by John Young
Crypto currencies such as Bitcoin have a lot of positive potentials. From our perspective, their greatest value lies in their ability to enable commerce that would otherwise be prohibitively expensive or impossible because standard credit card processors like Paypal selectively “black hole” peaceful pro-European-American efforts. Bitcoin and similar currencies give us a way around that – and, in fact, a way to bypass the banking system altogether, which can allow us to be more protective of member identities.
So that’s a positive.
Where things go awry is when people see these currencies as an investment vehicle.
There is absolutely no question that if someone bought 20 Bitcoins when they cost only $100, that today they can be exchanged for $15,000 each or more. So on the surface, this looks like a great deal, and undoubtedly, for some people it will be a great deal.
But I want to give you a wake-up call on some fundamentals of Bitcoin in particular, but which will be broadly applicable to Ethereum and Bitcoin Cash as well. I am going to do this with an example.
Pretend you sign up with Coinbase, the largest exchange for Bitcoin in the United States, and you purchase $1,000 worth of Bitcoin. Pretend 10,000 of your closest friends do the same. Now, Coinbase has a cool $10,000,000 in its coffers. We will pretend, generously, that Coinbase employees work for free and that the enterprise has zero overhead and works by magic. So Coinbase gets to keep that money handy in case its customers decide to change their Bitcoins back into cash.
Pretend, further, that the value of Bitcoin climbs so that your original $1,000 investment is worth $15,000.
Okay, let’s digress a moment. What does that mean? Where does that value come from?
Just like a stock, that value comes from exchanges that are taking place on Bitcoin exchanges that are very similar to stock exchanges, and they reflect what people, in real time, are willing to exchange for Bitcoins. But this reflects only a small number of people and a small number of Bitcoins compared to those that are being held in wallets.
As I write this, there are currently fewer than 17,000,000 Bitcoins in existence and, due to its design, there will never be more than 21,000,000. The peak trading volume of bitcoins was about $5B at a time when the Bitcoin was trading at $15k. So all of that trading really involved only about 330,000 Bitcoins changing hands – or about 2% of existing Bitcoins. And most of those are movement from one wallet to another, rather than outright purchases of Bitcoins at that price.
So the valuation of Bitcoins at $15,000 or any particular price is NOT a reflection that all Bitcoins could be exchanged for that much national currency. Instead, it reflects the fact that some people, somewhere, were willing – at a given moment – to purchase a tiny percentage of existing Bitcoins at that price. And that is an important thing to consider.
Now, let’s go back to our imaginary scenario. You and 10,000 of your closest friends, who purchased $1,000 worth of Bitcoin from Coinbase, are now all holding $15,000 worth of Bitcoin. What a deal! This is awesome! You need to fix your roof and the brakes on your car, and you’d love to take your wife on a much-deserved vacation. So you all go back to Coinbase and trade in your Bitcoins for national currency (dollars) to be deposited to your bank account.
Uh oh.
You and your friends gave Coinbase $10,000,000. And even if Coinbase runs completely free of all expenses and is run by the most perfectly honest people on earth, it only possesses $10,000,000. But you and your friends all just sold your Bitcoin back to Coinbase for $150,000,000. Looks like Coinbase is $140,000,000 short. Where is the company going to get the dollars to pay you?
Okay – it can get that money, because it is an exchange, by selling those Bitcoins to 10,000 people who are perfectly happy to pay $15,000 each for them, instead of the mere $1,000 that you originally paid. But what if they can’t find 10,000 people who are willing to pay the higher price?
And this is the key I am getting at. In our scenario, Coinbase only has $10,000,000 in its pocket, plus whatever it is able to RE-SELL your coins for.
This whole deal works fine only when a tiny proportion of total Bitcoin is exchanged for currency, and that is matched by a similar amount of currency being exchanged for Bitcoin. If that gets out of whack – by, for example, more people wanting to sell than are willing to buy, here is what happens:
Coinbase in our example only has $10,000,000 handy, plus another $40,000,000 from Bitcoins it was able to re-sell for currency, giving it a total of $50,000,000 – when 10,000 people show up to liquidate their Bitcoin, the first few – maybe 500 of them – will get the full “market price.” But as more and more show up to liquidate, the price drops … and drops … and drops. That is because Coinbase, even if run by the most perfect and most ethical people on earth, is not the Federal Reserve. It cannot create money out of thin air – it is completely at the mercy of willing buyers and willing sellers.
Bitcoin is not a currency – though it is used as one. It is more like a STOCK and it is traded on EXCHANGES – just like a stock. And just like stocks, its valuation reflects only a tiny proportion of it changing hands at any given time, and reflects only what a handful of people are willing to pay for it. It absolutely does NOT reflect what the value would be if the holders of a substantial portion of Bitcoin – say, 20% of it – decided to sell. If that were to happen, it’s value would drop like a rock. Even now with 5% or less being traded, its valuation is fluctuating wildly.
Even more importantly, even though a lot of the valuation of stocks reflects psychological factors of optimism or pessimism instead of the actual value produced by the company, at least, at its core, a stock reflects a portion of ownership of an actual physical enterprise. So a stock has a “bottom.”
For example, if I were to buy stock in a water company that paid a quarterly dividend of $2, that would come to $8 a year. There is a limit to how low the value of that stock can go, because if I were to invest my savings in a very good bank and got a 3% return, $8 would represent the return on nearly $300 in the bank. So the value of stock in that water company is not likely to fall below $300 a share because its intrinsic value in the dividend it pays makes it a better deal than simply holding money in a bank.
Where is the bottom of Bitcoin provided by its intrinsic value? Zero. It is just bits in computers. This is the same for all Crypto-currencies. Their intrinsic value is zero. This doesn’t mean they can’t have utility as currencies, but it means that as investments they are iffy at best.
So what about Bitcoin as a currency?
National fiat currencies fundamentally derive their value from the fact their issuing governments require you to use those currencies to pay taxes. If you don’t pay your taxes as prescribed, using their currencies, ultimately a large number of heavily-armed people without any sense of humor will show up and take you into custody. If you substantively resist, they will kill you on the spot.
So national fiat currencies rely on the fact that the most productive people in a society want to stay alive, and this is a rather reliable means of maintaining their value.
Previous alternative currencies that the federal government shut down with extreme prejudice were backed by physical assets: e-gold and the Liberty Dollar were backed by gold and silver kept in safes. THESE were indeed a secure store of value and presented a substantive risk to the status quo, and hence they were shut down with their central purveyors taken into federal custody.
(Because Digital Gold Currencies were unregulated, it turns out many of them were fraudulent in that they accepted dollars for gold, but never purchased that gold and put it in a safe for the purchaser. An example of this was Pecunix. But both the Liberty Dollar and eGold were run legitimately.)
Crypto currencies, just as they have nothing backing them as an investment, have nothing backing them as a currency except for people’s willingness to accept them. But their viability as a currency depends on their ability to be used in transactions without substantial loss of value in transaction fees.
As I write, over the past week, the cost of a transaction – that is, transferring Bitcoin from one wallet to another – has varied from $28 to $55. Up until January of 2017, the transaction costs were reasonable – only pennies. But since then, the costs have skyrocketed from ridiculous costs of $5 or $10 up to obscene levels of $40, $50 or more. Transaction costs, to be bearable, need to be less than 5% the value of a transaction – so at this point Bitcoin isn’t even useful as a currency for amounts less than $900. Since most transactions ordinary people undertake are far less than that, Bitcoin transaction fees have made it useless.
Let me put it in real terms. If I want to buy a $20 shirt from a website, on what planet would it make sense for me to pay $20, plus a $40 transaction fee, just to use Bitcoin instead of dollars? Nowhere would it make sense.
Transaction fees go to pay miners. Miners are people or companies running massive (and energy hungry) specialized computers 24x7x365 to process transactions using cryptographic hashes. Because the specialized (ASIC) computers are expensive and use a lot of electricity, it isn’t worthwhile to run them unless there is a reasonable pay-out. Furthermore because electrical cost figures into this, most of the mining is done in China where electricity is cheap. Centralization of transaction processing in a communist country isn’t exactly a brainy move.
To make matters worse, because the Bitcoin ledger is not obfuscated, it is relatively easy to compromise the privacy of any wallet with a known address. For example, for several months now Antifa activists have been tweeting the balances of the Bitcoin wallets of prominent alt-right figures.
So Bitcoin has some fundamental problems, even as a currency, that need to be solved, and without getting into the technical details, other Crypto currencies are working on dealing with these privacy, centralization and transaction cost issues.
After all of this, what am I getting at?
Two things.
First, Bitcoin is exceptionally volatile in terms of its pricing, and investing in it is pure speculation. You may win, you may lose. Use your own judgment, but it’s not something I’d personally recommend. If I were to recommend an investment, I would advocate buying a stock that pays a solid dividend, and have that dividend automatically re-invested.
Please understand that anything too good to be true usually is. There is no doubt that some people benefit from the run-up in price of any commodity, stock or currency. But there is also no doubt that many people lose: for everyone who collects $15,000 from an exchange, someone else had to pay $15,000 into it. You might get lucky, but the general way to build wealth is something any sixth grader understands: earn more, spend less, save the difference. Do as you wish and as your luck demands, but if you can’t afford to lose the money, don’t put it in a crypto currency.
Second, as a currency, Bitcoin likewise has issues – long transaction times, high transaction fees, public disclosure of your wallet balance and concentration of transaction approval in a totalitarian communist country. (Also, there are entire companies specifically dedicated to tracing Bitcoin transactions. And the IRS is starting to look very carefully at Bitcoin in particular. If you DO make money, please report it on your taxes.)
Due to its decentralized nature, crypto currency in general (though not Bitcoin in particular) has a lot of positive potential to help us build a parallel economy, and even a European-American nation independent of any state. So you will be hearing more from us about crypto currency in the future. But try not to get caught up in hype.