Uh . . .
Okay . . .
To be clear, I am not against bitcoin, or any other of the so-called “cryptocurrencies” (cybercurrency sounds more accurate, but I’ll stick with the current convention). Neither in principle nor in practice do I object to these immaterial, manufactured, fiat currencies. Hell, I’ve had a bitcoin wallet since 2011, when I parked a few hundred bucks in it when it was at $8 a BTC.
So I’m fine with bitcoin—but I’m not a mindless cheerleader for the thing.
When talking about bitcoin, cognoscenti have to admit, and neophytes have to understand, that bitcoin does not do all that people claim it does. Far from it, bitcoins and other cryptocurrencies are severely limited.
• Anonymity/Privacy: Bitcoin is not anonymous or private. All exchanges require you provide your banking and verifiable address information before they will set you up with a bitcoin wallet, in order to comply with anti-money-laundering legislation. So dreams of evading the Eye of the NSA are misbegotten. As if to add insult to injury, some exchanges automatically identify the public key with the owner’s email, which again makes it a snap to connect the wallet to the person. If your bitcoin public key is connected to your real name even once, it’s a matter of a simple Google search to identify the “anonymous” bitcoiner. Why does this matter? Because it’s no trick to connect the public key to specific blocks of bitcoins. And bitcoin blocks are easily tracked. Consider Bitcoin Block Explorer, which does this task. Thus you can track the transactions the individual carried out with relative ease. A big middle-finger to dreams of anonymous buying and selling with BTC.
• Security: Wallets haven’t been hacked (yet), but they’ve been phished. There’ve also been numerous thefts/frauds involving the exchanges, which seems to be the weak link in the whole bitcoin enterprise. You can find bitcoin theft and fraud horror stories here. To take just one such nightmare, in 2011 Bitomat—then the third-largest exchange—lost its bitcoins. (Lost in the literal sense: The owner of the exchange lost access to the bitcoins file he had.) Imagine if the third largest U.S. bank, Citibank, lost all $1.3 trillion of its depositors’ money? With no recourse to make its depositors whole, except the good intentions of Citibank’s owners?
• Fungibility: Individual bitcoins are not fungible (able to be replaced by an identical one). They are uniquely identifiable, and easily linked to a specific wallet. (Paper currency is also uniquely identified—but not so easily indentifiable with a particular wallet. Pick up a found dollar bill on the street, and you will never find out who owned it before you—unlike with a BTC.) Thus lack of fungibility allows for all sorts of possibilities whereby a subset of bitcoins might somehow become invalid or valueless for reasons beyond the control of the owner of that particular BTC. For instance, it is possible that at some future date, a class of bitcoins—say bitcoins involved in some nefarious scheme—are declared “marked”, and thus anyone who ever had contact with them becomes either enmeshed in a law-enforcement dragnet, or discovers that those “marked” bitcoins are rendered valueless at some point in time. Conversely, some governmental power might dictate that only some bitcoins that they sanction are “compliant”—thus making everyone else’s worthless. Farfetched? Tell me that after the FBI unloads the 144,000 BTC they seized from Silk Road.
• Limited Bitcoin Supply: When created, bitcoins had a built-in limit as to how many could be mined, just over 20 million, a point which will be reached in 2140. This means that bitcoins are a deflationary currency: Demand for the currency will always outstrip supply. Thus it creates the near-perfect conditions for a deflationary spiral. It pays to buy and hold bitcoins, rather than spend them. Thus bitcoin can never be a viable currency, because it will always smother any market built to take it. The only market that will always boom is the market for BTC, rather than for any good or service bought and paid for with BTC.
These are some—though by no means all—of the rational, reasonable caveats and objections to bitcoin as it now exists.
The last one especially—that bitcoin inherently creates deflation, thereby stunting any economy and preventing it from growing—ought to be enough to dismiss the claim that “bitcoin is the currency of the future”.
But even if we let slide and/or set aside these objections/caveats, it still has to be acknowledged that bitcoins will never be the dominant currency for a very simple reason: There is no necessary market or seller that requires bitcoins exclusively.
I’m highlighting “exclusively and necessarily”, and made a to-do about it in my last post, because I want to make clear that I am using those words in the strictest sense: There is no market which buyers have to participate in (necessity), and which only accepts bitcoins (exclusivity).
To make these two conditions easily understandable: Imagine for the sake of argument that all food sellers without exception accepted bitcoins exclusively. Food is of course a necessity for all people; can’t live without food. So if I necessarily have to buy food, and all supermarkets/restaurants/hotdog-stands/whatever accept bitcoins exclusively, and will refuse any other currency, then bitcoins will become the dominant currency in the food market.
Thus under those hypothetical conditions, bitcoins would be a useful, necessary currency.
This exclusively and necessarily condition for a currency is really pretty powerful, and it’s one that cryptocurrencies fail to meet. The Chartalists—currently operating under the pseudonym “Modern Monetary Theorists”—with whom I virulently disagree with about deficits, still have a point when they define a currency as the medium of exchange that the government will exclusively accept in payment of taxes, taxes which the citizenry necessarily has to pay off for fear of getting penalized by said government. If you have to pay off the government in dollars, then you need to earn dollars. Thus dollars become the currency in the economy, as per the MMT argument.
At this time, bitcoins are not exclusively needed in any necessary market. That’s why it’s not a currency. Sure, lots of stores/people accept bitcoins as payment—but will any of them turn down dollars for their goods or services if you offer them? Or if they do, is there no other place where you can get an acceptable replacement product/service with dollars instead of bitcoins?
You see my point. This is what I mean by saying bitcoins will never be a dominant currency. Because like it or not, they aren’t necessary for a person to function in the economy.
If they ever do—if Ralph’s or the IRS decide to only take payment in bitcoins—then we’ll talk about cryptocurrencies being the “currency of the future”. But for now, cryptocurrencies are not currencies—they are an asset class.
And there’s the rub: If cryptocurrencies are not currencies at all but merely an asset class, no different from real estate, precious metals, equities, or bonds, then cryptocurrencies ought to be analyzed both collectively as merely one more asset class, and individually as one more exempla of this new asset class.
Things then become clear—and the dangers become obvious as to investing in cryptocurrencies: They float on nothing but air. They have no intrinsic value. Their value depends not on some thing, but rather on a relatively small group of people saying it has value.
Think about it: Every other asset class is backed by a tangible asset. Equities by the company’s assets, ditto bonds. Real estate by the physical land.
“What about gold?”, ask some of my critics. “Gold and other precious metals do not have intrinsic value!”
And you know something, they’re right: Precious metals do not have intrinsic value. However, there always has been and always will be a large group of heterogeneous people who will accept precious metals—gold, silver, platinum—in payment for some good or service. Don’t believe me? Take a brick of 420 ounces of gold to any assayist or jeweler anywhere on earth, and see how well you do.
If bitcoins or any other of the myriad cryptocurrencies get to that point, then there will be nothing to worry about. But for now, that is not the case. Only highly specialized people in a rather limited universe will trade bitcoins for dollars.
Therefore, bitcoins is nothing but speculation. A flyer that’s just gone parabolic.
So . . .
At my Strategic Planning Group, I discuss other issues, such as possible dollar collapse, looming commodity spikes, and other investment contingency planning. If you are interested, check out the SPG Preview Page.