Tuesday, April 17, 2018

Bitcoin

The technology used to create Bitcoin comes from the field I used to work in professionally. I’ve followed Bitcoin from its obscure beginnings to its recent bubble-like rise. After fielding so many questions about cryptocurrencies, it’s about time I organized my thoughts about Bitcoin as an investment and as a currency.

To understand Bitcoin, you don’t have to understand the technology behind it. The big problem anyone can see with digital money is that after you spend it you still have a copy of it, so you can spend it again. Much of the effort in creating digital money centers on preventing this double-spending. Bitcoin does this with some clever cryptography and computer protocols called blockchain.

Another feature of Bitcoin is that more money gets created over time. Those who do enough calculation with their computers get more Bitcoins. This is called mining, and is intended to roughly mimic mining for gold.

Bitcoin as an investment

Before Bitcoin’s meteoric rise, the few people who’d heard of Bitcoin understood that it is a currency, and is intended to be used like money. Now most people have heard of Bitcoin, and they tend to think of it as an investment. Some in the financial world suggest that cryptocurrencies should be considered an asset class. This is nuts.

It makes no more sense to invest in Bitcoins than it does to invest in Somali shillings, Indian rupees, or British pounds. The typical person should think of these things as currencies, not investments. The fact that the Bitcoin exchange rate is so volatile should make us stay away, not dive in.

Bitcoin as a currency

The digital and cryptographic nature of Bitcoin sets it apart from more familiar currencies like dollars. But this doesn’t really capture the important difference. After all, most transfers of dollars are digital and use cryptography.

Bitcoin isn’t backed by any particular government. No such backing is necessary. The U.S. government backs U.S. dollars, and it can impose rules about how dollars are used. If a bank doesn’t play by the rules, the U.S. government could cut that bank out of the dollar system. There is no easy way for the U.S. government or any government to regulate Bitcoin.

One thing governments do with their currencies is demand that electronic transfers not be anonymous. A certain amount of anonymous transfer is possible with physical cash, but this is limited. For the most part, if governments want to trace large money flows, they can do so.

Bill Gates recently said that cryptocurrencies are being used for illegal activities and that governments’ “ability to find money laundering and tax evasion and terrorist funding is a good thing.”

I agree with Gates as long as governments are stable and serve their populations reasonably well. However, Bitcoin could play a role in limiting the power of a government out of control. For example, if all electronic transfers get heavily taxed, Bitcoin is a workaround for the people. So, one use for Bitcoin is as a safety valve if a government stop serving the people. Each of us can decide for ourselves whether we think this is likely enough to justify owning some Bitcoins or other cryptocurrencies.

Other cryptocurrencies

There are some technical objections to Bitcoin. The main one is that it’s gobbling up computer processing power and electrical power. Other cryptocurrencies were created to solve some of Bitcoin’s problems. There is no consensus on which cryptocurrency is best. Even if some other cryptocurrency comes into widespread use, there’s no guarantee that is has even been created yet. This makes speculating in cryptocurrency challenging at best.

Many organizations are creating their own cryptocurrencies. However, these currencies are designed with an important difference. The organizations are maintaining control over their cryptocurrencies. So, they may seem similar to Bitcoin, but they’re not. They’re more like travel miles or loyalty points. Expect the controlling organizations to devalue these cryptocurrencies whenever it’s profitable to do so.

Abbreviating “Cryptocurrency”

For some reason, “cryptocurrency” is often abbreviated as “crypto”. I don’t expect this to stop any time soon, but it makes little sense. Just about everything we do online involves cryptography, including online transfers of dollars. The “crypto” abbreviation makes about as much sense as shortening “blueberries” to “blue”.

Conclusion

Cryptocurrencies are not an asset class you have to pay any attention to. For now, few of us have any real need to use Bitcoin as a currency, and that’s likely to stay true unless our governments run amok.

6 comments:

  1. Well I think you've just given a few people a reason to start demanding a constitutional "right to bear cryptocurrencies" :)

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    1. @Richard: Good one. That right might be less damaging than the right to bear arms.

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  2. Bitcoin "investing" is the new penny stock / boiler room type get rich scheme of today. It really seems like there is a group of people trying get people to jump on board to pump up the price so they can sell their Bitcoins at a high. It's lost what it was supposed to be created for.


    I think people are also under the false impression that they can avoid taxation if they make transactions only in Bitcoin. Lastly if Bitcoin becomes at all a threat vs. a mild irritation to any countries currency's or its financial systems it will be dealt with swiftly in some way.

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    1. @Paul: If you make money in Bitcoin, you can't avoid taxation legally. It wouldn't surprise me, though, if tax authorities have difficulty tracking cheats. I have no interest in breaking tax rules, but not everyone thinks the way I do.

      It's not clear how to shut down Bitcoin. With life so good for almost everyone in the first world right now, it would be easy to scare most people into avoiding Bitcoin. However, if a government were to run amok making the population less compliant, it's not at all clear how to shut down Bitcoin.

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  3. Most early adopters usually never last long term. My first search engine was 'Web Crawler' and remember'Napster'?
    Google was the 21st search engine to hit the market.

    Cryptos have a future but I doubt Bitcoin does. There are now over 50 digital currencies to choose from. No thanks!

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    1. @Peter: I agree. At one time there were hundreds of car companies. Guessing which ones would survive was very unlikely.

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