Tag Archives: cryptocurrency

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.

Revised – Inflation Scare in Argentina

Earlier this month Argentina’s currency experienced its largest devaluation since 2002. This substantial devaluation caused a rise in inflation and increased uncertainty within the economy. Argentina’s currency devaluation is not only a result of US tapering and weak manufacturing numbers from China, but also long-term domestic policies that have created a large distrust in the Argentinian government.

According to the Wall Street journal many economists believe that the inflation is a result of “heavy state intervention, price controls and corporate nationalization that have underpinned [Argentina’s] policy making for more than a decade.” (WSJ – Inflation Fuels Crisis in Two Latin Nations) To further this distrust in the central government, the state released inflation index for 2013 was reported at 10.9%, while an independent figure measured by an independent group of economists came in at 27%. (WSJ – Dispute Leads to Revise Index) As a result many local businesses are struggling to price their products and are being forced to close shop. One local coffin maker in Argentina said, “I have to tell customers that I can give you a coffin today, but you’ll have to pay for it later, at who-knows-what-price.” This confusion in pricing has resulted in decreased consumer spending and investments in Argentina. Bank of America Merrill Lynch recently forecasted that the decrease in investments and spending as a result of higher interest rates and inflation will lead to a 3% contraction in GDP this year. (WSJ – Inflation Fuels Crisis in Two Latin Nations)

Argentina has reacted to the inflation scare by issuing strict warning to business owners to not increase prices. The government warned that fines would be placed on businesses that continued to raise prices. If Argentina continues to mandate pricing, they may be able to temporarily curb inflation but businesses that rely on imported goods will be unable to sell products for profit. This will inevitably lead to further economic contractions.

As government discontent and uprising continues, one alternative plan for Argentinean citizens would be the adoption of Bitcoin or another cryptocurrency for payment. Cryptocurrencies are essentially independently created digital currencies that are not regulated by central banks and governments. An adoption of one of these cryptocurrencies would free businesses from the political constraints and corruptness of the central government and would provide them with better pricing transparency, as well as the ability to purchase exports.

The one downside of cryptocurrencies is the volatility of the currency. These currencies can experience drastic intraday changes that would directly affect the wealth of those using them. For citizens in Argentina, the high level of inflation is nearly as volatile and has the real potentially of becoming more volatile if price mandates continue.

For small business owners that are at the mercy of price ceilings emplaced by the Argentinian government, cryptocurrencies could be the only solution for these business owners. With the current restrictions emplaced by the government many small business owners cannot break even with the pricing ceilings.

As inflation continues to rise and reach levels believed to be unstable by economists (about 50%), inflation will likely rise exponentially. If this occurs and the price ceilings are enforced there will be no way for businesses to continue selling goods at the ceiling price and they will be forced to either close shop or adopt a new method of payment.

I have argued previously that the volatility of cryptocurrencies will likely be the downfall of their ability to become a legitimate form of transaction, but Argentina is a different case. The price controls and the potential for hyperinflation make cryptocurrencies a reasonable alternative for many in Argentina. For this reason, it will be interesting to see what happens in Argentina in 2014.

 

The Rise and Inevitable Fall of Cryptocurrencies

I recently wrote an article about Bitcoin and how I believed the volatility of Bitcoin would make it an unfeasible currency in the future. Unknown to me at the time was that there are currently over 100 cryptocurrency competitors to Bitcoin. There are even online exchanges that allow investors to trade currencies with names ranging from RonPaulCoin, FedoraCoin, and DogeCoin.  Furthermore, many of these cryptocurrencies were made by anonymous computer nerds just for fun and now they are actively traded by speculators and hold million dollar market caps.

Looking at the environment of cryptocurrency exchange, it is hard not to see the comparisons to the dotcom bubble. Similarly as public companies with “.com” at the end of their name rose 50% in a few months, so have these cryptocurrencies ending in “coin”. None of these currencies hold any intrinsic value, but they are similar in that they are all mined by computers solving complex algorithms. Some of these cryptocurrencies advertise having faster transaction times or tighter transactional security than Bitcoin, but are not backed by any guarantees or commodity. Besides Bitcoin and LiteCoin, none of these other coins are accepted by any major retailers or online sellers. Yet, online currency exchanges such as Cryptsy and BTC-E coin process tens of thousands of trades a day in these currencies. Such high levels of speculation in these cryptocurrencies have led to even higher intraday volatility than Bitcoin. It is not uncommon for these currencies to double their value or lose half of their value in the course of a single day. By looking at the market list of cryptocurrencies traded on Cryptsy you can get an idea of how volatile these currencies truly are.  (Cryptsy)

 

Cyrpotcurrencies have been artificially supported by internet communities such as Reddit and Forchan. Posts about new currencies and stories of riches made in currency trading have led to increased speculation and confidence in the digital currency market. Investors continue to buy into the idea that they are on the ground floor of the “next big thing”, and despite the increasing number of competing cryptocurrencies they site the commodity markets as an example of a proven investor appetite for multiple types of investments for a stored value. (WSJ – Virtual Currency Crazy Spawns Bitcoin Wannabes)

The increased level of news exposure to cryptocurrencies has only led to further speculation. A recent story released online talked about how the new digital currency called DogeCoin, named after the popular online meme raised $30,000 to send the Jamaican Bobsled team to the Sochi Olympics. (Metro – How the Cryptocurrency Saved the Jamaican Bobsled Team) The news of this story nearly doubled the price of DogeCoin. The rise in cryptocurrencies will inevitably be followed by the fall in the majority of these valueless currencies just like the fall of the internet bubble in 2000. Pumped by pure speculation, these currencies will inevitably fall as investors realize that the million dollar valuations of these currencies are utterly absurd for something of no value. If Bitcoin begins to lose value, look for these knock-off currencies to take a huge dive in 2014.

 

http://online.wsj.com/news/articles/SB10001424052702304607104579210051252568362?KEYWORDS=digital+currencies

https://www.cryptsy.com/

http://www.metro.us/newyork/news/national/2014/01/22/what-is-dogecoin-how-cryptocurrency-saved-the-jamaican-bobsled-team/

Bitcoin: Beyond the Currency (for good)

You know, I thought I’d be the first person here to write about this, and then all of a sudden there are two posts on the matter. But not to worry, because I think I can add a new angle to this discussion. We’ve heard about Bitcoin’s issues – volatility, (lack of) regulation, and, I’d add, inherent deflationary pressure. It also seems there’s a whole industry around mining Bitcoins (i.e. creating new ones), which to me, on the surface, seems like a giant waste of resources. After all, the beautiful thing about most fiat currencies is that they’re so incredibly cheap to create, rather than having to be digitally mined or actually dug out of the ground like gold (mined, quite literally).

However, there are some aspects of Bitcoin that I feel are underrepresented here; there are some lessons to be learned from it. I’m not talking about some sort of supposedly libertarian ideal of an unregulated currency; the ideological side of Bitcoin, as I’d call it, has little merit to it. In fact, the whole idea of Bitcoin as a currency is rather unattractive. What’s interesting is the technical side. With the technology that makes Bitcoin so attractive as a gray- or black-market currency also come a multitude of applications that aren’t getting the publicity they deserve.

Why is it that Bitcoin seems so attractive for illegal transactions? I’d argue it’s because it circumvents the (traditional) banking system, written contracts, proofs of purchase, and a whole array of other financial and legal institutions. If Bitcoin user A gives Bitcoin user B some Bitcoins in exchange for whatever product he wishes to purchase, there’s no need for any of that. This is because, in a sense, Bitcoin comes with a public ledger of all transactions ever made using it:

Bitcoin accomplishes this by distributing the necessary ledger among all users of the system via a peer-to-peer network. Every transaction in the Bitcoin economy is registered in a public ledger called “the blockchain.” Complete copies of the blockchain reside on the computers of everyone who uses Bitcoin. New transactions are checked against the blockchain to ensure that the same Bitcoins haven’t been previously allocated […]

So there’s no need for any third party to verify the unwritten contract between buyer and seller. Interestingly enough, this is a lot closer to Econland (that magical place we all visited in Econ 101) than having notaries and attorneys write up contracts and threatening lawsuits. Homo economicus buys and sells on “the market” (usually he exchanges Y for C, or Y for F; a fulfilling live, surely). He (or she, for that matter) doesn’t care about verifying that the C he/she bought is really his (or hers); everyone in the economy knows that he/she bought it – there is perfect information. It’s not so much that homo economicus wouldn’t cheat if given the chance; it’s that he/she doesn’t get the chance, because they’d instantly get caught! So in Econland, there’s no need for all the second-best clutter of legal documents surrounding transactions.

And Bitcoin has the potential to eliminate a lot of that clutter in the real world. This goes beyond verifying purchases in online stores without needing a third party such as PayPal (or Visa/MasterCard). A single Bitcoin could be used to verify its owner’s identity online. It can also be used to verify copyright claims; a digital signature can be embedded in a document, proving that it existed at time t, authored by individual X. There’s research in Princeton about using Bitcoin to construct prediction markets (granted, that’s basically a fancy term for betting).

So should we all abandon the dollar and flock to Bitcoin? I certainly don’t think so. Beside the flaws we heard about earlier, Bitcoin also lacks a central bank (by design). This may appeal to self-declared libertarians, but simply dismissing monetary policy as a tool for countercyclical actions is like voluntarily cutting off one of your hands (it’d also make future versions of this course a lot less interesting). The whole currency aspect of Bitcoin, from an economic point of view, is deeply flawed. Also good luck paying your taxes with it!

However, the largely unexplored technical possibilities it holds are more than worth being looked at. Maybe Bitcoin, clinging to its self-styled image as a currency, isn’t the right vehicle for these innovations. Once they start being utilized, they may outgrow its confines quite quickly. If they could be incorporated in a new system though, something aimed at being a revolutionary new tool for financial transactions (and much more), then I could see some hope for that aspect of Bitcoin to redeem itself.