading.  As a thinly traded "commodity" it is subject to price volatility.

But its illegal uses (which are its only uses) are the real reason why Bitcoin makes such a lousy investment.  In the post 9/11 era, our government has been clamping down on money transfers of all sorts.  I know from experience that trying to pay my overseas clients or being paid by my clients from overseas has become more difficult as the government now scrutinizes overseas money transactions to see whether or not we are funding terrorism or whatnot.

Many governments worldwide are clamping down on Bitcoin because it is used mostly for illegal purposes.  Thus, the future of Bitcoin seems somewhat dim - eventually, the US will clamp down on it as well, unless the CIA has some nefarious use for it.   If you're heavily invested in Bitcoin, it could all come crashing down if it is outlawed in a large number of countries.

But the ultimate problem with Bitcoin as an investment, is that its perceived value is based on its perceived scarcity.  And scarcity alone doesn't make something worth anything.

People have described Bitcoin as virtual gold, but gold has an inherent value both as decorative jewelry and for industrial purposes.  If people did not wear gold or use gold in semiconductor circuits, it would have no value whatsoever.   It's scarcity alone doesn't make it worth anything.

As I noted before, I picked up a rock on the beach that has an interesting colored stripe on it.  There's no other rock like it in the world and thus is very unique and scarce.  I own the only rock like this. And no, you can't have it, because it's worth an awful lot of money because it's very scarce.

But scarcity doesn't always equate to value.  Just because something is in limited supply doesn't make it inherently worth anything, unless there is a greater demand for it than the supply.   Bitcoin's volatility is in part due to this problem.   The value of Bitcoin (and other virtual currencies) depends solely on supply and demand.  Supply is fixed, or in the case of Bitcoin, slowly decreasing over time as coins are lost or damaged.   Demand is based entirely on perception, and thus subject to emotional responses to world events and items in the news.

For example, a story in the news about millions of dollars worth of Bitcoins being stolen might cause some holders to liquidate, which then tanks the price.  A story about people buying Bitcoin piques interest, and thus drives up the price.   Both types of stories can be planted in the media - and particularly on social media - to manipulate the price of Bitcoin or any other virtual currency.  It is a market ripe for manipulation and fraud.

And what would anyone want to "invest" in that?

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