I've written many articles about the Bitcoin, and the question I struggle with most is "why?" I just don't see how the benefits of the Bitcoin outweigh the costs and risks. The main drawback I see is the volatility. If there is anything you don't want a currency to be, it is volatile, and Bitcoin is volatility on steroids. In this highly entertaining article about the struggles involved in just buying a Bitcoin, the Bitcoin broker explains that the first time he purchased a Bitcoin it appreciated from $6 to $15 during the time it took to just set up his Bitcoin accounts. That may sound great, but what that means is that when the transaction was finalized he only got 6/15 of the original amount of Bitcoin he had intended to purchase, and if he had signed a contract to be paid in Bitcoins when he started the process, that cost of that contract was now 15/6 of what he had intended to pay. Had he signed a Bitcoin contract to buy a $60,000 house priced in Bitcoins, by the time he got everything set up to pay, he would owe the seller $150,000 worth of Bitcoins.
That weekend when I tried to buy it, the price was $6. But by the time I got my money into Mt. Gox, it was $15."
The main selling point about the Bitcoin is that it is virtual "cash," as opposed to a virtual bank account. The best way to think about Bitcoin is the money in your wallet, not your bank account. The benefits of cash over a bank account is that it is anonymous. This is where I've struggled with the Bitcoin. I've studied economics, monetary systems and currencies my entire adult life, and never once have I read something identifying anonymity as being a critical aspect of a currency. Almost every text book lists the same 3 to 5 characteristics of a currency and none that I've ever read state anonymity as one of them.
The closest thing I can identify as being similar to the Bitcoin is an internet Swiss Bank account. I'm not one of the rich and famous, deal in drugs or prostitutes, evade paying taxes or engage in illegal activities so I never really had a reason to fully understand the value of anonymity when it comes to a monetary system. I just didn't get it, but Bitcoin forced me to adjust my understanding of the functions of money. The movie "Wolf of Wall Street" does a great job highlighting why anonymity is so important, and how Swiss Bank accounts facilitate that role. Bitcoins are essentially an attempt to bring Swiss Bank accounts to the masses, but it fails miserably.
Watching "Wolf of Wall Street" however also provides the real solution to the cryptocurrency issue. As I've written in past articles, the Bitcoin is designed with a fatal intentional libertarian inspired flaw, it is inelastic, and will therefore always be highly volatile. That volatility is a high price to pay for anonymity, especially considering I can't think of a single transaction that I've engaged in where I would need anonymity. That does not mean however that the need or desire for anonymity isn't a real benefit to a currency. If I walk up to a stranger at a yard sale, it is nice to be able to give them cash instead of a credit card, and I always worry when I give the waiter my credit card and he disappears behind those swinging doors. Bitcoin basically turns every transaction into a yard sale transaction, where the only necessary information exchanged is the item being purchased and the amount to be exchanged. No personal information is needed, but unlike using cash, the value of your Bitcoin may change dramatically from the time you place the transaction to the time it is completed, and that is why cash is far superior to the Bitcoin.
The solution to this however is obvious. The Bitcoin needs to be convertible. Yes, the Bitcoin can be exchanged for US Dollars, but that does not make it convertible. One day a Bitcoin can be exchanged for $50, the next $500, the next $1,000 and then $500. That isn't a viable currency, and you could never base a business on it, especially an illegal business. Try paying a drug dealer or pimp with something worth $1,000 at the time of transaction, and have that value be worth $500 when it gets converted back to US Dollars. I'm pretty sure the drug dealer or pimp won't be the one taking the loss, and even if they do, you won't ever feel safe going outside again. When people accept cash, they expect a US Dollar to be worth the same today as tomorrow, Bitcoin doesn't even attempt to satisfy that objective, and that is why it isn't truly an alternative to cash, it is an entirely different beast. It is more like a virtual ounce of highly leveraged gold, not cash.
It is only a matter of time before someone decides to fix the fatal flaw of the Bitcoin, and that is why I write these articles. The Bitcoin bubble will eventually pop and a lot of people will be hurt, I'm simply trying to make everyone aware of the likely outcome of the Bitcoin so they can prepare accordingly. What is likely to happen is that a Swiss Bank account/money market/gift card Bitcoin model will develop. A Swiss Bank account is anonymous, but the value of it remains fixed. If you have $100,000 deposited in a Swiss Bank account today, you will have $100,000 deposited in that account 1 week, 1 year, 10 years in the future if you don't touch it (ignoring any fees or interest). It is impossible to know what a Bitcoin will be worth minute to minute, let alone weeks and years in the future. Try making a pro-forma proposal valued in Bitcoins and you will see why the Bitcoin will never be a viable currency. Tell your boss you have calculated out the costs involved in building an oil field and refinery over the next 15 years in Bitcoins and watch how fast you get fired.
The likely replacement of the Bitcoin will be a convertible virtual currency, where a credible Swiss Bank or major retailer like Amazon (NASDAQ:AMZN), sells SwissCoins or Amazoins. The Swiss Bank would then sell a SwissCoin for a fixed $ amount, and ensure its convertibility. The Swiss Bank would then have an account that holds all the revenues from the sale of SwissCoins. Like a money market account, the holder of the SwissCoin would be able to sell the SwissCoin back to the Swiss Bank for the exact amount of money they paid for it, but unlike a money market, there isn't an account set up for every SwissCoin owner. The funds from the sale of SwissCoins are comingled into one account that backs the convertibility of the SwissCoin, much like an old fashion gold standard or a gift card.
The Swiss Bank would invest the collateral money into interest bearing assets, and because there aren't any expenses associated with maintaining individual accounts or involved in settling transactions, it is possible that this system would be low or no fee, just like the current Bitcoin. The Swiss Bank would essentially function as the "miner" of the SwissCoin, but unlike the current Bitcoin where the "miner" pockets the money, under this system the money used to purchase a SwissCoin would be used to back its convertibility.
The key point here is that because the SwissCoin was convertible, there would be no need to convert it to US Dollars. Right now smart merchants will only accept Bitcoin if they immediately get converted to US Dollars. The currency risk inherent in a Bitcoin is simply too great for a merchant that wants to stay in business long to accept. As this video points out, Bitcoin is a "brilliant first step," but how many people are willing to risk their saving, incomes and livelihoods on a "first step?" Not many, even early adapters like Sir Richard Branson's Virgin Galactic, Overstock, Casinos and other major players that accept Bitcoin immediately convert the Bitcoin to local currency. They understand that it is simply too risky to hold for any period of time. Even casinos won't gamble on Bitcoin that should tell you everything you need to know.
Watching the above linked videos, it is obvious to me that the "second step" will eventually be discovered, in fact I find it shocking that it already hasn't. The video of the casino operator accepting Bitcoin is about as ironic as they come. Talk about not seeing the forest through the trees. Casinos already have a form of alternative currency, it is called a "Casino Chip." A Casino Chip" has a stable value, is used anonymously like cash, is accepted as currency, AND IS CONVERTIBLE!!! Hello McFly, anyone home, Think McFly Think!!!?
A virtual "Casino Chip" would be far superior to the highly volatile Bitcoin. The casinos, retailers and banks shouldn't be looking for ways to accept the Bitcoin, they should be spending their time and effort towards developing a Bitcoin that works with their current system, doesn't force their consumers to take unnecessary risks, doesn't require a complete accounting and infrastructure upgrade, isn't legally ambiguous and will save or even make them money. Gift cards, money markets and casino chips already exist, and combining select characteristics from each of them will create a far superior alternative to the current Bitcoin. There are over 140 different Bitcoin "Copycats" in existence, but unless they address the convertibility feature, they are doomed to die with the Bitcoin. Converting a Bitcoin to a US Dollar is difficult enough, imagine the headache a merchant would have trying to track the value of 140 different virtual currencies. Start to see the picture? A virtual currency convertible to US Dollars solves almost every problem I can identify with the current Bitcoin.
One last alternative to replace the current Bitcoin would be a Bitcoin convertible to gold. Each Bitcoin would represent an ownership share of an ounce of gold. The price of the Bitcoin would still fluctuate, but it would be far less than the current Bitcoin. This would have real appeal to the gold bugs, and people that favor "hard money." The administration of it would be much like the old gold note or certificate system, where an entity would store the gold and give owners a "note" detailing ownership. The gold would be comingled, but the gold vault manager would ensure that the note bearer would always be able to convert the note back into gold.
The biggest problem a major corporation faces with issuing their own Bitcoins is the tax liability that they would generate and the issue of comingling client assets. When a store sells a gift card, they have to pay tax on that sale. When a money market is opened an individual account must be established with accurate accounting of the assets deposited. Taxing the sale of a Bitcoin and individual accounts would defeat its purpose. The system established would have to be similar to how a casino deals with chips. When I go to the casino and exchange cash for chips, no tax is charged on the transaction. When I leave and exchange the chips back to cash, no tax is charged on the transaction. The casino doesn't record that I purchased a chip, and they don't record that I turned the chips back in. It is completely anonymous and void of taxes. Basically what the casino did was make me an interest free anonymous loan in the form of a casino chip. That casino chip allowed me to freely use their facilities, anonymously, securely and at no cost.
Another analogy would be an anonymous, interest free, collateralized inverse pawn loan. I give a pawn broker $100, they give me a $100 bearer pawn token and the pawn broker stands willing to exchange that $100 bearer pawn token back into $100 when it is presented for exchange. The pawn broker doesn't care who returns the $100 bearer pawn token, there is no name on it, they just stand ready to exchange it back into a $100 bill.
In conclusion, at its very heart, the Bitcoin is a libertarian, anti-Government and anti-Banking System political statement founded in a misunderstanding of Austrian Economics on an epic scale and developed as an interesting computer science problem. Not that many people are willing to accept the extreme volatility of the Bitcoin just to make a misguided political statement. Most people, and especially merchants don't want to participate in an effort to undermine the US Banking System or facilitate money laundering and/or illegal trade. To most people, the Great Depression and 2008 are periods we want to forget, not repeat and crime is to be prevented, not assisted.
The intent of these articles isn't to undermine the Bitcoin, it is to warn people of its flaws and demonstrate that a far better alternative isn't difficult to construct. The Bitcoin is either intentionally or accidentally designed to fail, and it will. Yes I know the computer scientists behind it are extremely smart, and the Bitcoin is very secure, but those things simply don't matter when it comes to money. Most people don't hate and fear banks, they rely on them, trust them and succeed because of them, especially merchants. Merchants can either let the tail wag the dog, or they can take control of the situation before it gets out of hand. I would expect that most merchants, banks, casinos and others that run businesses would rather have a convertible Bitcoin designed to facilitate low to no fee anonymous global transaction centered around their needs and existing accounting system, and aren't really interested in promoting some misguided political agenda.
Once the issues discussed in this article get resolved, and corporations get into issuing convertible Bitcoins, I would imagine that the current Bitcoin will become nothing but an obsolete memory, much like a floppy disk or dial up modem. The importance of the Bitcoin is that it is a first step, not a final destination. The people that created the Bitcoin work in computer labs, they are well aware of the product lifecycle of any cutting edge technology product, and they know it has a very short expected lifespan. Unlike Netscape, dial-up modems and floppy disks, when those items became obsolete owners of them didn't lose their life savings. When the Bitcoin becomes obsolete, and the "new new thing" hits the market, some people will lose fortunes.
Disclaimer: This article is not an investment recommendation or solicitation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice. Full Disclaimer and Disclosure Click Here.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.