Why Intrinsic Value Matters To Crypto Currencies

Crypto currencies were one of the big stories of the now ending year 2017. These once geeky little software projects have truly hit the mainstream, and exploded in price. Bitcoin valuations are now featured in pretty much any major newspaper. Some believe that cryptos will take over the world monetary system, others think it is a fraud.

I myself have gone on record twice this year, arguing that cryptos are in a classic financial bubble, which will burst eventually. Given the popularity of crypto currencies, I got a lot of criticism for my opinion. A lot of smart people think that I got this one wrong. Getting critical feedback is always helpful. Ultimately, however, the critics have not convinced me. Of course, it is possible that I am missing something, but so far I have not heard any really convincing arguments for the case, that crypto valuations are justified.

Many of the arguments made against critics are ad hominem. These range from accusing critics of simply being jealous for having missed out, to having a special interest in preserving the currently rotten world monetary system. The most common rationalization, for not having to listen to critics, probably is the accusation that they simply do not understand blockchain technology.

While these arguments might be true for some people, simply attacking the integrity of a critic is a rather weak way of arguing. Either crypto currencies work or they don’t. Whatever the motivation of a critic, they are either right or wrong. The truth can only be settled looking at the actual arguments. If we want to understand what is going on, it is not helpful to start with the conclusion, and then cherry pick the evidence accordingly. This is never a pathway to truth, and particularly in finance, it may cost you a lot of money. I am talking from experience here!

Being an anarchist, the idea of an anarchic monetary system is actually very appealing to me. It would be awesome if we had a simple, technological solution to one of the most evil state monopolies. That is why I initially loved crypto currencies. But having examined the arguments, I simply cannot believe that cryptos will be able to establishing themselves as a true alternative to government money.

To me, the key argument against computer code functioning as money is the fact that it lacks any kind of use outside of trying to be money. In other words, it does not seem to have an intrinsic value. But crypto currencies believers have come up with two arguments why this is a false criticism.

Do Cryptos Have An Intrinsic Value?

The first one is to argue that cryptos do indeed have an intrinsic value. Blockchain is an incredible useful technology. It solves the problem of having to trust a human institution to enforce rules. With blockchain, we now do not have to trust potentially corrupt humans. Instead we can trust a mathematical algorithm, which seems a lot more solid.

I actually totally agree with that. This is indeed extremely valuable. Blockchain technology will change the world. But there is a problem with this argument. It is not clear how this use will give a monetary value to a crypto currency.

For something to have a monetary value, it needs to not just be useful, but also scarce. Air is a good example. For humans, air is incredibly useful. In fact, it is one of the most useful things I can think of. It is so useful that it is the absolute last thing I would want to live without. That is because, cutting me off from a constant air supply will kill me more quickly than cutting me off from anything else. And yet, despite this extreme usefulness, it is free of charge. In everyday life, it has no monetary value, because it is not scarce.

At this point, crypto advocates will say, but Nico, crypto currencies actually are scarce. With mathematical certainty, the number of Bitcoins is limited to 21 million. So there you have it. It is useful, and it is scarce. It therefore clearly needs to have a monetary value.

I don’t find this convincing. It is true, the number of Bitcoins is limited to 21 million. But this overlooks that Bitcoin is not the blockchain. It is merely an application of the blockchain. And there are many others. That means that one does not own the useful blockchain by owning a crypto currency.

The individual crypto currency unit in itself is useless. Pictures of Bitcoins tend to portray shiny gold coins with a big B on it. But in reality, a Bitcoin is just a bit of digital code. It has no other use than being a piece of information. So we are not dealing with something that is scarce and useful. Instead, we are dealing with something that is scarce, but useless. This combination tends to result in a monetary value of zero.

The useful blockchain technology, on the other hand, is not scarce. Luckily, it is open source, and in the public domain. Everyone can, and many people are using it in thousands of applications. There are even multiple Bitcoin applications at this point.

Crypto investors have one good defense to this objection. They argue that there is a network, and prime mover, effect which makes Bitcoin unique among crypto currencies. Bitcoin was the first crypto currency, and it currently is the most highly valued in dollar terms. This gives Bitcoin an edge over other blockchain currencies. So again, there you have it, now it is useful and scarce.

This is not a bad argument, but it ultimately fails to convince me. First of all, even if there is a network effect, it is not clear to me, why the prime mover will be the one that wins this competition. There are often problems with new technologies. Therefore, it is the second or x generation which makes the race. Only in later generations all the bugs from the beginning have been fixed. Google, for example, was not the first search engine, and Apple by far not the first computer company.

Basing hopes of owning the future crypto reserve currency on a network effect, is a risky gamble. Even if cryptos ultimately were to succeed, no one yet knows which one will eventually make the race. And as I write this, the technology of the Bitcoin application in particular does seem to have some problems. It is too slow for transactions, and the mining network uses too much electricity. That is why we have already seen multiple forks. Bitcoin, therefore, might turn out to be a terrible investment, independent of whether cryptos succeed or not.

The real problem with the network argument, however, is that it confuses cause and effect. In order for a crypto currency to profit from a network effect, it first needs to be used as a currency. But how can it be used as a currency first, if all that gives it value is the network effect?

Bitcoin believers will counter this by arguing that we are simply past that point. Yes, this might have been the problem when the currency started in 2009. But, for whatever reason, Bitcoin now undeniably has a monetary value. It therefore can now profit from the network effect. Superficially, this seems correct. Bitcoins clearly sell for lots of dollars. But if we look closer, the argument becomes rather unconvincing. To explain why, we need to look at the second argument made against the lack of intrinsic value criticism.

Cryptos Do Not Need An Intrinsic Value

Many people argue that cryptos do not need an intrinsic value to have a monetary value. That is because nothing really has an intrinsic value. The theory of intrinsic value died with the marginal revolution, and the insight that value is not objective. Each person decides for himself, how to value something. In other words, if someone is willing to pay 1 million dollars for a Bitcoin than that is its monetary value.

Intrinsic value, however, is not objective value. The objective value theory, which was falsified in the marginal revolution, was the idea that everything can be objectively valued according to the amount of labour that was needed to produce it. This theory is indeed completely false.

But intrinsic value refers to something else. Something has an intrinsic value if there are multiple uses for it. It can therefore be traded on different markets. That means it can still be sold, if its demand drops on one of the markets.

For example, a business usually has an intrinsic value in the from of all its assets. Let us say a computer store goes bankrupt. That means that all the computer equipment of that store has no further use for the business, as it is discontinued. But there are other people who will still have some use for all the assets of the shop. The amount, a potential liquidator could sell all these assets for, is the intrinsic value of the business.

This intrinsic value is not objective. It is not the same for everyone. Many people will have no use for these computers. Intrinsic value is merely the market value for which you would likely be able to find a buyer, assuming a big enough market. As such, the intrinsic value is not even a precise number, but varies within a range.

Accordingly, when it comes to currencies, intrinsic value means that if something fails to function as a currency, the owner can still sell it on a different market, or use it himself. This gives the potential currency trust, as it would need to loose its usefulness on all potential markets to become completely valueless.

And trust is really the key when it comes to the value of a currency. Prices are indeed subjective. If people do not consider a currency to be valuable, then it won’t be. On the other hand, if enough people do trust a currency, they will accept it for business. Therefore, there will be a constant demand for it, and the currency stays valuable.

Crypto currency advocates correctly object to gold bug critics that most of the monetary value of gold does currently not come from its intrinsic value. Yes, gold is an incredibly useful metal, but at current prices, it does not seem to be used for much in the industry. Most of the monetary value seems to come from its use as a store of value.

I completely agree that once trust has been established for a currency, the intrinsic value does not matter anymore. An established currency does not need to have a secondary market as a commodity. State currencies, like the dollar, are a good example. Once the currency enjoys trust, all it needs to do is to not blow it. That is why a lot of people around the world accept US dollars, even though the US government does not force them to do so. And they will continue to do that, as long as the US government does not do anything stupid to undermine the trust of the dollar. Historically, the way currencies have blown trust is through a too rapid increase of the currency units.

This is where crypto currencies get it exactly right. By limiting the units of the currency, they are designed to not blow the trust once they have established it. If they ever get that far, they will not need an intrinsic value anymore. But the problem is, how will they get there?

The only way I could see them getting there is by force. If a government declared a crypto currency as legal tender, and forced everyone to pay their taxes in it, then that would create an artificial high demand for the currency. This demand would quickly stabilize prices and would make people build trust in it. In other words, the government would have created a big, artificial network effect. In that case, even if the government were to withdraw its force, people would likely continue to trust the crypto currency.

But the problem is, how can a potential currency build trust on a free market? The only real solution for it seems to be, by having an intrinsic value. That is how Gold became a currency. Only with an intrinsic value can holders of a currency be secure that if the underlying commodity does not work as a currency they can always use it for something else. This puts a floor into the price.

I do not see crypto falsifying that theory. They are currently not being used as a currency. The volatility is way too high. People who buy crypto currencies perceive them to rapidly go up in value. And since Gresham’s law tells us that bad money drives out good, crypto currencies are not being spend. In addition to that, because of the volatility, and the fact that cryptos cannot be used to pay taxes, businesses do not account in them either.

People are not buying Bitcoins, because they are longing for a reliable payment system. There are a number of very well and cheap payment systems out there, which currently work better than crypto currencies. They also don’t really buy them because they mistrust government money. No, if we are honest, the reason why the vast majority of people currently flock into Bitcoin is pretty much exclusively, because they are hoping to be able to sell that same Bitcoin, in the relatively near future, for a significantly higher price to someone else. Any other conclusion seems delusional in my view.

And this is a big problem. It is an unhealthy economic phenomenon called greater fool investing. Ponzi scheme is another word for it. As long as cryptos get their monetary value from being a speculative asset, they cannot function as a currency. In order to gain trust as a currency, cryptos would need to be as stable as possible in price, ideally only going up with the increased productivity of the economy. But they cannot stabilize their monetary value as long as they are not a currency.

In other words, cryptos, currently, get their monetary value from the projected higher future prices. They get it from the perception that, in the future, there will be a greater fool who is going to buy Bitcoins for an even higher price. But if that is the only reason why crypto currencies have a monetary value, than they will lose this same value, once it becomes clear that the market has run out of greater fools. Once that happens, far from stabilizing prices on a high plateau, subjective value starts to work against the price. The very reason, why Bitcoin had a monetary value in the first place disappears. Everyone runs to the exits to cash in their profits. But there won’t be any buyers waiting for them at those exits. At that point the currencies will fall back to their intrinsic value.

This is the outcome of every greater fool investing scheme in history, and there are many. It is not clear how crypto currencies will be able to go from being a speculative asset to being an actual currency. This would be unprecedented. Greater fool investing schemes always, always! end in a collapse, in which the underlying asset goes back to its intrinsic value. I don’t know of any exceptions. As I explained in detail in my previous article, they always have to end this way, because there is a natural scarcity of greater fools. Someone will have to be the greatest fool.

The crypto mania very much reminds me of the dot com bubble at the end of the 90th. Back then the same two arguments were made, to justify the high valuations of internet companies. The first one was the argument that the internet was this great new technology which would completely change the world. Therefore, everyone wanted to own a piece of it.

This assessment was undoubtably correct. The internet has indeed changed the world, and it has done so far beyond what was even imaginable back then. But that did not stop the stocks of many dot com companies from going to zero. What investors did not realize was that, by owning an internet address, they did not own a part of the internet. They merely owned a few, often useless, information on the internet. The same mistake is now being made with the blockchain technology. Bitcoin owners simply do not own this technology. No one owns it. What crypto investors own is a piece of one application of the blockchain. One of a potentially unlimited amount.

The second argument in the 90th was, that since the internet was so new, old economic insights did not apply anymore. Trying to understand the ‘new economy’, as it was called, with old economics would fail. Old School investors like Warren Buffet were seen as dinosaur, who should better retire. Dot com companies did not have to have any intrinsic value. In the new economy, people were clearly valuing things differently.

This turned out to be an epic miscalculation, and dinosaurs like Warren Buffet had the last laugh. All the dot com stocks eventually fell back to their intrinsic value. That meant that a lot of them went to zero, as they only were useless internet addresses. The only reason why they had a monetary value in the first place was, because people thought that prices would continue to go up. The ones that survived had real businesses with real values behind them. In other words, they had an intrinsic value.

The same argument is now being made for cryptos. Apparently, the fact that they lack intrinsic value does not matter. Old economics does not apply. It is all so new and so great. But I am not convinced. Now does not look very different from back in the 90th. I see no reason why well tested economic theories are supposed to be falsified by crypto currencies. That is why, I predict that the monetary value of crypto currencies, like all other assets, will eventually go back to their intrinsic value, which is zero. It simply seems to be the only reasonable conclusion to draw. Nevertheless, given that I like the idea of an anarchic currency, I hope I will be proven wrong. But I won’t invest my money in pure hope against reason.

Bitcoin – A Textbook Example of Investing Psychology

Bitcoin seems unstoppable. Since I last wrote about it in June, the price has doubled again. And with every new high, the bitcoin community gets more emboldened in their view that bitcoin is changing the world.

I however, remain unconvinced. The blockchain certainly will change the world, but cryptocurrencies not so much. Nothing has changed, bitcoin is still a speculative bubble. The price, in my view, will eventually go to zero. But of course, on its way there, it might first go to more ridiculous highs. A higher price does not mean that it is not a bubble. It just means that the bubble is getting bigger.

It is very amusing to watch this, as it is a textbook example in investing psychology. Having been critical about bitcoin for a while now, I get often asked whether I regret not buying any. The answer is, no I don’t. I don’t regret it in the same way I don’t regret buying that winning lottery ticket last week. Sure, now I know which numbers won the jackpot, but last week I did not. In hindsight, everything looks easy.

It was, and it still is, unpredictable where the price of bitcoin is going to top out. Is it $5000, $10 000, or $100 000, who knows. For all I know, there is an equal chance that tomorrow I might loose half, or even more, of my money. That is not a good bet to take. The first rule of investing is, to protect your downside risk. You always want to invest in things, which have high upside, and predictable low downside. An asset, in which you might double, triple, x-tuple your money, but in which you have an equal risk of loosing everything, is an asset to stay away from, if you are not a gambler. It is not worth the risk.

Most crypto investors, however, don’t seem to realize that there is a risk in bitcoin at all. They are making the classic mistake of confusing a bull market with brains. I know, I know, it feels good being invested in a bull market. This is particularly true for bubbles. You wake up in the morning, only to discover how much money you made in your sleep. What a great way to start your day. The longer the bull market progresses, the more you become convinced that you are indeed an investment genius, and you are already starting to plan for your early retirement.

All of this is classic investment psychology. People are chasing assets that have gone up in the past. Humans cannot help it. Inductive reasoning is deeply rooted in our thinking. We see a trend in the immediate past and project it into the future. That way, investors consistently invest in things that have already gone up by a lot. The fact that something has gone up in the recent past, makes us feel secure that there is little risk in investing in it. After all, the trend looks solid.

But, thinking about it rationally, the dumbest reason to invest into anything is, because it has gone up in the past. I think everyone will agree that the goal of investing is to buy low and sell high. So why buy high? The reason, of course, is that people expect to buy high, and sell even higher. What they overlook is that this is every suckers strategy in a bull market. But eventually, all potential buyers are invested in the asset. Once there are no buyers left, prices have to inevitable come done. This is the start of a bear market.

By its very nature, this turning point comes right at the top of the euphoria, when hardly anyone expects the bullish trend to reverse. This has to be the case, since the trend reverses when there are no buyers left, in other words when everyone is invested. But everyone is only invested, if they are positive about the market. At that point, prices have to come down to attract further buyers. These buyers will most likely be people who are already invested in the asset, and think they have a nice opportunity, to buy a bargain, before the bull market continues. After all, every time prices retreated in the past, the bull market eventually continued to new highs.

Unfortunately for them, that time, the bull market will have topped out and won’t continue. The longer there is a lack of new highs, the more people start to think that now is probably a good time to cash in their profits. But they are trying to sell into a market that has already run out of buyers. This makes prices fall even further. The more prices fall, the more people start to get nervous and will try to cash in. The downtrend in motion is going to feed on itself. Eventually, people are going to panic, and prices crash. At that point there will be virtually no buyers left.

Well, that is not quite true. Usually, investments have some intrinsic value. A company, for example, has real assets with real values. Once prices go below the intrinsic value of the underlying assets, smart investors, who are not driven by primitive investment psychology, come in as new buyers. They know they are buying a bargain. This is the reason, why every assets class goes through cycles of bull and bear markets. The trick is, to buy at the bottom of the bear market, and not at the top of the bull. That, however, is very difficult, for it is at the bottom of a bear market that everyone will warn you to invest, and it is at the top of the bull market that everyone thinks nothing can go wrong.

There is, however, a big problem with bitcoin. It does not have an intrinsic value. There are no real assets behind it. The reason why most people invest in it is, because they think the price only knows one direction, which is up. But because it lacks an intrinsic value, there will be no one stopping it from going to zero in a real bear market. And bear markets always follow bull markets, with almost absolute certainty, because there is never an unlimited amount of buyers. That means that there will be no smart money buying into bitcoin once it crashes. That is the nature of Ponzi schemes.

With mathematical certainty, in crypto currencies, for every investor making a profit, there will have to be others who loose that exact same amount of money. It is a zero sum game. So if you hear about someone having made a lot of money in bitcoin, you know there is some poor sucker who has lost that same amount. That poor sucker might not yet know it though, because he things he can cash in his coins at any time for the price advertised on the internet. Eventually, however, there will be a lot of suckers, who will not only have to cancel their plans of an early retirement, but will instead have to start saving again at a lower level then they started. In numbers, those will be more people than the numbers of winners, as most people come to the party at the late stage of a bull market.

None of what I write here, will likely affect a lot of the readers, who are currently invested in crypto currencies.. They will say, Nico, your investment psychology theory is all good and well, but you don’t understand bitcoin. Bitcoin is different. Bitcoin is not just a Ponzi scheme. It is going to replace the global monetary system. That is the reason why prices are going up. You just don’t understand what is going on.

Again, this is classic investment psychology. People always convince themselves that the bull market they are invested in is different from previous ones. Confirmation bias is one of the strongest psychological biases we have. We always like to confirm our theories about the world. This is particularly true if we have a lot of money invested in these theories. So, I am fully aware that most people reading this, will shrug it off as another idiot not understanding the revolution.

I know how strong this psychology is from my own experience. I have been invested in bull markets in the past, in which I too dismissed anyone criticizing the idea that the upwards trend is unsustainable. So, I have been there, done that, and no, bitcoin is not different. It is not going to replace the global monetary system. Right now, I don’t know of any honest business that does its accounting in bitcoin, or any other crypto currency. In addition to that, all the articles I read about bitcoin, and there are many, even in major newspapers, are all about, how much higher will the price go, how much money can you make in crypto. And that is why people are invested in it, not because of some idealistic reason to fight the government.

So, for what it is worth, be warned. If you have investments in crypto currencies, you are invested in a Ponzi scheme. At the end of this, for every winner, there will have to be the same amount of losers. The only way to not end up on the loosing side is, to sell before everyone else does. I am not saying you should not gamble in this game. That is up to you. Just be aware that it is a risky game, at the end of which there will be a lot of suckers. And you might be one of them, if you play for too long.

Bitcoin – Currency or Bubble?

Bitcoin, the first crypto currency of the world, has come a long way. When I first heard about it, I thought it was a joke. A purely digital currency, really? Since bits are almost free these days, it seemed obvious that the value of such a currency would have to be zero.

It took me a while to understand that bitcoin was actually based on a genius new technology called the blockchain. This technology limits the amounts of bitcoins with mathematical certainty. More than that, it appears to be entirely libertarian. The whole purpose of bitcoin is to create a currency, that is as scarce as gold, and cannot be controlled by governments. But unlike gold, it also comes with a whole integrated, anarchic banking infrastructure. What an amazing idea.

Bitcoin could really be a great form of money. It has almost all the characteristics that we know money needs to have. Firstly, it is durable. So far, the software seems secure, and the bitcoins cannot be destroyed. Secondly, it is divisible. There are many bitcoins, which in itself can be divided into many subunits. Thirdly, it is fungible, meaning all bitcoins are interchangeable. It does not matter which bitcoin you own. And finally, bitcoin is convenient. It is easy to use. In fact it is probably more easy to use than anything else out there that tries to be money. All it needs is an internet connection and a very simple computer, and it can be transferred anywhere instantaneously.

There is however one problem with bitcoin. Unfortunately, it is lacking a characteristic that, according to the Austrian School of Economics, a potential currency needs to have. And that is an intrinsic value. For something to be money, it first needs to be used for something else but being money. Only then will enough people trust to keep their savings in that new currency, because only then they will have a guarantee that they can never fully lose their savings. The intrinsic value puts a floor into how far the currency can fall. It also spreads the usage of the commodity, and therefore establishes a market, before it is used as money. This is, so the argument, essential to give it the necessary trust, and acceptability to function as a currency.

Gold, for example, has been used as money for thousands of years. But it is also an extremely useful metal for other purposes. Even at current prices, it has a limited usage in the industry. If prices were to fall, it would immediately become attractive for all kinds of purposes. That puts an effective floor into the value of gold. It is this what we can call an intrinsic value.

Bitcoin however, does not seem to have an intrinsic value. It tries to jump this important first stage, and wants to be money straight away. The question is, is this possible? Or at least, is this possible on a free market. Sure, it is probably possible if a state forced people to use it. We have seen this happening with fiat currencies like the Euro. But will people voluntarily adopt something as money, that does not have an intrinsic value. With crypto currencies, we are currently in the process of finding out.

So far, one could make a strong argument that bitcoin proofs the austrians wrong. When I discovered bitcoin, the price was already around $30. Not bad for something without an intrinsic value. Ever since, the price has hugely fluctuated, but the tendency has been clearly up. As I am writing this, a single bitcoin sells for way north of $2000. It has more than doubled within a few month, and the chart seems to have turned parabolic.

But is this enough to proof that the Austrians were wrong? I thought about this a lot in the last few years. Since bitcoin already seemed to have a dollar price when I discovered it, I originally tended towards thinking that it indeed can be money without having an intrinsic value. However, I have since more and more changed my mind about this. I now think that bitcoin, or any other crypto currency, will not become a widely accepted currency. The idea that high bitcoin prices in dollars proof the opposite, seemed to have been a bit premature. It was literally wishful thinking on my part. I wanted it to be true.

I am sorry to say this, but I think what we are currently seeing is a classic speculative bubble. And far from being encouraging, this is going to kill crypto currencies in the end. That is because, as long as it is in a bubble, people are going to hoard it. This prevents it from being used in daily business transactions. And once the bubble pops, lots of people will get burned. For good reasons, humans don’t tend to forget painful experiences like that quickly. That means that when this is over, they will have likely learned to mistrust crypto currencies.

From very early on I realized that people who own Bitcoins were not all idealists. Yes, they kept telling me about the great technical functions this new currency had, and how it would create big problems for governments. But a scarily high number of people also told me, that they expected the price to skyrocket and consequently for bitcoin to make them rich.

These two things are not really compatible with each other. Sure there are currently a lot of traders in all kinds of established currencies. That means, the idea of making money on a currency is not unique to Bitcoin. What is unique however, is the scale of upwards volatility that people predicted in the crypto currencies, and also the high percentage of speculators.

Despite the fact that there are traders in all major currencies, the main function of these currencies is to facilitate everyday business activities. Most people use them that way. For that reason the volatility in these currencies is relatively low. It would be a major problem for any currency, if people started to abandon it for their everyday business. That is what we are seeing in a hyperinflation, which usually marks the end of a currency.

Despite the hype that we are witnessing at the moment, bitcoin currently is not used often as an actual currency. In fact, percentage wise, the number of people who use it as such seems to decrease rather than increase, as more and more speculators enter the market. So why are prices going up? Instead of seeing solid demand from real businesses for these currencies, the demand appears to come from people, who are betting on higher prices instead. I currently see a lot of media attention for bitcoin, hardly any of which is praising it as a currency. Pretty much all are promising new investors big fortunes. And that is even true for articles coming from the hardcore bitcoin community itself. But where exactly are these fortunes going to come from, if bitcoin is not used for real business?

And to my knowledge, there really is currently no major business out there that accepts bitcoins. I know, people will tell me that that is not true. Bitcoin can be spend in many shops. Yes, you can pay with them, but that does not mean that the business accepts bitcoin. I still have a euro account in Germany, with an attached VISA card. I can buy stuff with that card in pretty much any shop in the UK. That does not mean that euros are widely accepted in this country. The prices and all the accounting are still done in pounds. My euros are simply immediately exchanged into pounds at the time of the purchase. So what is really happening is that I have to sell my euros for pounds, and then pay the business in pounds. The technology simply enables me, to do all these things in only one step.

The same is happening when someone pays with bitcoins. However, at least for euros, there are many businesses outside of the UK which account in the European currency. But how many businesses are pricing and accounting in bitcoin at the moment? Hardly any, or maybe even none. For a legal business this is indeed close to impossible. Everyone has to pay their taxes in the local fiat currency. But also, it is impossible, because bitcoin is extremely volatile. This volatility makes business calculation and planing impossible.

A lot of people will argue that yes, currently the volatility is high and therefore bitcoin is not yet a currency. But the more people have it, the more it is going to be used as one. That way, over time, the volatility will go down and bitcoin will become a real currency.

There are two problems with this. Firstly, for the volatility to go down, people need to stop using it as a speculative asset. The speculators are driving volatility up, not down. First, they are driving prices up very quickly, which is what we are seeing at the moment. And then, when the time comes that enough people want to take their profits, they will drive down prices even more quickly. If bitcoin wants to become money, the speculators will have to go.

The problem is, they currently appear to be the only people who give the crypto currencies value and liquidity. That is because of bitcoin’s lack of an intrinsic value. At the moment, it is essentially just a Ponzi scheme. In other words, it is a zero sum game. For every winner there must be a loser. Winners are usually the early adopters, if they manage to get out in time. This puts a big incentive on these people to cash in their bitcoins for a more accepted currency. And as mostly in investing, the losers are the ones that come late to the party, which is often the majority of people. Those people will get burned.

That creates the second problem. Once these people got burned, the crypto currencies will gain a very negative reputation. While before anyone new about them, the reputation was at least neutral, after a major crash, the reputation will be bad. And that of course is not helping on the way to establish these currencies as trustworthy for business and savings.

So what we are seeing right now does not look like the breakthrough of crypto currencies. It looks more like the beginning of the end. It is a classic speculative bubble, in which people enter for no other reason but prices going up.

If you don’t believe that this is indeed the main reason for the current strong interest, then explain to me why are all of the crypto currencies going up simultaneously? If we were witnessing the breakthrough of a crypto currency, we would need to see one or two market leaders going up, but not all. The others would need to go down to zero. We cannot have all of these currencies establish themselves. That defeats the purpose of a currency, which needs to be as widely accepted as possible. The fact that there are so many appreciating crypto currencies out there, also proofs the critics right, who argue that, despite the blockchain technology, these currencies are not really scarce. Yes the internal number of units is limited, but there is no limit to the number of currencies itself. Anyone can easily create one.

I am sorry, but what we are seeing right now very much looks like a speculative bubble, a Ponzi scheme. Some people will make a fortune, while the majority will get burned. I am therefore fairly convinced that, although we are still in the middle of the party, the bitcoin experiment has failed. That is not to say that this party will necessarily end soon. But it does mean that bitcoin, or another crypto currency, will not become an actual currency. Before a crypto currency can take off, it will have to have a use in some other wide spread application.

None of this however means that the blockchain won’t be successful. We will almost certainly see this technology transforming the world in many, non money applications. And maybe one of these applications will get widely used, and eventually becomes a form of money. But as for bitcoin, it seems the austrian’s will be proven right again. At least on a free market, we will not see anything being adopted as money that does not have an intrinsic value first.

Dominic Frisby: Is Bitcoin changing the world?

Bitcoin itself isn’t changing the world, but the technological breakthrough that made it possible, the blockchain, is.

The first big point made in Dominic Frisby’s talk concerned the difference between money and cash.  Money can be coins or bank notes, but it can also be bank accounts, air miles, supermarket points, and so on –  anything you can swap for some good or service with the people promising to do this.  Cash is something else again.  Cash transactions depend on no middle man to register the change in the numbers.  Cash is anonymous.  Person A hands over cash to Person B, in exchange for whatever they’re exchanging.  Nobody else is involved.  Neither needs to know who the other person is or how he came by the thing being exchanged.  That is cash, and the point about Bitcoin is that it accomplishes digitally that same kind of one-to-one, completely anonymous relationship.  Bitcoin is digital cash.

For years, computer coders had been trying to replicate that cash  transaction digitally, and none of them could find a way of doing it without involving some kind of middle man.  … The blockchain was the breakthrough tech.

A blockchain is a huge database which is shared by all the people who use Bitcoin, which records every Bitcoin transaction that has ever taken place, and which is updated every ten minutes, with a new “block”. Each update then remains in the Bitcoin blockchain, unchangeably, for ever.

The price of Bitcoin at first rose crazily, but then it fell back.  Boom, and then, not bust exactly, but a big decline and then a flattening out, with a corresponding decline in public excitement and interest.

So Bitcoin hasn’t, despite all the early excitement, changed the world.  The one big Bitcoin change that Frisby did talk about is that it has made life massively easier for online black marketeers.  Black marketeers always want cash, and thanks to Bitcoin the “dark net” is now booming.  It took the FBI forever to shut down just one internet black market site.  When they did, dozens more immediately went online to fill the gap.

Similarly, Bitcoin is only the most prominent of many new digital currencies that the blockchain idea makes possible.  As long as governments control money, they will always have disproportionate power.

But:

We seem to moving into a kind of Hayekian period of competing currencies.

Which is, as Frisby said, nice.

But the blockchain idea has applications right across the computing board, and Frisby then moved on to talking at some length about these.  The application that spoke most appealingly to me was that identifying yourself to your computer, and hence to all the people with whom you interact via your computer, will become a lot easier, less clunky, and more secure.

Much less attractive, to me, was the idea that there might be a lot more political voting.  Blockchains make possible, said Frisby, voting that can be both non-corrupt and immediately counted.  Again, you stop relying on that middle man.

However, influencing the world by giving an Uber customer or a hotelier a good review (both things that Frisby also mentioned), or for that matter a bad review is one thing.  The political obsessives of the world foisting their political opinions, directly, every day, upon everyone else sounds like a nightmare of politicised interference, rather than any sort of libertarian utopia of competing currencies and completely secure internet trading.  Frisby merely alluded to such voting arrangements.  And although I may be jumping to a wrong conclusion here, he sounded like he was in favour of them.  Nevertheless, if blochchainery makes such arrangements possible, and if the politicians embrace them, then that will certainly change the world, and Frisby was not wrong at all to be mentioning such a possibility.

At the end of the bit of his talk where he discussed blockchain tech, Frisby said he had spent too long talking about it, but it seemed to me very reasonable that he should have got a bit carried away about blockchains and all their many potential impacts upon the world.

He ended by alluding to the fact that mobile phones, and in particular mobile phone banking and finance, are taking off big time, worldwide.  More people now have mobile phones than modern toilets.  This is a new world, upon which blockchainery will impact hugely.

If you sense that I feel rather out of my depth in describing all these dramas and excitements, you would not be wrong.  Do you say “blockchain”, “the blockchain”, “blockchains”, “blockchain tech”, or perhaps my own suggestion of “blockchainery”, when talking about this stuff?  I also remain rather mystified about how exactly (the) blockchain(s) (ery) (tech) remain(s) impervious to the attentions of hackers.  If Frisby explained this in his talk, I missed that bit.

There were some mysteriously annoying noises off picked up by the video camera that night, sounding rather like sudden gusts of high wind.  But these noises are well worth listening past, so to speak.  Also, Frisby mentioned that he was suffering from a rather bad dose of hay fever, which would not have been obvious to me if he hadn’t said, but which may account for why there were moments when he seemed to lose the thread, somewhat, of what he was saying.  (In this respect his manner of public speaking reminded me of me.)  But such blemishes did not, for me anyway, spoil this hugely interesting and informative talk.  It lasts under half an hour, and I recommend it.

More generally, I recommend the man himself.  Dominic Frisby is, despite the occasional hesitations in this particular performance, and despite also what he said at the start of this talk about how he keeps his commentary about things like Bitcoin and blockchains separate from his other career as a stand-up comic, a most engaging and entertaining speaker.  His air of good humour and all round nice-guy-ness comes across no matter what he happens to be talking about or how serious he is being about it.

There are many other bits of Frisby video available on the internet, both serious and comic, and there is now of course his book about Bitcoin.  I also particularly liked his earlier book, which he also mentioned in this talk in passing, entitled Life After The State.

Very interesting talk.  Very interesting man.

The Common, the Wizard and the Blockchain by Zach Cope

‘A tragedy, that’s what it is John,’ Bill moaned into his pint.

‘You upset about the Common again?’ John replied. ‘Can’t you just get used to it? So it floods for half the year, and our sheep don’t grow so fat, and the kids keep getting trench foot, but at least it’s ours again – we’re free!’

Bill sighed, ‘I suppose so, but I hoped freedom would be better than this. Obviously it’s better than when the council existed. I mean they were ok at first, with that caretaker Phil they paid for with our money. Most people didn’t mind paying, and grouchy Fred soon paid up when they called in their tax collector to rough him up a little.

 

© Peter Craine

© Peter Craine

The problem was that once Phil retired, the new caretaker wouldn’t work as hard, so they replaced him with two caretakers. And when that skinny one went off sick we ended up paying for three caretakers, and the yearly drainage repairs still took months to be done.’

‘I’m glad we threw them all in the well,’ mused John, ‘they had been telling us what to do for too long,’

‘Of course the next lot weren’t much better,’ John continued. ‘That company we hired seemed ok at first, with their flashy brochures and those presentations at the donkey racing track. ‘Let us use the common for 10 years and we’ll do the work and charge you to use the common,’ seemed a good idea at the time. They did a great job in the first few years, and we were all happy to pay them the fee to use the common. It was sad they were bought out and they had to send round that guy with the abacus.’

‘Yep he was a real magic bean counter,’ Bill replied. ‘I think the tipping point was when he decided they would focus the use of the common on hut owners only, increasing the charge so that the hovel owners couldn’t use the common. I wasn’t surprised when they threw him and his abacus in the well.

To be honest I’d be happy to pay more than my fair share to keep the common drained as it’s worth it to me. I just wish others would contribute a little.’

‘I remember that meeting we had to find out what people would pay,’ John said, ‘Only a few of us turned up. I later found out that lots of people didn’t want to reveal how much they would pay, particularly if it was less than others might pay, and they didn’t want to give up their groats until they were sure the maintenance project was going ahead. I don’t know what the answer is.’

A deep voice boomed from a corner of the Rose and Crown, ‘I have the answer.’

The two friends turned to the man they knew as the Wizard, who sat in front of several empty beer glasses and seemed to be lit by a small book that emitted a flickering light.

Bill shrugged, ‘We’ve tried everything else, what do you suggest?’

‘Payment first,’ Wizard growled, ‘do you have a Node?’

‘What’s a Node?’

‘A Connection then, do you have a Connection?’

‘What’s a Connection?’

‘Sand then, any Sand?’

‘Wizard I don’t know what a Node, Connection or Sand is!’

Wizard sighed, then his eyes narrowed and he tapped the empty beer glass. Bill nodded and signalled to the barman, whereupon the Wizard’s eyes brightened and he exclaimed:

‘I suggest an application of blockchain technology and escrowed anonymous contracts in order to create an algorithmic blind auction, based on the maximum amount each villager would be prepared to pay to prevent the common from flooding. If the required amount is not met this shortfall is announced and the villagers have the opportunity to increase their contribution until the required amounts are met. Payment is only released once the full amount is met, otherwise the groats are returned. Donators may implement rules, such as their donation only stands if a certain percentage of villagers contribute certain amounts, and these rules can be announced so that individual villagers can make decisions based on this. All rules and bids to donate money are entirely private in origin, reducing the incentives for villagers to throw low donators into the well.’

There was a loud silence for some time. The Wizard, apparently noticing the friends’ confusion, seemed to retreat into a fugue, and a solitary tear rolled down his muddy face. John did the only thing he could think of, and pushed a fresh ale across the table to the Wizard, whose sparkle seemed to reappear.

‘Never mind the detail chaps, just whisper the amount you would be happy to pay towards the maintenance on the Common into my magic book here, and make sure the rest of the villagers do the same.’

And so the magic book was used, and surprisingly to John and Bill, the villagers managed to pay for the maintenance of the common that year, and in subsequent years. Occasionally agreement would take some time but everyone seemed happy with the process. The Wizard never had to pay for drinks in the Rose and Crown, although still muttered about Connections, Nodes and Sand. Even the water tasted better as no one was thrown in the well.

15 years after the Wizard’s magic hat was instituted there was a significant shortfall in the amount raised. The community agreed individually and anonymously to increase their donations. The Commons were maintained, and everyone realised that the biggest donator, once he could do it privately and without compulsion, had been grouchy Fred, who had died earlier that year.

Bitcoin founder Satoshi Nakamoto identified

News from Pimlico is that Satoshi Nakamoto has been identified by writer, libertarian and comedian Dominic Frisby, although suspiciously you must buy his book to find out who it is.

The big news item was that Frisby reckons he has cracked the identity of the founding genius of Bitcoin, a mysterious figure who is currently only known by a Japanese alias. Who is he? Read my Bitcoin book, said Frisby. This will be available some time around late spring or early summer, and I will keep Samizdata posted.

Catching up with Bitcoin

So I read on Samizdata this morning that Bitcoin has encountered it’s first truly serious issue. Control over a substantial fraction of the currency has been lost as popular bureau de change Mt Gox has gone bust. The BBC business editor seems to call this right, or at least nearly:

There is no central authority to step in and give any kind of guidance to Mt Gox customers whether their money is safe or gone. And there’s no compensation safety net.

Bitcoin has been set up on the basis of pure caveat emptor. If its participants take any losses in their stride, and learn the lessons, it can go from strength to strength.

If they are unable to develop any kind of governance system that provides confidence that Bitcoins are where they are supposed to be, then it will disintegrate into fringe territory for loons and wild-eyed monetary anarchists.

I think he is right that this is a big test for Bitcoin and of the committment that the participating companies have to keeping it going, but it is not a choice between centralisation or anarchy.

First it is worth noting some confusion about timing. The BBC date the problems back to 7th February and describe them as technical. The leak that precipitated the crisis (according to this sequence of events) is date stamped 24th February. I will trust that Tumblr datestamp over the BBC fact checkers in this case. Also, I like to beleive I have not been asleep for 19 days, although this is possible.

© ZCopley

© ZCopley

I have not yet read much of the detail, but the timeline is important because it reflects how survivable the crisis is for the core Bitcoin system. Just as the Dollar would not be systemically affected by a bankrupcy of Travellex, Bitcoin is not directly affected by the closure of one exchange. The problem is of credibility.

If users begin to perceive Bitcoin as a risky and difficult option then they are less likely to buy into the concept, just as you are less likely to by a Ford if you think they suffer from rust (I am neither a bitcoin nor a car expert, do Fords rust?). If we were to find ourselves 19 days into a crisis with no-one stepping forward to sort it out, then we would have a serious credibility problem, but if we are just 48 hours in then there is still time.

If the people involved in Bitcoin are just chasing a quick buck, and regard this as a nice job to have while the fun lasts, a job the can leave to go and work in computer games in 5 years time then they will let Mt Gox and $409 million of Bitcoin just melt away. If, however, they have decided that their life mission is to make Bitcoin work then they should be willing to step up and put forward the funds and manpower necessary to mount an orderly bankrupcy process (or investigate the theft, retrieve the coins, repair vulnerabilities etc), by way of mutual contractual agreements – just like a proper political anarchy.

We are about to discover what kind of people are running this system.

 

UPDATE: The FT have credible details. It seems there was a “bug” at Mt Gox ~19 days ago, and the site vanished very recently after a theft. When is a bug not a bug?