Tag Archives: bitcoin

[REVISED] Bitcoin. Yea or Nay?

Was the shutdown of Mt. Gox, one of the major Bitcoin Exchanges, signifying the doomsday of Bitcoin?

No. Although $400 million worth of Bitcoins have lost as a result of the heist on the exchange, Bitcoin is far from a failed attempt. As an up and coming cyber currency, Bitcoin is going through the roughness during its infancy of being a “cyber product” and a “currency” at the same time.

Like every other cyber product, flaws and bugs are inevitable. Therefore Mt. Gox’s incident is not completely unforeseeable. Sooner or later, another bug will be exposed, some people will be hurt, some agency will lose its reputation, and some superhero will come to save the world. The release-bug-fix-release loop of software development has defined the imperfectness nature of bitcoin from day 0.

Bitcoin as a currency, although rebellious in nature and virtual in existence, is still exposed to the risk of being stolen. In fact, the $200 million heist is not the biggest heist on currencies. Beside no firearms involved and nearly untraceable, I don’t see the Mt. Gox meltdown any different from other bank robberies.

So, does Bitcoin have no problem at all?

Absolutely not. When it comes to security and trustworthiness, Bitcoin is much inferior to the dollar bills. In terms of security, in good days, Bitcoin is safe because it’s untraceable. When things go south, however, Bitcoin can be very dangerous, also because of the untraceablility. In the Mt. Gox’s incident, no one can find the suspect, let alone reclaim the money. The double-edged sword of information privacy makes Bitcoin a perfect choice for illegal transactions, and the worst option ever for people who want to secure their money.

In terms of trustworthiness, since Bitcoin is decentralized by design, there’s no institution backing it up. Columnist Megan McArdle explained this very clear in her article:

“… as yet, no currency exchange (for bitcoin) like the ones we use for regular currency — backed by large institutions that can be sued if things go wrong. … for folks in the regular old economy, that’s a problem. It’s hard to get enthusiastic about saving in a system where hundreds of thousands of dollars can disappear overnight, leaving you with no recourse.”

Now, what’s Bitcoin’s future?

I’ll argue that Bitcoin will continue to exist, but not as a full-fledged currency.       On one hand, a currency must be durable, divisible, transportable and uncounterfeitable. Although Bitcoin satisfies the latter three, it fails to be durable in terms of retaining the same value over time, which is the most important characteristic of money. On the other hand, even if someday Bitcoin managed to stabilize its price-to-dollar and became a reliable currency, it’ll receive enormous pressure from the government. The better it does at evading governments’ surveillance, the harder the governments try to shut it down. At the end of the day, it is the government that controls the ecosystem, and never will it allow the existence of a currency that poses a potential threat to the homeostasis.

As a result, for Bitcoin to be a successful currency, it has to fundamentally alter the economy system and take “government” out of the equations. Ironically, in order to be strong enough to fight with the government, it has to be accepted by the vast majority first, and that’s only achievable without the big brother’s interference. Simply put, Bitcoin can’t beat the government without first beating the government. This paradox has decided the cryptocurrencies’ defeat: you can be either a crypto product, or a type of currency, but you can’t be both.

Sliding Stocks Carry Hedge Funds Downwards, Few Worry of Bubble

2014 has been a rough year for internet tech and biotech stocks. Despite their 2013 gains, recently Google has fallen around 10% since last month, and Valeant Pharmaceuticals Intl Inc. has fallen over 17% since February. While the recent dip in the stock market has impacted many investors over the past few months, according to the Wall Street Journal, many top hedge funds have been hit especially hard.

It sounds like many hedge funds, not wanting to be left behind, jumped into stocks in the beginning of the year after watching last year’s bull-market rally. However, those that increased their exposure to last year’s darling companies have often seen their lackluster returns drastically missing the S&P 500 average. For instance, while the S&P 500 has been down around 1.2% since the beginning of this year, the $28 billion large hedge fund Viking Global Investors LP has fallen more than 4% in both march and april. John Thaler, a former analyst at the tiger cub hedge fund Shumway Capital, saw his $2.2 billion JAT Capital Management fund take a 10% loss for the year (on a side note, the tiger cubs are hedge funds that spun off of Julian Robertson’s famed Tiger Management Corp hedge fund that, although incredibly successful in the later 1990s, eventually went bust when its largest holding in U.S. airways crashed in 2000).

The culprit behind the lackluster returns of these hedge funds, according to Brian Shapiro, founder of the hedge-fund analytics company Simplify LLC, is that duplication has become common among hedge fund managers. Many firms end up placing the same bets, either by independently coming to the same conclusions about stocks or, more likely, because they hope to ride a momentum wave by copying the strategies of other hedge fund managers. This inevitably pushes up the price of the asset that everyone is buying, and creates “wealth” on paper, but if a few of these managers get smart and decide to sell to lock in their winnings, the stock begins to sink all of their boats will capsize together.

To me, this kind of speculative behavior seems to be the kind that could form a bubble, since people are attempting to make a profit on the rising price of an asset by investing in places where others have already made money. However, according to Vikram Mansharamani, a lecturer at Yale University who has written extensively about how to detect a bubble, this may not be the case.

In an interview with the Wall Street Journal, Dr. Mansharamani outlines 3 red flags that may signal a potential bubble.

  1. Rapid Rise in Prices: In the beginning of a bubble, investors push up the price of an asset quickly. For instance, in the year before the dot-com bubble the Nasdaq rose 110%. Also, the price spike might also be interspersed with panicked selling, says Professor Didier Sornette, who holds the Chair of Entrepreneurial Risks at the Swiss Federal Institute of Technology Zurich (ETH Zurich).
  2. Prices Breaking from Asset’s Underlying Value: Using the Shiller P/E, which is the market price for an asset divided by the 10-year inflation adjusted average earnings, a high ratio may indicate a bubble. For instance, while the median P/E ratio of large U.S. stocks has been around 16 since the late 1800s, but during the dot-com bubble the Shiller P/E surpassed 44.
  3. “Exciting”  innovation as justification for the price increase: If, in an effort to justify their irrational exuberance, investors point to new technological innovations as a rational cause for the price increase, there’s reason to be skeptical. This can be seen in both the dot-com boom and in the housing crisis (with the popularity of innovations in mortgage-backed derivatives). Overall, it’s important to remember that irrational people will find a way to rationalize anything.

By these criteria, the overall S&P 500 may not be in a bubble. Although the S&P 500 returned 32% last year, it’s Shiller P/E is only around 25, which is somewhat worrisome but not yet alarmingly indicative of a bubble. Professor Sornette’s models did, however, identify internet retail stocks and healthcare and life-sciences stocks as bubbles before the recent sell-off. As evidence, the Nasdaq biotechnology index has fallen more than 18% since the beginning of the year after last year’s rapid ascent.

 

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On the other hand, the famous Bitcoin does meet the criteria for a bubble. The price has exploded in the past year, rising from a low of around $120 last April to a high of near $1126 last December. Investors have also justified its ascent due to its “innovation” and “potential to change the world” (just see the website bitcoinquotations.com for a list of quotes from hyped up entrepreneurs, economists, and politicians), while the fact remains that few retailers currently accept payment in Bitcoin and there are no underlying assets backing the currency. This is not to say that Bitcoin, or a similar technology, won’t be important to the future of finance, it just suggests that Bitcoins recent gains are likely the result of hype and popularity.

Overall, It’s important to remain level headed and rational when investing, as even institutional investors and hedge fund pros can and often do make poor bets.

Who made Bitcoin?

In class, we’ve discussed the Fed and its position as the central bank of the US. Central banks can regulate currency and its value by simply producing more of it. To introduce this newly created money to the public, this central authority bank ends up purchasing financial assets or offers the money as a loan to financial institutions. This is coined as fiat money or money that has its value derived by a governing entity.

But there is a new type of currency system (that I’m sure we’ve all heard about by now) called cryptocurrencies. The first and most notable cryptocurrency is Bitcoin. “Bitcoin is designed to bring us back to a decentralized currency of the people,” said Gavin Andresen, chief scientist at the Bitcoin Foundation, “this is like better gold than gold.”

But Andresen isn’t responsible for this marvelous “better gold. Someone who goes by Satoshi Nakamoto created Bitcoin. Yes, this is to say that Nakamoto true identity is unknown. Many have gone through hurdles trying to pin point Satoshi Nakamoto’s identity. Many interesting facts have been uncovered and plenty of theories exist out there. A handful of people have been accused of being Nakamoto (see my tongue-in-cheek tweet). I particularly like the idea that he is a team of people for reasons that the code is ‘too good’.

Dan Kaminsky, a security researcher who read the Bitcoin code,said that Nakamoto could either be a “team of people” or a “genius”; Laszlo Hanyecz, a former Bitcoin core developer who had emailed Nakamoto, had the feeling the code was too well designed for one person.

I’m more interested in the underlying reasons on (1) why we (or at least a large number of people/media) care and (2) why does Nakamoto decide to remain anonymous. I see one reason behind both these questions: unwanted attention from being a celebrity type figure. I’ll quickly tackle this point.

People are fascinated by geniuses. While I don’t believe there is anyone who is a ‘perfect genius’, the people behind Bitcoin are clearly a group of very intelligent forward thinkers. Perhaps too forward for their own good. World governments aren’t pleased with competing untraceable currencies that can be used for illegal transactions. People also believe Nakamoto has in his/her/its/their possession roughly one million bitcoins. To put that in perspective, in December 2013 when Bitcoin valuation peaked that was worth over $1,000,000,000 USD! It’s unclear whether Nakamoto’s identity will became public news, but it is clear that Bitcoin and its offspring cryptocurrencies has brought us to a new age for currency that the next “The Ascent of Money” will include in their history of financial systems.

(Revised) Bitcoin; why should we care?

I haven’t mentioned Bitcoin in a blog post in a while so I thought now would be a good time to revisit my very first blog post of the semester. While the title may no longer be relevant as I think Professor Kimball convinced us that Bitcoin and, more broadly, digital currency is something that we should all care about, I think there are some new developments in the Bitcoin world that are worth discussing.

Although I am sure that many of you are a lot more familiar with Bitcoin now than in the beginning of the semester, I will still leave this bitcoinbasic.com explanation here to reference.

There are plenty of digital currencies out there, many of which have similarities to Bitcoin, but none have drawn the attention or market value that Bitcoin has over the last year. Aside from the millions made by those who owned Bitcoins when they could be purchased for fractions of a penny or mined with greater success, why should we care about Bitcoin?  For starters, this image of a college student that appeared on a College Gameday broadcast received over $20,000 worth of Bitcoin from generous Bitcoin users.

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((credit: theverge.com article One college football sign netted over $20,000 in donations for a Bitcoin enthusiast))

As I mentioned in the original post, Bitcoin was receiving a lot of attention from central bankers and lawmakers around the world. This continues to be the case, as just a couple days ago, China has “ordered the country’s commercial banks and payment companies to close Bitcoin trading accounts in two weeks” While there were many reasons for this decision, a central argument against Bitcoin for the Chinese government was the “potential threat to financial stability” and the ability of Bitcoin to get around some of their capital and currency controls. The end result, however, is that Bitcoin will be harmed if governments worldwide follow suit and take similar stances towards the digital currency.

The United Stance is also continuing to give attention to Bitcoin. A couple of hours ago the House Small Business Committee has a hearing on the effects of Bitcoin on small businesses. A couple of days ago, the IRS decided that Bitcoin is property, not currency, causing the price to slip about 17 percent.

Another issue that I discussed in the original post was the volatility of Bitcoin. While this would still be considered highly volatile for other more standard assets, Bitcoin’s price jumps have settled down considerably over the last couple of months. While volatility is still a concern, it is a good sign for Bitcoin that its price is no longer jumping up and down by tens of percents every day.

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The issues discussed above would be cleared up overnight if you changed the word “Bitcoin” to “United States Digital Dollar”. The backing of a legitimate government in the creation of their own digital currency would cause the price to fluctuate no more than its paper equivalent. Additionally, it would be difficult for foreign governments to make policy against a digital currency that had the backing of the United States government. While my opinion on the impact of Bitcoin hasn’t changed a whole lot, my reasoning for Bitcoin’s importance has. I used to be confident that Bitcoin itself would become an alternative to government regulated currencies. After continuing to read articles and think about the policy implications of negative interest rates if governments adopt digital currencies, I realize that Bitcoin alone isn’t all that important but the idea of digital currency will be Bitcoin’s legacy that has the potential to change the future of currency and monetary policy.

Bitcoin to be Taxed

Yesterday, the Internal Revenue Service issued a formal statement declaring Bitcoin property, as opposed to currency, for taxing purposes. An article in CNN Money explains that the IRS has decided payments worth at least $600 (in Bitcoins) will be taxed in the same way as any other property transaction taxed by the agency. This includes any payment with Bitcoin, gains acquired by investing in it. and income from producing Bitcoins on your computer (known as “mining”). Additionally, “If you pay your employees with bitcoins, that would have to go on your staff’s W-2 forms, and they would have to pay federal income tax on it. Paying an independent contractor? They have to put bitcoin payments on their 1099.” Notably, the IRS acknoledges that Bitcoin surely functions like real currency, but its lack of legal tender status means that there is no jurisdiction over it as such.

The IRS, the and United States in this sense, has joined many countries in the attempt to regulate Bitcoin as it becomes increasingly utilized/traded. The United Kingdom, Germany, and Singapore are among other countries that have put forth this effort as well. In the near future, we should expect to see many other countries joining in the attempt to regulate Bitcoin — assuming it continues to grow in relevance as it has been recently.

In fact, a Wall Street Journal article explains the growth in Bitcoin awareness and confidence. Pollster Harris Interactive outlined the thoughts of 2,039 people around the U.S. It found that 48% have heard of Bitcoin, but most of them don’t trust it enough to invest in it. In fact, only 13% said they would choose bitcoin as an investment over gold. Personally, I am surprised even 13% would choose to invest in it over gold; I figured it would be less. Additionally, results indicate a correlation between increased awareness and decreased trust. It seems that the more people learn what it is, the less they trust it enough to invest in it (hypothetically, of course). Interestingly, respondents in western states proved to be more likely to have heard about Bitcoin, but only 7% of those who knew about it said they would chose it over gold when investing.

Thus, the increase in Bitcoin’s popularity is eminent, though people’s trust in it is still very questionable. However, in pure numbers, it is gaining ground quickly. This decision by the IRS is not necessarily negative for Bitcoin-ers. In fact, I think it’s a positive step for those who want to see it grow in the future. A government attempt to regulate it means that it is being acknowledged as a significant “property” and that the US is taking notice of the increased popularity of Bitcoin. As of now, I find it almost impossible to convince me to invest in it, but all the power to those who do. Regulation may not be an investor’s idea of a positive step, especially when their investments are being taxed, but this move by the IRS is important as it creates a form of acceptance and acknowledgement (as property, though).

[Revised] U.S. government better gets ready for rising of private e-dollars.

On March 5th, 2014, WSJ editor columnist, Michael Casey, wrote a thought provoking article which made me think of the next “runner” after the collapse of Bitcoin. Before, I have never thought of a private company can handle such an overwhelming duty of money exchange, yet I have changed my mind after reading this article. It is possible. Either by the government or by private company; the next runner of ‘money exchange’ will mostly like be the electronic dollar. Use of electronic dollars and its benefits, in terms of our professor’s blog posts, How governments can and should beat Bitcoin at its own game, can convince people to believe that complete use of electronic dollars can get rid of zero lower bound problems as well as stimulating economy more effectively than under the use of paper currency. In theory, I think that the use of electronic dollars is very profound and plausible which likely to happen in real life sooner than what most people expect. Once again, this WSJ article, What if the Bitcoin End Game is a Digital Dollar?, gave me a spark on which I have not thought about it before. That is, the possibility of U.S. government losing its own game.

Not a long ago, we saw Mt.Cox crashed because Bitcoin algorithms were hacked. This left a big punch hole inside of the most important function of Bitcoin use which is trust.  Bitcoin fans, entrepreneur, and enthusiasts of Bitcoin supporters are disappointed and many of them left the market. However, those people are not given up their dream of what seems to me is like dethroning U.S. government dollars. It seems to me first that their dream must be the “Mission Impossible”, yet I start to doubt and ask questions: “What if?”

“History repeats itself” is very powerful phase. This gave me chill when I began to write this post. Think about the time when gold standard was getting replaced by paper money. I can imagine economists back then might also have been having very similar discussions as now we are talking about possible scenarios of electronic dollars replacing paper currency. For example, what I think the reason why the gold standard was dethrone by the paper currency is that U.S. government wanted to devalue their paper currency against hyper-inflation, yet they were unable to achieve because their paper currencies was originally pegged to gold. Similarly, having zero lower bound prevents the U.S. government to more economic stimulus when it needs most. In the past, U.S. government, precisely under the President Franklin Roosevelt, had forcefully yet covertly taken out the gold standard out of U.S. in order to achieve their goal of stabilizing paper currency. In side Bloomberg, How Franklin Roosevelt Secretly Ended the Gold Standard, better explains the power of U.S. government and how it was attained its goal of changing medium of money. However, it is questionable if today, U.S. president can enforce similar foot-steps of Franklin Roosevelt when it comes to politics and money matters.

This is why I think that a giant company with right approach may complete its “job” faster than U.S. government. If a giant private tech company can invent impenetrable and secure algorithms for electronic currency, it is possible that the use of electronic money may popularize faster than previous Bitcoin spread. When it does, it will also gain huge political powers. Before this time comes, U.S. government better have been prepared to win its own game against a giant private tech company, otherwise U.S. government fiscal and monetary policies may not work as effective as before.

Creativity of individuals and their own powers are influencing billions of people around the world today. With the help of more advance technology, it is quite possible that private company issued electronic money behaves like U.S. dollars. May be, someday, it even can dethrone the U.S. dollars if it get enough political and worldwide supports. This can be a disaster for many of us. This may be the end of the liberal democracy. I cannot imagine how rules and regulation will be change in the future, yet in human history, so much power in the hands of few always brought the end of empire. Thus, I hope that U.S. government getting prepared to bit its own game by considering more seriously about potential gains and losses of using electronic money.

U.S. government better gets ready for rising of private e-dollars.

On March 5th, 2014, WSJ editor columnist, Michael Casey, wrote a thought provoking article which made me think of the next “runner” after the collapse of Bitcoin. Before, I have never thought of a private company can handle such an overwhelming duty, yet I have changed my mind. It is possible. Either by the government or by private company; the next runner will mostly like be the electronic dollar. Use of electronic dollars, in terms of our professor’s blog posts, How governments can and should beat Bitcoin at its own game, can convince people to believe that complete use of electronic dollars can get rid of zero lower bound problems as well as stimulating economy more effectively than under the use of paper currency. In theory, I think that the use of electronic dollars is very profound and plausible which likely to happen in real life as well. This WSJ article, What if the Bitcoin End Game is a Digital Dollar?, gave me a spark on which I have not thought about it before. That is, the possibility of U.S. government losing its own game.

Not a long ago, we saw Mt.Cox crashed because Bitcoin algorithms were hacked. This left a big punch hole inside of the most important function of Bitcoin use which is trust.  Bitcoin fans, entrepreneur, and enthusiasts of Bitcoin supporters are disappointed and left the market. However, those people are not given up their dream of what seems to me is like dethroning U.S. government dollars. It seems to me first that this must be the “Mission Impossible”, yet I start to doubt and ask questions: “What if?”

“History repeats itself” is very powerful phase. This gave me chill when I began to write this post. Think about the time when gold standard was getting replaced by paper money. I can imagine economists back then might also have been having very similar discussions as now we are talking about possible scenarios of electronic dollars replacing paper currency. If a power private company could invent impenetrable and secure algorithms for electronic currency, it is possible that electronic dollars get popularized faster than previous Bitcoin spread. When it does, it will gain huge political powers. Before this time comes, U.S. government better have been prepared to win its own game against a giant private tech company which has gained supreme power of producing crypto-currency.

Creativity of individuals and their own powers are influencing billions of people around the world today. With the help of more advance technology, it is quite possible that private company issues electronic money that can behave like U.S. dollars. May be, someday, it even can dethrone the U.S. dollars if it get enough political and worldwide supports. This can be a disaster for many of us. This may be the end of the liberal democracy. I cannot imagine how rules and regulation will be change in the future, yet in human history, so much power in the hands of few always brought the end of empire. Thus, I hope that U.S. government getting prepared to bit its own game by considering more seriously about potential gains and losses of using electronic money.

Bitcoin. Yea or Nay?

Is the shutdown of Mt. Gox, one of the major Bitcoin Exchanges, signifying the doom day of Bitcoin?

No. Although $400 million worth of bitcoins, which accounts for 6% of all existing bitcoins, have lost as a result of the heist on the exchange, bitcoin is far from being a failed attempt. As an up and coming cyber currency, bitcoin is going through the roughness during its infancy of being a “cyber product” and being a “currency” at the same time.

Like every other cyber product, flaws and bugs are inevitable. Therefore Mt. Gox’s incident is not completely unforeseeable. Sooner or later, another bug will be exposed, some people will be hurt, some agency will lose its reputation, and some superhero will come to save the world. The release-bug-fix-release loop of software development has defined the imperfectness nature of bitcoin from day 0.

Bitcoin as a currency, although rebellious in nature and virtual in existence, is still exposed to the risk of being stolen. In fact, the $200 million heist is not the biggest heist on currencies. Beside no firearms involved and nearly untraceable, I don’t see the Mt. Gox meltdown any different from other bank robberies.

So, does Bitcoin have no problem at all?

Absolutely not. When it comes to security and trustworthiness, Bitcoin is much inferior to the dollar bills. In terms of security, in good days, bitcoin is safe because it’s untraceable. When things go south, bitcoin is also dangerous because it’s untraceable. The double-edged sword that is information privacy makes bitcoin a good choice for trading without the big brother’s watch, and a worst option ever for people who want to secure their money.

In terms of trustworthiness, since bitcoin is decentralized by design, there’s no institution backing it up. Columnist Megan McArdle explained this very clear in her article:

“… as yet, no currency exchange (for bitcoin) like the ones we use for regular currency — backed by large institutions that can be sued if things go wrong. … for folks in the regular old economy, that’s a problem. It’s hard to get enthusiastic about saving in a system where hundreds of thousands of dollars can disappear overnight, leaving you with no recourse.”

Now, what’s bitcoin’s future?

I’ll argue that bitcoin will continue to exist, but not as a full-fledged currency.       On one hand, a currency must be durable, divisible, transportable and uncounterfeitable. Although Bitcoin satisfies the latter three, it fails to be durable in terms of retaining the same value over time that is the most important characteristic of money. On the other hand, even if someday bitcoin managed to stabilize its price-to-dollar and became a reliable currency, it’ll receive enormous pressure from the government. The better it does at evading governments’ surveillance, the harder governments try to shut it down. At the end of the day, the government has control over the financial tools and it’s an irremovable part in the ecosystem. Bitcoin can’t achieve its goal of “decentralization” without fundamentally alter the economy system and take the government out of the equations. Meanwhile, in order to be strong enough to fight with the government, it has to be accepted by the vast majority, and that’s only achievable after the removal of the government. Simply put, Bitcoin can’t beat the government without first beating the government. This paradox has decided the doomed failure between Bitcoin and governments.

The Fall of Mt. Gox and the Future of Bitcoin

Yesterday, the most prominent online bitcoin exchange Mt. Gox completely shut down. According to the New York Times, approximately 750,000 bitcoins were lost as a result of the shutdown – a notional value of around $430 million at today’s current market price and nearly 12% of all outstanding bitcoins. As the news came out yesterday, the bitcoin community and financial press was buzzing with rumors and predictions about “the end of bitcoin.” While this may be bitcoins “Lehman Brothers moment” as Mark T. Williams, a finance professor at Boston college told the Wall Street Journal, this is not the end of the cryptocurrency. Bitcoin still has many challenges to cement its legitimacy into the future but it also has several strengths that will likely allow it to rebound and become a successful electronic currency.

In light of the Mt. Gox collapse, the most important thing worth noting is that this problem stemmed from one company’s incompetency and ultimate failure – it was not a failure in the underlying bitcoin protocol. Mt. Gox, while the most popular and highest volume bitcoin exchange, had a reputation for incompetency and problems. Trading was halted several days before the site was taken offline and users had experienced similar issues in the past. Bitcoin as an electronic currency protocol, however, has proven to be incredibly resilient and effective throughout this whole ordeal and throughout its ascent. Saying that bitcoin is doomed because of Mt. Gox’s failure, it like saying paper currency was doomed after the fall of Lehman Brothers – a failed institution does not make a failed system.

Bitcoin, however, does face several key challenges to regain its tarnished legitimacy. The Wall Street Journal quotes a research note out today from Citigroup that outlines bitcoins three biggest challenges:

  1. Bitcoin traders and potential investors lose confidence in the security and safety of Bitcoin transactions and holdings.
  2. Other digital currencies start eating into Bitcoin’s market share, taking away some of the first-mover advantage.
  3. Competition emerges from conventional financial institutions using generic bitcoin technology, without the decentralization and within the conventional regulatory framework.

The essential problem is that Bitcoin’s value is entirely reputation based. Like fiat paper currency, there is no intrinsic value. Unlike fiat paper currency, however, there is no implicit government backing, the value is derived from faith in the decentralized peer-to-peer network that accounts for individual bitcoins. A major negative event such as the failure of Mt. Gox creates the type of negative perception that can ruin bitcoin.

The reason while I do not believe Mt. Gox’s fall will not ruin bitcoin is that the community supporting the cryptocurrency have proven resilient and adaptable. Many are hackers, programmers, and other tech savvy individuals. While many lost a great deal of money in Mt. Gox, they also seem determined to push forward. As entrepreneur and bitcoin enthusiast Erik Voorhees described in a Reddit post yesterday morning, many believe that bitcoin is about more than making money – it is about creating a system that is outside the government’s realm of supervision where libertarians can flourish. If the community embraces this idealism, it will have the strength to innovate through the challenges and create a more stable and accessible system for all.

The Bitcoin Blunder

Bad news for Bitcoin users and proponents this week. From an article in the New York Times:

A document circulating widely in the Bitcoin world said the company had lost 744,000 Bitcoins in a theft that had gone unnoticed for years. That would be about 6 percent of the 12.4 million Bitcoins in circulation.

While Mt. Gox did not respond to numerous requests for comments, and the companies issuing the statement scrambled to determine the exact situation at Mt. Gox, which is based in Japan, the news helped push the price of a single Bitcoin below $500 for the first time since November, when it began a spike that took it above $1,200.

I think that this breach confirms most of the problems of those who oppose Bitcoins as a fundamental currency: namely, that those who control the supply of Bitcoins are not adequately equipped to protect the national currency, and that Bitcoin is not a stable store of value.

The first point should now be obvious. Those who thought that the suppliers of Bitcoins could adequately protect them through encoding have been proven wrong, and it should be clear that currency should be left in the hands of a very powerful central power. The Federal Reserve would be an excellent choice, I should think.

But on to my other point. That Bitcoins are not an adequate store of value was obvious from the beginning, and still is. Indeed, the price of a Bitcoin in USD had already been dropping dramatically since the beginning of January — this itself should have been proof positive that the currency is not stable. But for those who held out hope for Bitcoins value, the effect the recent theft has had on the  value of the Bitcoin should be a wakeup call. It is not surprising that the theft pushed the value down even further, but the magnitude of the drop, as shown in the graph I linked too, is striking. In other words, even in the absence of bad news Bitcoin cannot hold its value, and bad news has particularly harsh implications. if Bitcoins were the national currency this would have disastrous implications.

Still, I can’t help but imagine that some will still want to fight for Bitcoin, saying that once Bitcoin is a more widely accepted form of currency it will be a more dependable store of value. But this is not true. The fact is, there is nothing that gives Bitcoin intrinsic value — it is fiat money in its purest form. The USD, which is also technically fiat money, actually does have an intrinsic value: it is legal tender for the payment of all debts, public and private. That is, people have to accept it as a form of repayment for debt. So, even though the USD is no longer tied to gold, it has an intrinsic value that Bitcoin just doesn’t have, which probably grants the USD stability that Bitcoin just doesn’t have.

So, the recent fiasco has confirmed what Bitcoin opponents knew all along: it just can’t work as a form of national currency.