I’m not an expert on bitcoin or cryptocurrencies in general by any means. I have some programming experience and an interest in finance and economics, and I am acquainted with people who are more knowledgeable than I am in both fields. However, out of curiosity I recently looked into the subject and came to a few conclusions about it (albeit from an amateur’s point of view).
The short version is that you’d be better off buying tulip bulbs. The long version is a little more complex.
Cryptocurrency and Some Preliminary Concerns
For those who are confused by the subject (which is easy to be), I’ll try to give a broad high-level overview. Cryptocurrency is an attempt to set up an alternative monetary system entirely in the digital sphere, where strings of complex data created through specific algorithms function as currency. The entire network of users then employs another, related algorithm to validate these strings and track their transfers between users at all times, creating a string of validated transaction history called a “blockchain”, thereby theoretically preventing fraud.
One way to to look at this, is that essentially cryptocurrency is an extremely dull and very complex massive multiplayer online game wherein scores are continuously tracked, recorded, and validated across the entire network and can be exchanged between users, and where the game data is tracked by each and every individual gamer rather than a central server. The idea is to create a de-centralized, anonymous economy outside the need for a governing authority.
The first problem I really hope you are seeing comes right out of that description: so, you want an anonymous, decentralized, secure economy, and your solution is to have ten-thousand strangers tracking and validating every transaction at all times? This is called a ‘decentralized ledger’ and the assertion is made that sharing monetary data publicly and continuously across a massive, decentralized network renders it nearly impervious to fraud. Especially since a supposedly bad actor would need to control over 50% of the computing power of the network to have a noticeable effect on it.
Except, even if that’s the case, which would only account for directly trying to insert a false transaction into the blockchain; it does not account for any of the countless other possibilities for fraud represented by such a system.
Some examples might be someone setting up his bitcoin software to skim pennies or half-pennies off of each transaction and then launder the money through the bitcoin market itself. Or someone could set up multiple accounts under different aliases, ‘sell’ the bitcoin back and forth to themselves at steadily increasing prices, and then use that decentralized public ledger to sell their cryptocurrency at an inflated price. Or finally, even if you didn’t touch the transactions themselves, you could use them as back-door access for data harvesting.
Beyond all that, there’s still something else that might still have gone unnoticed, which is, as an Investopedia article stated, “There is no central authority to keep tabs on all bitcoin transactions, so the participants themselves do so by creating and verifying "blocks" of transaction data.” True, there is no central authority keeping track of the data. However, the data has to be run through, validated, and interpreted by software. That software has to be provided and maintained by a team of developers, usually in the employ of some company or another. In practice, it will either be one of a handful of significant companies dedicated to that purpose or it will be one of numerous smaller, independent teams or even independent developers.
In the case of the former, you have exactly what you’re supposedly trying to avoid: a central authority. In the case of the latter, you are entrusting your monetary information – which is continually run across a network – to anonymous strangers on the internet, with all the attendant dangers of hacking, malware, data-mining, and so on. As noted above, the possibilities of exploiting ‘bitcoin wallets’ as they are called are nearly endless for a skilled hacker or fraudster.
And in any case, there’s the obvious major issue that bitcoin and other cryptocurrencies only function, let alone have value, when there is a stable power grid and internet connection available. One which both you and the seller have access to and don’t mind running your exchanges across.
What’s in a ‘Bit’ and What’s it Worth
Apart from the security and centralization issues (of which admittedly I’ve only scratched the surface), and assuming the points I mentioned were or have been corrected or accounted for, it really wouldn’t matter. For in my estimation there is a much more important problem I see with cryptocurrencies, and that is that it is simply a meaningless strings of data that has no value apart from the fact that people expect it to rise in value. In short, it is a 100% speculation market, the bubble of all bubbles.
Now, the answer may come back “well paper money doesn’t have value either.” But, in fact, it does. The value of fiat currency lies in the fact that it is backed by the State. If I acquire a genuine five-dollar bill, the State guarantees and legally enforces that it will always and everywhere be worth five dollars. The value of the five dollars comes from the fact that any seller under the authority of the issuing government is legally required to accept it as five dollars (things get a lot more complicated when you ask “and what is five dollars worth?” but that’s a tale for another day).
However, the entire point of cryptocurrency is that no one is backing it. It is worth only what someone is willing to pay for it. Thus, something like bitcoin only exists relative to actual currency; its value is expressed in terms of being worth so many dollars only because there is someone who is willing to trade that many dollars of backed currency for that many bits of un-backed crypto (or pseudo) currency.
Say I sell a portion of bitcoin to someone for a hundred dollars. If he has any sense, he will only buy it if he expects that it will either be worth more than a hundred dollars in the future or that he can trade it for something that is worth at least a hundred dollars. In short, he expects at least that much value from bitcoin, and the only reason anyone would trade him something for that bitcoin is if they think they can get at least that value in backed currency. In either case, the backed currency is still the standard by which bitcoin is judged.
This means that bitcoin will never be a viable currency in its own right, but will always exist relative to backed currency because the backed currency has a guaranteed value and bitcoin or other cryptocurrencies does not. This also means that bitcoin doesn’t work as a hedge against inflation, which are usually things like bonds or works of art that always retain roughly the same level of inherent or guaranteed value regardless of the state of the currency.
However, when it comes to bitcoin or other cryptocurrencies, its value keeps changing based on speculation and based on how much backed currency someone thinks he can get for it. If the backed currency loses its value, then so will the amount of bitcoin you expect to be able to get it with, even assuming the bitcoin market doesn’t crash in the meantime. Thus a Monet’s monetary value rises and falls with inflation because people will always want the Monet to roughly the same degree. Nobody wants the bitcoin except for the chance to exchange it for a certain amount of backed currency.
Does Bitcoin Have a Future? Probably Not.
There are only two possible ways that the bitcoin craze can end. Either it will become generally understood that bitcoin will never be a viable currency and people will stop expecting it to rise in value, or the government will step in to regulate or outlaw it (or, more likely, both). And once either of those things happen, the value of bitcoin will quickly fall to the value of meaningless strings of data. That is, zero. You see, the one source of value that bitcoin seems to have going for it, independent of speculation, is its supposed anonymity and de-centralization. But once the government gets involved with any degree of seriousness, that goes away.
Someone might answer, “Ah, but the government can’t regulate it; it’s decentralized!” No, all the government has to do is rule that only certain “legitimate” bitcoin software must be used in all transactions, so as to provide a means to identify users and transactions for tax and law-enforcement purposes. You would thus be forced to either sacrifice the entire reason for using bitcoin or trust some third-party software put out by those operating outside the law. Not to mention exposing yourself to prosecution for tax evasion.
In the event the government actually did find it impossible to adequately regulate bitcoin, they would simply ban it, ruling that anyone found trading or selling bitcoin would be subject to fines and jail time. Not to mention that this would, again, prevent legitimate companies from providing and maintaining bitcoin software, destroying what little stability the market has. Now someone might protest, “But that would be unconstitutional,” to which I would answer (as always), “Good luck with that”. From the 1930s to the 1970s, it was illegal for Americans to own gold bullion, so nothing at all would prevent the State from banning bitcoin.
The answer may come back “But the government outlaws drugs and people still pay good money for them.” Yes, because drugs have an inherent value. You will always be able to find people who are eager to buy drugs in order to use them (though even then, most people will not buy drugs simply because they are illegal. Who would buy something valueless in itself that is also illegal?). Likewise gold is recognized as having an inherent value, because you will always find people willing to buy gold to use it, or simply because it is known that gold will always be worth something due to its immemorial cultural usage.
And even if it was banned, it wouldn’t even be useful as a black market currency. Unless you have a completely black market economy, to the point where people never have to rely on white market goods, then no one would accept as payment something that they can’t either convert into cash (i.e. something that has inherent value) or use as currency in the white market. After all, there is a reason criminals don’t accept counterfeit money for their black market deals.
Someone could also reply, “But what about if the U.S. Government or the world monetary system collapses….” If that happens, it is doubtful that you will have the electrical grid or the internet providers you need to even access your imaginary fake money. Besides, as I mentioned before, who would buy it under those circumstances? I can tell you right now that I’m not exchanging food or shotgun shells for meaningless strings of data that I need a special software and an internet connection to even attempt to use.
In all of the above scenarios, I hope it is clear that there will always be a point where no one in their right mind would expect bitcoin to go up in value, and thus have any reason to buy it even if they still could, nor to exchange goods and services for it. Its value would fall to whatever inherent value it has, which, again, is non-existent. So if you’re thinking of investing in bitcoin or other cryptocurrencies, I advise you to go buy tulip bulbs instead. They have a better chance of retaining their value, and if nothing else you can plant them to make a nice garden (or eat them if things get really bad).
Photo Credit- foto.wuestenigel.com