By Gary Kinghorn (owner, N-27)
I just read Doug and Louis’ weekly Conversations with Casey on Bitcoins. I had a very similar take initially, but I think Bitcoins are much more interesting than they are giving them credit for. I’ve actually spent a good amount of time understanding how this system is different than other alternative currency systems, and why it could have some merit at some point in the future, even if there are a number of “implementation details” to work out on the way to viability.
The first common misperception about Bitcoins is that they are backed by nothing, and hence that Goldmoney (also digital money, but backed by gold) must be superior. Or that Bitcoin is another form of fiat currency. This is a flawed argument if you flip it around and compare Bitcoins, not to Goldmoney, but to gold itself.
The value of gold is largely a reflection of the amount of work that is consumed in mining and refining it, along with its ideal suitability as “money”. A gold coin represents a large amount of land, highly refined, with the input of a great deal of energy, labor and capital. Similarly, Bitcoins are representative of the computing power, energy, and capital required to create them. A fast, expensive computer has to run for many days to create a Bitcoin. Just like most mining operations, it is a very difficult proposition to do profitably.
In fact, the creation of a Bitcoin is called “mining”*. There’s even a burgeoning industry of “mining consultants”, although the Bitcoin analogy of a Doug Casey has clearly not emerged yet. Bitcoin mining is risky, it’s somewhat random, and it’s very competitive between the number of people that are trying to mine at the same time. It’s probably never been a profitable venture, unless you assume greater prices in the future. So, in fact, the recent price rises that we’ve seen were not so much due to “greater fools” pursuing an unbacked currency, but a reflection of the more competitive nature of creating Bitcoins, the corresponding increases in computer cycles required to generate them, and the approximate costs of that computing power increasing. Naturally, the speculators come in to play that increase, amidst the early hoarders cashing out, and with the small size of an early market, you’ve got a formula for volatility, no question.
But if Bitcoins are “backed by nothing”, well, nothing backs gold either. It’s just a mineral dug up out of the ground with no inherent use other than jewelry. The fact that gold is not someone else’s liability is its supposed strength, and you can say the same about Bitcoins. Gold’s value relative to other strong conductors limits its industrial use considerably. The fact that gold looks better than a Bitcoin, and can also be used as adornment is an advantage that’s hard to argue; but it’s also true that its value as jewelry comes from its value as a rarity and its perceived value based on its ideal inherent properties as money. One could argue Bitcoins have all these same properties in terms of rarity, divisibility, convenience (OK, these are the implementation details that need to be worked out, but should be with time), and durability. When it comes to transporting wealth, say from the US to Argentina, would you rather try to carry $500,000 in gold past the TSA, or $500,000 in Bitcoins? So, maybe, in fact, they
are more portable than gold, certainly one aspect of their convenience. With a well-protected wallet (encrypted with a long password), they are 100% theft-proof.
As we all know, bad money drives out good money. In other words, Federal Reserve Notes are bad money, getting more and more worthless, and hence these are the first things to be used as currency (legal tender laws aside). The stuff that’s appreciating in value, like gold and silver is driven into hiding and hoarded by investors. They are not used as “currency”, at least today. But the real measure of Bitcoin value to society will not be determined today, but in the future when the fiat currencies have served their purpose and humanity is scrambling to find a replacement. How would Bitcoins have fared in the currency collapse in Argentina when local scrip was put into circulation and quickly forged? How would Bitcoins have helped in Zimbabwe last decade when people were digging in their backyard for gold dust to buy bread to survive? Today’s Bitcoins may have not solved the problems of these countries completely, but one can envision a future where even most third world citizens have a cell phone to carry a Bitcoin wallet, and every family has a home computer to mine a few hundredths of a Bitcoin per day.
In our dystopian future, very few people are going to have gold, or even silver to conduct many meaningful transactions. Bitcoins may well be the only currency at that point for the common man (the non-Casey subscribers), aside from the family silverware, neighborhood scrip and other local currencies with far deeper flaws than Bitcoins.
One of the main advantages to Bitcoins is that it is completely peer-to-peer. In a computer sense, this means that there is no “issuing authority”, no central repository, no managing group, etc. With amazing foresight, even the inventor has remained completely anonymous, adding something to the mystery and attraction of Bitcoins. There is no liberty dollar creator to arrest on trumped up tax charges, there’s no stockpile to confiscate, there’s no repository to raid. When compared to Goldmoney, who’s to say James Turk can’t be “taken out”, his vaults confiscated, or his database of users and transactions compromised. When compared to gold itself, there is no way the govt. could confiscate Bitcoins under any scenario, as long as there is electronic communication between users. If fiat currencies collapse, it’s very likely gold and silver could be completely taken out of the equation, but not Bitcoins. The volatility that gold and silver are going to go through are going to whipsaw most casual Americans through an emotional wringer on a day to day basis, for the ones that can get their hands on the precious metals. Just look at January 1980 for a preview. This may well be the case with Bitcoins, as we have already seen, but that is NOT to say gold and silver are always a “consistent store of value” by comparison.
Finally, the casual observer of Bitcoins is overlooking a real opportunity in my opinion. Let’s compare Bitcoins to facebook. Bitcoins have quickly garnered an almost religious-like cult following among its early adopters. Rather than dismiss this as an aberration, perhaps we should pause and better understand why. These are not just naïve videogamers and crypto-hackers. The adoption rate of Bitcoins could at some point in the future compare with the community of facebook users. Who wouldn’t have loved to have gotten in on the facebook craze back in the early Harvard days, by either being one of the early programmers, or being one of the first to benefit from the early market penetration and advertising models that were created.
Already the earliest Bitcoin miners (when there was comparatively little competition) are online millionaires, and are starting to cash out. If Bitcoin really becomes practical and widely used, even just for online purchases, the opportunities to add value with a simple service are going to be legion. The price of Bitcoins is going to go up by orders of magnitude, and the early adopters are going to (continue to) receive a windfall. Like any gold rush, there will be lots of losers, but there is also plenty of opportunity. The security flaw exposed in the largest exchange last weekend shows the need for a number of more stable, secure exchanges as the community grows. The lack of merchant terminals at your average Starbucks creates an opportunity for a simple payment app on a cell phone and a corresponding terminal at the merchant site. The lack of convertibility into physical dollars, or other currencies, in many locations is a clear opportunity to provide a valuable service. There is plenty of room for people who wish to provide capital, and a great opportunity for speculators as well. Think of investing in Bitcoin today as akin to investing in an early stage start-up in Silicon Valley, or a speculative mining venture. You still can’t rule out a four bagger.
Believe me, I know enough about Bitcoin to know all the downside risk, the limited viability, the potential for fraud, and the wild-west nature of this emerging technology. It may very well not survive at all. I know many of my arguments are hand-waving, but I’m playing the devil’s advocate, not because I have all the answers, but because I know nobody has the answers to rule out the future viability of this system. Would I invest much in it today? I doubt it, and I would only do it because I’m fully versed in as many issues as I can be. How would I invest if I did? Mining? Probably not. Speculation? Only in small amounts. Bitcoin-related services and products? Well, maybe, but I am a technologist and I can see a potential path to getting tech products off the ground. Are the risks great? Yes. But to dismiss Bitcoins as a “straw in the wind” is to be making a serious mistake in my opinion.
Truth be told, only last week I made my first small investment in Bitcoins after testing the viability of mining them for a couple of weeks. Unfortunately, I got some of my funds locked up in the now famous Mt.Gox security breach temporarily, but I expect all the funds to be recovered in short order, and it was a small test amount anyway. I am not deterred by this setback, and I don’t think the Bitcoin community will be for long. Other exchanges are operating normally and prices quickly returned. Mt. Gox is rolling back many of the trades in the unusual sell-off so the fraudulent “flash crash” will be undone. It’s just part of the learning process, and the growing pains in something as fundamentally important as a new currency.
[*Since somebody is bound to ask: What exactly do you mean “mining” a Bitcoin on a computer? Very simply, bitcoins are computer files that are cryptographic key blocks (a.k.a. a hash) that are assembled out of blocks of very large numbers. Putting together a hash block is not unlike a brute force cracking of a password. In mining, you have to try millions and millions of number blocks until you “find” the right one. The bitcoin network limits the amount of coins that can be minted to asymptotically approach 21,000,000 by the year 2030. Transactions may be common with 1/1000 or 1/10,000 of a coin as deflation seems built in by design. As computers get faster, and more people start mining, the blocks that are required to create a coin will correspondingly get longer and more difficult so that the mining rate is never exceeded. A good geologist in gold mining has a big advantage over a poor geologist, but in bitcoin everyone is equally looking in the dark so to speak, and it’s a bit more random, but you also don’t have the unpredictability of mining accidents, geopolitical instability or dependence on the price of oil. Want to try mining quickly on your own? Go to http://www.bitcoinplus.com and click on “Generate Bitcoin”, then “Start Generating” to start.
Earlier in my career as a network security guy, I worked at RSA, which designed and produced many of the foundational cryptographic algorithms used in these kinds of applications, which was what initially attracted me to study bitcoin, along with my interest in alternative currency systems, of course. Upon cursory research, the design is incredibly elegant and well thought out. From an engineering perspective alone, bitcoin is something like looking at the Hoover Dam for an industrial engineer. It’s a testimony to somebody’s great design and the belief in that design of a large and growing community of talented programmers in the open source community, and throughout the world.]
