Bitcoin Frenzy

The BITCOIN frenzy. Is it valid or not? 

Please be aware, I am not a technician or computer scientist. This article is written with a basic understanding only of what BITCOIN is, and from the point of view of having observed numerous markets through fast changing economic environments over several decades.

This experience of human behaviour in relation to markets, overlaying fundamental economic and commodity demand shifts, may be of value to the reader. Especially in the environment as exists at the moment, of almost blind optimism about this product.

That does not mean there is not further upside to the BITCOIN price valuation in terms of existing currencies, but such a fast market situation does warrant consideration.

The term “product” seems most appropriate. It is most definitely being sold as a product or commodity, with constant references to Gold and then to real national currencies. I say “real” because you can hold them. I do not dispute that Bitcoin is “real” in its own way either, but there is nonetheless a very obvious distinction to be made between physically manifest items of value, be they diamonds or dollar notes, and pure software algorithms.

This distinction does not negate the value of Bitcoin, but it is something purchasers of bitcoin need to remind themselves. Money too, can be lost. Through being misplaced and perhaps a fire. It is just that it is rare that a very large amount of wealth, many millions, even hundreds of millions vanish over-night. Yet this is the case with Bitcoin.

The biggest Bitcoin centralised accounts collapse, so far, has been Mt Gox. Where it is estimated $500 million of Bitcoins did in fact completely disappear over-night. Where did they go? Nobody seems to know.

For the small investor too, there are increased risks. If your bank account is defrauded, and your account is empty, in many countries something very wonderful happens. The bank, the demonised by the Bitcoin industry bank, returns the same amount of funds to your bank account. There are limits to this of course, but it is just one example of how perhaps the banks are not all bad after all.

Now I happen to be a big critic of banks, their ineptitude and inefficiencies and their level of control of your money. They do serve a purpose however. In the main, they do an excellent job of keeping your hard earned money safe. They do charge too much for this service, but they do it rather reliably nonetheless.

Which brings us to one of the key “selling” points of Bitcoin. That it provides a better service than the banks.

Bitcoin proponents claim it is safer than the banks. This is a completely false claim.

Bitcoin proponents claim you can transfer coins instantly. This is largely correct. Though the ledger is updated only every ten minutes. Which means while it may appear on your screen that it is instant, again this is not entirely correct. Banking apps now allow you to transfer funds to someone else right in front of your and their eye too. Though the funds may only actually arrive overnight to the recipient. In the case of Bitcoin, this is reduced to a maximum of ten minutes.

Bitcoin proponents claim the product circumvents governments and oversight. This was initially true when Bitcoin represented a very small proportion of transactions. As popularity grows, however, it works to remove this feature from the coin itself. We are already seeing numerous, though not all as yet, governments begin to regulate Bitcoin transactions in the same way that they do traditional banking transactions. This will be an increasingly effective process, so to think Bitcoin movements will remain under the radar is rather optimistic.

Also note that anyone, unrestricted, can become a bitcoin miner.

“Bitcoin Mining” as defined on the official bitcoin website is “the processing of transactions on the Bitcoin network”.

Each new block creation, which the miners generate every ten minutes, involves re-doing all the calculations ever done before. This is part of the cornerstone of the product’s “proof of work” process. It is not a copy and paste, and then work on the latest problem process. Whoever solves the latest problem first, gets the coins generated by that block creation. Being first is all important. Otherwise, there is no income for the miner beyond transaction fees. As complexity and cost go up, the reward offered by the system, the issuance of coins, goes down. This is clearly an unsustainable proposition.

The get-of-gaol card for the system from this challenge, is said to be that the coins will continue to be manufactured until a total of 21 million coins have been produced. This is estimated to occur around the year 2136. Which leaves plenty of time for the current miners to get rich processing the transactions that have just occurred in the past ten minutes, and receiving coins.

Except that it doesn’t.

One of the largest miners in the US, who claims to have represented 1% of global mining, has already closed down as the situation became a loss maker. In other words, the opportunity of coins and transaction fees was no longer enough to offset the cost of mining.

One of the largest miners in the US, who claims to have represented 1% of global mining, has already closed down as the situation became a loss maker. In other words, the opportunity of coins and transaction fees was no longer enough to offset the cost of mining.

So what has been the industry response to this dilemma? There have been two. The first is to on-sell mining rights to third parties. Quite possibly you? As this seems to be the most popular form of participation at the moment. To be part of a mining pool, but this is at a significant margin. You have read up to here…… In other words, the miners involved are no longer making money mining but by on-selling the ming to further afield investors. The second form of response has been to shift mining to cheaper locations. Where costs are lower. Such as China and even Mongolia.

This means computer server operations of unknown quality and reliability are the new “banks” of the Bitcoin system?

It is not my wish to overplay this aspect, as the proportion of mining that is being done in less than ideal circumstances is difficult or near impossible to estimate. The point is valid, however. As the difficulty, read complexity of processing the transactions goes up, the seeking of cheaper and cheaper locations for mining will intensify. Notice, I said the processing of transactions. That’s right. Mining IS the processing of the transactions that have occurred to date. The new additions being those of the past ten minutes.

Which brings us back to the point about government oversight. Governments and intelligence agencies are well used to operating at a loss. It is what they do best. Therefore there is nothing to stop governments being miners. Bitcoin’s own rules make this absolutely allowable.

Personally, I would hazard a guess that organisations like the CIA are already miners, with all transactions already on their servers. Whether they are able to decipher those transactions to the degree needed to identify the individuals they relate to, is not known.

However several hackers have already claimed to have unlocked blockchain codes to that effect.

In one swoop, you have transparent government observation and tracking.

The biggest of all perhaps, emotional selling points of Bitcoin, has been its ostensibly rebellious nature. In an age of drastic over-regulation and over-taxation by governments around the world, no wonder there is a willingness to circumvent these processes by otherwise responsible citizens. There is a very real, and I believe justified sense of injustice about tax systems and many regulations as they stand. This is a product of the now 100 years and more maturity of the modern democratic capitalist system.

Basically lawmakers have had a century of making laws, which involve ever greater cost to administer, and there seems no stopping this madness. We even have laws and government departments to keep an eye on the laws and regulations of other government departments. The public service everywhere is obese. Drunk on its own sense of self-satisfaction.

The people have had enough. Are frustrated at the lower levels of tax paid by high income earners and the rich, and only because they themselves cannot afford the expertise to achieve the same outcome. We have created a class structure based purely on the ability to pay to have lawyers and tax experts working for you.

Into this ripe for rebellion time, marches Bitcoin. Let there be no doubt. Bitcoin is immensely clever in its institutionalising of scarcity in both quantity and time. It is also extraordinarily valuable in bringing to the world the underlying technology of the block chain. The question then, is whether the “value” will stay in Bitcoin, or move elsewhere?

If there are no longer profits to be made from mining, why will people want the expense of maintaining the ledgers? That is, the continued processing of the transactions. The industry suggested solution is that transaction costs will rise substantially for the ledgers to be maintained. Which means anyone could come to control the cost of transactions to their own enrichment. Sounds a lot like the banks. Which defeats one of the cornerstone reasons for Bitcoin in the first place.

If there is no longer freedom from government oversight of transactions, already occurring, then again, why would you bother with using bitcoins.

You also don’t actually have stability of buying power. The day this essay was written, the value of Bitcoin dropped sharply, and in fact it changes in value every ten minutes. this creates challenges in knowing just how much that shiny new car will end up costing you. The fluctuation from first looking, to buying, can be quite significant.

The biggest threat of all, comes perhaps from the very target of the rebellion, governments and the banks. They could if they wished, very quickly become the main miners of Bitcoin and therefore defect custodians of the ledger. That is, all your transactions. Governments have great difficulty in tracking cash transactions, but once they are Bitcoin miners and if they are as successful as some hackers claim to have been, then they will know it all.

Taking things up another notch, the Bitcoin industry is currently championing the great interest being shown by the traditional banks, and particularly the Wall Street Investment style banks, as yet another reason for believing in their product. Having worked in investment banking for a couple of decades, and observed the creation of new non-traditional exchanges for currencies by a select group of the biggest investment banks in the world, I would seriously suggest to you that their interest is more to learn and replace, than to enhance.

That is, do not be surprised to see the announcement of a new block chain form of exchange backed by the the world’s largest investment banks, very soon. While most investors are seeking to be rebellious against a system that deserves rebellion, they will also quickly accept that with government oversight of their transactions emerging, and with the custodians of the blockchain itself, the ledger, becoming less and less shall we say dependable, the wisdom of a similar technology, even an improved form of the blockchain that is seamless with their existing traditional accounts including those in the Bahamas or elsewhere, to be simply irresistible.

Another possibility, is that the big banks buy out the current Bitcoin system for the value of the market share it has already achieved. The problem with this idea is cost. It would seem far more attractive, to simply create a superior product which the banks are quite capable of doing, and this would also not-surprisingly come to be supported by government regulation.

We are not talking here about what we would like to see happen, but about what the most likely scenarios are for the technology as it stands.

It is also, of course, possible that Bitcoin users will accept a high enough level of transaction fees, despite this being a defeating of the intended purpose of the product, to keep the system of ledgers going.

We cannot be sure of the demise of Bitcoin. Just as we cannot be sure of its on-going success, or even existence. That’s quite a risk. The saving grace, if there is one, is that most people believe the day of reckoning to lay somewhere in the next century. The only practical problem with this claim, however, is that in the main, mining is already unprofitable. I cannot emphasise enough, that without mining there is no ledger and therefore no Bitcoin. It will not matter, if you have a wallet with some code on it if there is no network of cross-validation and maintenance of the ledger.

The great majority of people buying Bitcoin today, are doing so quite simply and blindly because the price has been going up. That others before them, have made a fortune. This is buying frenzy mentality, and is a significant warning sign. In the mainstream markets fraternity, we have a saying about the “Front page effect”. If a market move is suddenly on the "front page" of usually mainstream newspapers, then the up-move is usually very close to being completely over. So, just from a market savvy perspective, Bitcoin is screaming warning signs.

It is a new phenomena however, and therefore we should willingly accept that anything is possible. As with the world wide web, this has never been seen before. It could all somehow continue to work, the ledger maintained, and the increasing popularity will drive demand and prices to such dizzying heights that mining even becomes profitable again. This is doubtful, but as with the worldwide web and the rapid spread of Uber anything is possible. It is just a question of whether the product is sustainable when the reasons for its purchase are increasingly, dare I say, under-mined. Uber, by the way, has so far lost $5 billion.

In 1634 to 1637 in the Netherlands there was the infamous Tulip Bulb bubble. The Tulip bulb was trumpeted as an alternative to currency as it reached ever higher price levels. More and more people bought for the simple reason that the price kept going up and other people were getting rich.

Why miss out? A single bulb became so valuable in this particular frenzy, that it surpassed even that of a house at the time.

Quite naturally, when everyone who wanted to buy had, there was an over-supply of tulip bulbs and everyone at the same time began to ask the question: what is a tulip bulb really? They quickly went to zero and the Netherlands suffered a severe and lasting depression due to the instantaneous nature of such a tremendous loss of wealth.

Let’s hope Bitcoin is not leading the world down the same path.

That the investment banks are interested in Bitcoin, is a particular kind of additional warning all of itself. The last product they went crazy about were home mortgages and bundling them. That lead to a Global Financial Crisis. Makes you wonder what might happen with their hands on blockchain technology and blockchain offerings. Complex and difficult to understand, they are the perfect sales item for an investment banker.

WHAT WILL BITCOIN DO?

Difficult to say. May I suggest it will either go to a whopping $20,000 per coin due to the spreading global buying frenzy based on its perfectly and purposefully inbuilt scarcity of both time and quantity and then suddenly reverts to zero. Or, it may just go straight to zero from where it is now.

The problem for Bitcoin is exactly what Bitcoin thought it had answers for. That is the banks and government regulators. It is also the case that control of the ledger is increasingly going to less reputable locations. Hardly the places where you would really like to store your wealth.

It is not beyond possibility, that Bitcoin evolves and finds solutions for its challenges. Yet, it is the case, that day by day this becomes less likely. While very few people seem to acknowledge this point.

Bitcoin has brought something very special to the world.

Blockchain technology will be used for all kinds of services and purposes. The world is a better place for the creation of Bitcoin, and its proponents deserve extreme applause for their work and ongoing efforts.

The sales culture, however, and some of the companies that have amassed around Bitcoin, do leave something to be desired. The sales pitch as it is has difficulty standing up to non-believer scrutiny.

Remember, no one thought the mortgage market would collapse, or the tech bubble, or even the mainstream stock market. In fact, no one thought tulip bulbs would collapse, but at least when it was all over, you could plant the bulb and something beautiful would grow.

The beauty in this case, is perhaps the technology itself. Rather than the bit.

Clifford Bennett