Bitcoin is backed by nothing other than the hope that it might be worth more tomorrow
Bitcoin is a relatively new crypto-currency that has received a lot of media attention recently as the price of bitcoin has skyrocketed to over $1000. It’s no surprise that in this Federal Reserve quantitative easing (QE) driven bubble economy that digital “assets” would be priced higher than paper assets and that paper ones would be priced higher than physical ones.
While I am in favor of consumer choice and competing currencies, including electronic currencies, I would not choose Bitcoin.
This is the case against Bitcoin.
Bitcoin proponents argue that it contains the properties of money namely, it is durable, portable, divisible, fungible, and in limited supply. They would also add that it is anonymous.
Bitcoin advocates overlook or dismiss the critical features that Bitcoin does not share with real money: it has no intrinsic value and is not a store of wealth. These important details, and other serious flaws (discussed below) are over looked because one of the REAL reasons many Bitcoiners defend and promote their digital currency with excessive zeal is that it comes with the bragging rights of being early adopters and proof of their superior foresight because the price has increased exponentially.
Early Adopter Smugness
Early adopters often overpay. Think of those that purchased the first Iphones and Teslas. Early adoption is a badge of honor, a validation of hipness. Early adopters like to describe others as “not getting it” or at least not getting it yet, like they have. This helps cement the early adopter’s self proclaimed unique position as among the select few that do. We hear from Bitcoiners re those that don’t get it things like “They don’t understand disruptive networked currencies” as they try to impress us with their erudition by spouting phrases like “decentralized peer to peer virtual ecosystems are the wave of the future” and warn we will be left behind and impoverished unless we pay $1000 for an encrypted string of code.
Further, many Bitcoiners fancy themselves as political activists that are going to bring down the the Fed or New World Order by using a Bitcoins to order pizza. These secret arm chair Snowdens believe that owning Bitcoin places them in an alt.cool world, touched by digital pixie dust that will transform their lives and revolutionalize the world. Certainly the first users of Compuserve and America On Line must have felt the same way.
The Case Against Bitcoin
Here are some substantive reasons that Bitcoin may become nothing more than “bit” and not too viable currency player in the coming years:
Is Faith Based – In Bitcoin We Trust (as long as everyone else does)
Bitcoin is like religion. You have to believe in it. You have to believe it has value and you must find a community of believers that also think it has value.
Bitcoin has an army of believers and evangelizers who have a vested interest in convincing others that there really is something behind the digital curtain.
Faith in Bitcoin is an ideology no different than faith in government; except governments have the force of law to defend their ideologies and currencies. While the dollar is not backed by anything other than the “full faith and credit” of the issuer, legal tender laws ensure its use.
In contrast, an attractive feature of Bitcoin is its use is voluntary and people are free to believe in it and ascribe value to it. The flip side, however, is people are also free NOT to believe in it and ascribe value to it. Bitcoin can not be propped up by force of law. It’s value is based on collective belief of value and usefulness. If collective faith is lost in Bitcoin, its value diminishes or vanishes.
Neither Bitcoin nor government currencies, like the dollar are backed by anything. Perhaps that is why the Chairman of the U.S. Federal Reserve, Ben Bernanke likes and understands Bitcoin and has said it “holds long-term promise.”
While Mr. Bernanke seems to understand Bitcoin’s money out of thin air nature, he has difficulty understanding tangible real money, like gold.
Ron Paul Asks Ben Bernanke – Is Gold Money?
Not Really Anonymous
Anonymity is one of the features of Bitcoin that is most touted by Bitcoiners. Bitcoin, however, is only anonymous if it is bought surreptitiously and not used in mainstream commerce. When one uses Bitcoin to buy tangible items like pizza or clothing, the merchant has to send the goods somewhere to a physical address that is attached to the person ordering the goods. At that point the Bitcoiner’s cover has been blown.
Can be Subject to Government Regulation
Bitcoin won’t stay hidden from the government’s prying eyes. When there are Senate Bitcoin hearings and statements by the Chairman of the Federal Reserve about Bitcoin you can be assured that the government will find ways to uncover illegal transactions, require disclosure of bitcoin holdings (like they do of foreign bank accounts) and collect payment of taxes on Bitcoin gains.
The spouting whale gets harpooned.
Not Limited in Supply
Bitcoiners like to note that the the supply of Bitcoins is strictly limited to 21 million Bitcoins of which about half have already been “mined”. This limited supply, however, can be subdivided infinitely and broken into component fractions which increases the supply as the price rises (something not practicable with gold as 1/100000 of an ounce would amount to less than dust). Conversely, if the price of Bitcoin drops, 21 million Bitcoins is a lot of Bitcoins!
Further undermining the limited supply argument is the ability of virtually (pun intended) anyone to create additional unbacked digital currencies. Competing digital currencies can be created to have fewer authorized coins than Bitcoin and issue say, “just” 10 million digital coins. There are already competing virtual litecoins, feathercoins, terracoins, namecoins, novacoins and ripplecoins. All of these are unbacked virtual currencies adding to the overall supply of digital currencies. As there are no barriers to entry in the digital currency field expect to see many more.
No Intrinsic Value
Bitcoin is not a tangible item and has no use whatsoever other than to be used as payment. As such it can not be deemed an asset. Rather, Bitcoin is really a payment service dressed up as a digital currency. The value is in the system NOT the bitcoin itself. Gold and silver in contrast are assets with tangible value other than their use as currencies. As Warren Buffet notes regarding gold – you can fondle it. You can also use silver and gold for industrial applications and you can use them as jewelery. Precious metals, however,should be characterized as assets and not investments because they produce no income. Precious metals just are. Bitcoins also just are, but just are… nothing and therefore can’t be characterized as assets or investments.
Not a Store of Wealth or Stable in Value
In order to be a viable currency, Bitcoin must be a reliable store of wealth. If the price of Bitcoin fluctuates wildly up or down constantly during short periods of time it can not be viewed as a reliable store of wealth or even a reliable currency. Currently restaurants taking Bitcoin for payment might see the price of meal rise 100% or drop 90% during the course of serving its Bitcoin diners.
In its current state, Bitcoin can only be viewed as a form of speculative gambling. If Bitcoin can not obtain some level of price stability (and there is no reason to think that it can as it has no value other than speculative) it will be difficult to view Bitcoin as a store of wealth or even as a reliable currency capable of being used to make contemporaneous transactions.
No Customer Service if Something Goes Wrong
Unlike Paypal, Visa, MasterCard and AMEX services that will refund their users’ money if a transaction goes wrong, Bitcoin transactions have no such protections. Bitcoin does have an escrow service that users can set up but its not the same as having a payment service provider backing transactions and willing to provide refunds for merchant fraud or misbehavior.
Bitcoin can not be insured against theft or loss as its value fluctuates wildly. For the same reason it would be difficult to pledge Bitcoins as collateral. In addition, if one were able to insure or use Bitcoins as collateral it would make them no longer anonymous.
Can Be Stolen or Lost
While Bitcoiners tout the encryption features of Bitcoin, its possible that the encryption can be cracked. Indeed $990,000 worth of Bitcoin were recently stolen after hackers successfully penetrated Bitcoin Internet Payment Services (BIPS), a large Bitcoin payment processor in Europe. Other Bitcoin exchanges have also been subject to denial of service attacks.
Another risk is the loss of Bitcoins. Once lost there is no way of retrieving Bitcoins as there is no central data base that retains a record of Bitcoin owners’ holdings.
Bitcoins are only useable and valuable where there is electricity and an Internet connection.
Can Be Manipulated
There may be limited amounts of Bitcoins but there are unlimited amounts of dollars with which to buy them. It is possible that self interested Bitcoin holders bought lots of them to drive up the price to attract other buyers. Or those that wish Bitcoin harm could have been purchased lots of Bitcoins to drive the price up so they can later sell and manipulate the price downward making the new digital currency appear volatile and untrustworthy. Or maybe neither happened and Bitcoin is inherently volatile. We’ll never know as Bitcoin trading identities are anonymous.
I am unaware of Bitcoin derivative trading and of any Bitcoin digital naked short selling.
Central Banks, like the U.S. Federal Reserve, as far as we know don’t hold Bitcoins. If they did we wouldn’t know as Bitcoin ownership is anonymous and there has never been an audit of the Federal Reserve. If Bitcoin was deemed to be a threat to the dollar, the Fed could use funds to destabilize Bitcoin. Indeed, the Fed has a fund set up “to promote exchange rate stability and counter disorderly conditions in the foreign exchange market.”
Future of Money and Payments
Many of Bitcoin’s issues cited above can be worked out if they have not already. Without, backing by something of intrinsic value, however, its hard to see Bitcoin gaining much greater “currency” than it already has. Electronic currencies do hold promise but I would think ones backed by something of intrinsic value like gold, oil, silver, commodities or income streams, rather than faith based values, would ultimately become the favored ones.
Electronic forms of payment are not the wave of the future, they are today’s reality. Bitcoin puts in private hands what was once the exclusive preserve of governments – the ability to make up currency out of thin air. Private electronic currencies will gain validity and users and will compete better with fiat government and fiat private digital currencies, like Bitcoin if they are backed by something of intrinsic value.
Emotions and mania may drive Bitcoin higher. Emotions are powerful but fleeting. Soon, Bitcoin will experience its “emperor has no clothes” moment as the primary purpose for owning Bitcoin is that it might go up. The same logic applies to not owning Bitcoin if the price goes down.
Gold while it has it ardent backers derisively called gold bugs, is neutral, doesn’t crash, doesn’t default on promises, threaten to default, go extinct, or rely on electricity, computing power or an Internet connection.
Gold and silver simply are money. Bitcoin is not.
* this is not to argue that digital items are not assets. Clearly, software, movies and music while not tangible are assets.
UPDATE December 4, 2013- Add Risk of Counterfeiting
The Monetary Future Blog by Jon Matonis
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