There’s a lot of buzz around cryptocurrencies and their place in the financial landscape (the recent Special Report on the subject by PortfolioMetrix CEO and Head of Investments Brandon Zietsman is well worth reading). There are currently over one thousand four hundred of them around with their own idiosyncrasies. Bitcoin has by far the biggest “market cap” and dominates discussion. This article is about Bitcoin in particular, however, some of it can be applied to cryptocurrencies in general. For the record, we are big fans of blockchain (the technology underlying Bitcoin) and smart contracts and other fantastic inventions that have flowed from Satoshi Nakamoto’s (pseudonym) ground-breaking work in designing the Bitcoin cryptocurrency.
This article is an attempt to unpack the “one liners” that dominate Bitcoin discussions and to move beyond the throw-away, statements of “fact” that tends to accompany discourse around it.
“Bitcoin will replace government issued currency”
Firstly, this isn’t a good idea at all. Many of the issues experienced in the euro crisis of 2009 were exacerbated by the common currency and that’s a relatively homogenous set of countries. Applying one currency to the world is almost certainly a very bad idea. Furthermore, the volatility of Bitcoin resulting from speculation is bad for business.
Whilst options contracts can counteract some of the downsides (in addition to forward exchange contracts), the “fee drag” of these options increase with volatility. This extra cost must inevitably be borne by the end consumer. Bitcoin suffers from significant challenges with regards to transaction volumes (and hence times).
In addition, some governments are looking at releasing their own cryptocurrencies (see J-Coin, E-Krona and others) which addresses some of the issues we highlight. Our view is that this combination of a stable government issuer and blockchain transparency could see large scale adoption.
“Big bad corporates/governments control us through currency. It’s time to take back the power”
Yes, some corporates and governments have been especially badly behaved, and the groundswell of anti-government and anti-corporate movements did not arise out of a vacuum. But that doesn’t mean ANY alternative is better. “Better the devil you know” may be sage advice in this instance.
According to some sources, 81% of Bitcoin mining pools are Chinese, where four mining pools control over half of the mining community. It’s hard to know the definitive number. However, assuming that these numbers are directionally correct, it gives one pause for thought. It certainly indicates a highly concentrated source of currency supply (given that it’s global). Imagine the political commentary if four Chinese banks in the world controlled most transactions. Should one feel more secure that it’s four Chinese-based mining pools rather than local large corporates?
The miners in the Bitcoin community hold significant sway in forks (changes) to the protocol. If every man and woman had a mining computer, we could understand the “take the power back” mentality. However, it looks suspiciously like we are taking influence from elected governments and regulated corporates (warts and all) and giving it to unknown cabals of miners located in other countries.
It’s very simple to become a major player in the Bitcoin mining community – buy vast numbers of mining computers, which one needs substantial capital to do. But that is akin to the abhorrent act of offering political favour to the highest bidder (we in South Africa are all too aware of the effects of this). Trust and influence that can be purchased with capital is necessarily compromised.
Lastly the average person in the street needs a place to store their “Bitcoin wallet”. Most people would plumb to use a well-trusted brand. But that would suggest we need that corporate after all.
“Bitcoin is a revolutionary digital currency”
Most money is digital already so let’s not get too caught up in that. Actual cash in circulation is dwarfed by that held in electronic form in banks and electronic banking actually works pretty seamlessly and efficiently already (unless you are a criminal or a rogue state – see below).
Bitcoin necessarily is a “currency” with some significantly negative exogenous effects:
it is estimated that mining hardware consumes more electricity than the whole of Serbia
the cost of the hardware employed to mine could be used for greater social good
There are approximately 1,400 other digital currencies in circulation, apart from being an early favourite what makes Bitcoin (or any other for that matter) so special?
The race to build new hardware (e.g. ASICs) ploughs significant resources into an activity that’s idiosyncratic to the cryptocurrency’s block authorisation mechanism rather than any underlying economic benefit.
Many organisations which previously accepted Bitcoin are now removing it as a payment option due to high transaction costs and volatility. That doesn’t bode well. Whilst these problems can be solved with “forks”, we certainly wouldn’t want to hold cash bills when we have serious concerns about the mint.
“Why should the corporates and governments have access to my financial transactions and use it against me”
Bitcoin benefitted from a significant amount of use and publicity on Silk Road and other dark-net marketplaces (which sell drugs, hitman contracts, sex slaves and a vast array of other items that aren’t deemed acceptable to sell on Amazon). This attention was helpful in bringing Bitcoin into the mainstream. The nature of the blockchain distributed ledger allows tracking of transactions. However, the source/owner can be partially obscured with effort. The partial anonymity offered by Bitcoin has a disproportional benefit to the criminal elements of society over the average man/woman on the street. “Cold hard cash” still offers the best anonymity (excluding issues with serial numbers) but it needs to be transported which creates massive issues for criminal networks. Why support a currency that is more likely to support criminal activity?
In fact, the anonymity is only partial – values and addresses (think To: for emails) are public record but addresses can be easily generated to fabricate some degree of anonymity.
“Person XYZ just made $1,000,000 investing in Bitcoin”
That statement reveals the cracks in a subtle way: the very fact Bitcoin’s worth is measured in dollars is a very strong indication of the usefulness of dollars.
The “making of money” in simple economic terms is a result of adding value to a product or service. Buying Bitcoin and holding it doesn’t add value to anything (except perhaps Bitcoin itself). Buying bonds or newly issued shares of a company give that company capital to add value to products or services. Trading existing shares provides liquidity needed to give rise to the market.
Resources and Bitcoin are limited. 21m Bitcoins is the current limit. Our planet and sun are the current limit on resources until space flight becomes reasonable for resource extraction. If everyone made $1m in Bitcoin investments, governments would need to be printing money and the ensuing inflation would ensure $1m wouldn’t buy someone much in terms of actual products or services. Bitcoin won’t miraculously make everyone dollar millionaires (in real terms).
These same words have been uttered many times – just replace “Bitcoin” with “Tulip”, “South Sea Company” or any other bubble. It takes a very confident person to see that this time it’s different, especially when there are no goods or services that are being created. At least tulips were still pretty after the crash.