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minorman
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Education: Engineer (Ms. Sci. Eng.) and PhD My investment interests are focused on the global "macro picture" - with particular emphasis on resources and commodities. I am only interested in long-term positions - typically 4-10 years.
  • Bitcoin: Such a good idea that it will probably fail 15 comments
    Aug 14, 2011 4:59 PM | about stocks: AXP, V, MA

    Bitcoin?

    If you have never heard of bitcion you are not alone! But if you had heard about it a year ago - and if at that time you had the courage to invest $100 your investment would now be worth about $16,600 (at the current price for one bitcoin of about $10). In other words, bitcoin (BTC) was far and away the best performing currency this past year returning more than 16000%. Not a bad investment return at all.

    Sound too good to be true? Must be some kind of Ponzi scheme, right?

    No - not right.

     

    What is bitcoin?
     Bitcoin logo

    Bitcoin  is a cryptographic, digital, internet-based (peer-to-peer) currency. There is nothing "backing" it. There is no government or central bank controlling its issuance. There are (and can be) no individuals or companies controlling BTC from behind-the-scenes . This is because the rules governing the issuance and exchange of BTC are completely transparent as they are open source for anyone to read.

    What makes BTC worth anything?

    Scarcity - just like regular "paper" currencies:

    There are only so many BTC available (at present just over 7 million BTC ) at any given time, but unlike regular paper currencies which pose unknown inflation risks the future supply of BTC is completely deterministic as it's issuance is built into the system. In other words: You, I or anybody else already know today, exactly how many BTC circulate today, tomorrow and on e.g. March 15th 2017. This is hardly true for USD, EUR, "special drawing rights", gold or anything else!

    Figure 1: Plot of total BTC in circulation as a function of time. By the end of 2033 all 21 million BTC will have been issued and there can never be added more BTC into circulation since all BTC are unique.

    Figure 1: Plot of total BTC in circulation as a function of time. By the end of 2033 all 21 million BTC will have been issued and there can never be added more BTC into circulation since all BTC are unique.
     

    Bitcoins, like all other currencies, are just a medium of exchange and a unit of account, but BTCs are much better for serving these purposes than any traditional "paper" currency, as I will explain.

    Based on asymmetric encryption any transaction of BTC from one place (wallet) to another is digitally encrypted and added to the so-called block-chain (transaction history). In this process, the network automatically confirms the validity of the transfer. This means that BTC transactions are not completely instant (it takes some minutes between block-chain updates), but it also means that there is no way any attacker can spend/transfer BTC the they don't have, nor cause the same bitcoin to be two places at the same time - unless that attacker has considerably more hashing power (computer power) than the entire BTC network - currently 170 petaFLOLPs/s. This compares to the World's largest supercomputer, called "K" running at “only” 8 petaFLOPs/s . The encryption algorithms used are industry standard SHA256 and ECDSA

    Bitcoins are divisible up to 100,000,000 times. In other words, the smallest "amount" of BTC that can be transferred is 0.000,000,01 BTC (10 nBTC = 10 "nano bitcoins"). Being the smallest unit, this amount is the functional equivalent of 1 cent in the USD currency (although 10 nBTC is currently worth much, much less than 0.01 USD). This divisibility is the reason why the "hard" upper limit of 21 million BTC in circulation is not a problem - even if the entire World trade were carried out with those 21 million BTC the value of 10 nBTC would still only be about 0.2 cent in today's USD.

    More general info on how BTC works may be found in the FAQ and a more technical presentation on how the system works may be seen here.
     

    What makes it a great idea?

    • Bitcoins cannot be two places at the same time. Just like a bar of gold which it is either in my vault - or in some other vault - a bitcoin is either in my wallet or some other wallet. Therefore, BTC cannot be "multiplied" in the banking system like regular "paper" money which makes traditional fractional reserve banking impossible. Banks can create an infinite supply of "promise-to-pay BTC", but unlike regular "paper" money this "checkbook money/bank credit money" is clearly discernible from "real" BTC: If you lend some BTC to the bank - those BTC will disappear from your wallet (since they can't be multiple places at once) and will be replaced with "promise-to-pay BTC" issued by the bank. This will make the difference between real money and debt-money clear to everyone. This, IMO, is the single best feature of BTC.
    • Bitcoins can be stored by its owner on a computer, smartphone or any memory device - or by an online wallet provider. Thus I may choose an online wallet provider (like having an account with an online bank), but I may also be my own bank if I so choose. In the future, therefore, my employer could transfer my salary directly to my BTC wallet - not to a commercial bank.
    • Bitcoins can - unlike gold or other precious metals - be transferred electronically via the internet as easy, fast and inexpensive as email: No fees to banks for international transfers or fees to credit card companies for payments. No holds for days or weeks. Not closed on Sundays. No frozen accounts. -  Instead, essentially free, and almost instant, irreversible transfers to anywhere in the World. This makes international payments much, much cheaper than physical precious metals or present day "paper" money.
    • Bitcoins have an entirely predictable issuance and by the year 2034 essentially all BTC to ever exist will have been "mined" (issued) and thereafter the total number of BTC in circulation will be fixed at 21 million BTC. Unlike any paper currency, therefore, there is zero counter-party risk in that sense that no one has the power to just "print" more BTC and debase the value of BTC by inflation beyond the built-in issuance schedule seen in figure 1.
    • Unlike essentially all modern currencies, bitcoins are not issued against matching pledges of interest bearing debt. In short: BTC is not a debt-based currency. This is immensely important should the World enter a era where global economic growth is no longer sustained - since in that situation an (interest bearing) debt-based money system is bankrupt by design.
    • Much like cash transfers, BTC transfers are quasi-anonymous. Everyone in the bitcoin network can see transaction histories (when and also which wallets the money came from and went to), but the owners of those wallets can remain anonymous. 
       

    Is it really money?

    Why do you accept USD, EUR or any other fiat currency for your work or assets? After all, you know that their intrinsic value is the same as BTC: Precisely ZERO.

    You accept them only because experience tells you, that someone else will accept them when you want to spend them. Money (any money) is really just a confidence game, but also a unit of account, a store of value - portable power!

    Given bitcoin's extreme convenience for transfers and storage, predictable supply with built-in scarcity, inherent decentralized and debt-free nature, bitcoins strike me as much more credible money than any government decree (fiat), debt-based currencies.
     

    What is the current status and should you invest?

    There are a number of web-based sites for trading bitcoins to and from various other currencies. A list including current exchange rates my be found at bitcoinwatch.com There are also websites providing advanced plotting tools for the technical traders. One place to start is bitcoincharts.com/markets.
    Figure 2: Google trends for "bitcoin" over the past 12 months. Clearly, hardly anyone had heard about bitcoin before April.
    Figure 2: Google trends for "bitcoin" over the past 12 months. Clearly, hardly anyone had heard about bitcoin before April.

    As evidenced by Google trends (figure 2) general interest in bitcoin has risen from almost zero during the past half year or so. Concurrently, the options for spending bitcoins on "real" things have been getting better all the time as the bitcoin economy has grown rapidly.
     

    A place to get an overview is this list of traders accepting bitcoins. You can buy real things and services like books, computer hardware, clothes, internet hosting and even gold and silver.

    Other sites to explore include:spendbitcoins.com, forbitcoin.com and weusecoins.com

    So should you invest in bitcoins?

    Clearly, if the bitcoin economy were to become comparable in size to even the smallest "paper" currency economies the value of 1 BTC would be substantially higher than it is today (about 10 USD/1 BTC) since the money supply would remain limited to 21 million BTC.This translates to an almost astronomical upside.

    On the other hand, should bitcoin fail (see below) the investment would of course be lost. At this stage I think it is too risky to go long BTC in a big way, but it makes sense to create a wallet, buy a few BTC and check it out - perhaps try paying with bitcoin next time you buy something online to get an understanding of the system.
     

    Why will it probably fail?

    Because, while the average person would be better off with bitcoin then debt-money, powerful interests would stand to lose if BTC became a success.

    Clearly, banks would loose on multiple fronts:

    First and foremost,the practice of "fractional reserve lending" where banks lend out money at interest with a leverage of 10 times or more - in effect lending out and collecting interest on money they don't have - would probably cease or at least people would learn the distinction between real money and checkbook-money. Good for you and me; very bad for the banks!

    Secondly, fees on transfers (particularly) international wire-transfers and on currency exchange would go down tremendously.

    In reality - banks would have to revert their business to what most people think is the core business: Connecting people with surplus money with people in need of money and charging a small commission therefore. Such a reversion to pre-fractional reserve banking practices would cut the banking sector from being >15% of the total economy down to perhaps 3% - great for everyone, except of course the banks.
     

    Credit card companies such as American Express Co. ($25.500 billion in revenue in 2010), VISA inc. ($8.000 billion in revenue in 2010), MasterCard ($5.500 billion in revenue in 2010) would become essentially irrelevant since BTC payments could be made on the spot using a smartphone. Because of this I have no doubt, that the financial industry will use their enormous power and influence to stop initiatives like bitcoin before they get any real traction. Not doing so would simply be too dangerous to their business.

    If you decide to try out bitcoins and wish to test how easy transfers are, feel to do so by donating to me:
    15kKFHVCUAK2AKCNqh93Fonj1QiEkPt1EQ



    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Additional disclosure: I have a small position in BTC.
    Themes: BTC, Bitcoin, currencies Stocks: AXP, V, MA
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Comments (15)
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  • Author’s reply » "First they ignore you,
    then they ridicule you,
    then they fight you,
    then you win."

     

    - Mahatma Gandhi

     

    ---
    Bitcoins appear to be between stage 1 and 2.
    16 Aug 2011, 12:57 PM Reply Like
  • A victory by such as bitcoin over the established financial systems would be the single greatest boon to the populace of the world since the invention of currency itself, IMO.

     

    But what are the odds? Who can say. It can win only by the choice of the population being so strong that no entity is large or powerful enough to overcome.

     

    Unfortunately, with a generally ill-educated population, there's not much chance of that.

     

    HardToLove
    17 Aug 2011, 07:31 AM Reply Like
  • Author’s reply » I couldn't agree more.
    That said, I'm pretty sure the banks will shut it down. Apparently the French banks are already trying to suspend mtgox.com's account making Euro transfers currently unavailable...

     

    If bitcoin starts gaining traction I think we will see the banks:

     

    1) Persuade politicians that bitcoin is the perfect tool for drug cartels and terrorists because it allows anonymous transfers. (This argument has already made its debut in the US congress [ www.reuters.com/articl... ]).

     

    2) Persuade politicians that bitcoin will somehow cause increased tax evasion.

     

    3) Persuade politicians that bitcoin's lack of centralized control (via central banks, etc.) will cause financial turmoil - and blame any such problems on bitcoin.

     

    4) Illustrate for politicians, that if bitcoin (or similar currencies) catch on the ability of government to spend beyond its means (deficit spending) will disappear (talk about a cast-iron debt ceiling).

     

    5) Scare ordinary people away from bitcoin by funding massive propaganda campaigns claiming that bitcoin is unsafe, can be hacked, is immoral, is unpatriotic, is a Ponzi scheme, is a bubble etc. etc.

     

    6) Launch cyber attacks on computers around the World running bitcoin clients and software. Launch DoS attacks on online "wallet" providers to cause the system to seem unreliable to the users.

     

    7) Who knows?

     

    ---
    All of the above arguments are, of course, easy to counter, but that won't make a difference. Just put enough money behind the propaganda...
    17 Aug 2011, 12:39 PM Reply Like
  • One exception to arguments easily countered: those relating to cyber attacks. DDoS attacks can be quite effective and difficult to initially recognize and shut down. About the most effective remedy for that is distributed "stealth" servers standing ready so that as soon as an attack is detected, the server(s) are switched and the attackers must again discover where in IP land (and with IPV6 it could take a bit longer) the new services are emanating from.

     

    But, as the detection and defensive measures have grown more sophisticated over the years, even that *may* be countered so effectively, with proper planning and sufficient distribution of servers, that the consumer might never know there was an attack.

     

    And *that* is just as good as if there had, indeed, been none.

     

    The easiest counter, purely for argument though, is that is certainly more secure than any of the banking institutions we have today because of the DES-grade public key encryption used.

     

    Oh, we could go on and on, but we'd just be preaching to the choir (each other)! :-))

     

    Anyway, I was glad to read your article and comments. I expect the worst, hope for the best and so can't be disappointed.

     

    HardToLove
    17 Aug 2011, 01:32 PM Reply Like
  • Author’s reply » Agreed. Thanks for the kind words HTL.
    17 Aug 2011, 05:00 PM Reply Like
  • This is the best idea for a universal currency I've seen since the system proposed in the novel "Cryptonomicon" by Neal Stephenson back in 1999.

     

    That concept used "stolen, hidden Japanese gold" in the Philippines as a hard backing for a cryptographic based electronic currency. This concept is much better. Fiat US currency or Fiat Bitcoin. No practical difference.

     

    But it will be attacked as if it's a terrorist plot. USgov will get hysterical just as soon as it rises above the radar limit. All of the arguments against it will be bogus, of course, but the banks and money boys can afford a LOT of lobbying.

     

    I wonder if Ron Paul knows about it? Most likely.

     

    Maybe it can go underground in a sovereign "data haven" somewhere. Physically protected servers and so forth. It is very hard to stop internet data transfer is you can't grab the servers. Some island nation with ties to more than one superpower. Maybe China will consider it good for them vs a vi the US?

     

    We can dream.
    17 Aug 2011, 08:29 PM Reply Like
  • Someone could sell insurance and futures against fluctuation of bitcoin exchange rate, or even Bitcoin's demise. If risks can be mitigated quantitatively many institutions would be more serious on using it. I wonder when Bitcoin ETFs can be created for the massmarket as an easily accessible store of value, a digital gold.
    14 Nov 2011, 04:41 AM Reply Like
  • Author’s reply » Actually, there is now a site:
    http://bit.ly/uZsVUd/

     

    Where you can do forex-style trading on Bitcoins. With a leverage of up to 5:1 you can go long and short Bitcoin. This site has launched since I wrote the original instablog.

     

    By the way, a service like bit-pay.com provides makes it essentially risk free for merchants to accept Bitcoin for goods and services since the Bitcoins given as payment can be instantly converted to USD etc. by bit-pay.com. In this manner the merchant get's the usual fiat currency, but without paying the insane fees to credit card companies or Paypal.
    21 Nov 2011, 12:32 PM Reply Like
  • Thanks for the link. The biggest risk seems to be in regulations -- it can get banned. In that regard Bitcoin is more vulnerable than the currency of even the smallest sovereign country.
    22 Nov 2011, 12:40 AM Reply Like
  • Author’s reply » Bitcoin can certainly get banned in individual countries and I think the countries which most often hold speeches about liberty and freedom will be the first countries to try to outlaw it.
    Remembering that the financial industry "owns" most politicians I fear that political attacks will start to happen as soon as Bitcoin emerges above the "irrelevant"-limit.
    Heck - even gold was outlawed as a currency in the US (by Roosevelt in March 1934) to try to shove debt-backed "Federal Reserve Notes" down people's throats...

     

    But globally, Bitcoin cannot be shut down by governments and I am sure it will survive and thrive in less regulated countries. After the inevitable sovereign defaults of the western world I think Bitcoin and similar non-fiat, open-source currencies will have their day - legal or not.
    22 Nov 2011, 04:10 AM Reply Like
  • Time for another bitcoin piece?
    11 Jan 2012, 06:36 PM Reply Like
  • Author’s reply » Here is one:

     

    http://seekingalpha.co...
    23 Nov 2012, 04:47 PM Reply Like
  • minorman : What foresight!

     

    I think with the Cyprus banking crisis the Bitcoin may have already gotten too big for the banks and major governments to get rid of. Big financial institutions and the Fed must be freaking out.

     

    What can they possibly do to outlaw it at this point? Physically sieze all of Bitcoin's servers? Where are they even located? How is this going to play out?

     

    If the Bitcoin becomes a recognized currency, and remains un-manipulable, there's a chance it will be the best thing to ever happen to the world economy.
    28 Mar 2013, 01:30 PM Reply Like
  • Author’s reply » If bitcoin is not stopped - I think it will evolve to be the most game-changing invention in decades (several decades), but I still think it will come under serious fire which is why only a small fraction of my net worth is in bitcoin.

     

    An attacker with *very* deep pockets can mount an attack on the "mining" infrastructure buy pouring +$100 million into custom designed ASICs and use this ("+51%" hashing power) to halt legitimate transactions from entering the blockchain effectively freezing bitcoins in the everyone's wallets and cause a panic and bad press.
    At the same time the government could make some high-profile arrests of famous bitcoin people for various charges (and release them after bitcoin crashes, of course) while spreading FUD in the media that bitcoin is only for terrorists and child pornographers and so on...

     

    Bitcoin is not (yet) immune (which is probably why 1 BTC is $100 and not $100 k)- but once we hit 100 million users the game is over for the bankers.
    28 Mar 2013, 04:45 PM Reply Like
  • If lagre financial institutions or governments could actually freeze bitcoin transactions for $100 million wouldn't that be a bargain? The price will only go up.

     

    Also not to be underestimated is the power of the state-influenced media to work in concert with the government, the Fed and banks to badmouth bitcoins.

     

    Another way to beat the bitcoin would be for governments and banks to become more transparent, accountable, and trustworthy. I'm not holding my breath on this one, but if it happened it would be a victory for bitcoin, as well.
    31 Mar 2013, 11:46 AM Reply Like
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