Archives for posts with tag: cryptocurrency

It’s been a terrible week for me. I was pretty much in bed for the first two days of the week and I couldn’t eat much until Thursday. Thankfully, I’m feeling close to a 100% now.

Hope your week ahead won’t be anywhere near as bad as mine was this week.

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The Big Read: Cryptocurrency crash offers industry the reality check it needs (TODAY Online)

Great read on the aftermath (yes, you’ve read it first. I’m calling it an aftermath) of investing in Cryptos with accounts from those who had substantial (relative to probably their own net worth) skin in the game.

Good lessons abound and I wish I had kept better records or accounts of what was happening in ’07, ’08 and ’09. I was only in university then and beginning to start learning about the markets but I remember how some guys were trading warrants and making/losing 5-figure sums in the room that us Honours year students were given to use.

That was in ’07 and of course, we know what came after. I would have liked to remember a little better how I felt about the markets in ’08 and ’09 because the sentiment now in 2018 certainly fits those times better.

Of course, in recent times, we haven’t seen the participation of the masses in any widespread, crazy speculation (apart from a tiny group in crypto) so my question now is: What is the next shoe to fall?

As Singapore’s population ages, I suspect we’ll see this sort of thing start to pop up as well. I mean, we hear of elderly folks being conned of their CPF savings through various means (appealing to their vices, taking advantage of their less-than-once-stellar mental faculties etc.) but I’m waiting to see if it happens at the financial institutions level.

I suspect it’ll come from the financial institutions offering a product that isn’t actually designed to give returns much better than the risk-free rate but with all the “protection” of a bond. That sounds like Structured Products which kind of gave banks a bad rep but if you know of anything new, do let me know. It’s fascinating stuff really.

Russell Napier: Equity Markets and Structural Change (Enterprising Investor)

A plausible sounding narrative for where U.S. markets are headed in the longer term. Not optimistic but if it does happen, it would provide a good buying opportunity.

Could we Model Our Retirement Spending like Endowment Funds? (Investment Moats)

Sharing this not because it’s a new idea to me but I think it could be a paradigm shift for many people.

Most people aim to accumulate a certain sum before they retire and upon retirement, spend down the sum and upon their deathbed, leave the rest for their beneficiaries.

It’s not that I think that’s wrong but I think the pros of acting as if your money should last forever outweigh the idea behind spending it down.

For starters, aiming to have the accumulated sum grow/last forever means greater prudence in spending. It also means greater prudence in investing as it requires a proper plan for investing the money instead of sticking to investments that guarantee the principal at the expense of purchasing power.

The biggest downside is what the growing sum of money is meant to do. If the beneficiaries are too few, you end up with a generation of spoiled heirs who will eventually squander it all.

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In case you weren’t following the crypto scene, “hodl” is a typo for “hold” and someone that became a meme for crypto fanboys to buy and hold crypto for the long run.

close up of coins

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As Josh Brown reminds us, this week is roughly the one year anniversary of when most of the world suddenly realised that people were “making tons of money” from investing in something called “bitcoin”.

Plenty of other cryptocurrencies followed but we haven’t really heard of the widespread use case being implemented. That basically means that the usefulness of bitcoin and other cryptos have not been proven yet. The only thing that has been proven is that the technology consumes a shit ton of energy.

I hate to say I told you so but I told you so (here, here, and here).

The next shoe is already dropping

airport bank board business

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By the way, remember when I said that bitcoin and cryptos were just a symptom of easy money going into certain areas of the market and those areas ride a lot on optimism which has a high chance of not coming true?

That whole setup largely explains why tech has been getting hammered the way it has. Just a few months ago, we were talking about companies with trillion dollar market caps. As of today, Apple’s market cap has fallen to just under $750b and is no longer the largest publicly-traded company as measured by market cap. As of writing, that honour belongs to Microsoft.

Now, don’t get me wrong. I’m not saying that Apple is a lousy investment or a company on the brink of disaster. What I’m saying is that the fact that what’s happening in the markets right now is all a reflection of Mr. Market’s mood swings. Just a few months ago, he was totally positive on tech which propelled Apple and Amazon to trillion dollar market caps. Right now, the bipolar Mr. Market is obviously running the other way.

 

In local news

So what does all the above mean for the local market?

Surprisingly, the STI has held up relatively well despite the carnage in tech. Possibly because the STI is financials-heavy and our markets don’t really have a huge pie in the tech sector. The property and financial sector will hit the STI much harder than anything in tech and to be honest, those sectors have been hit pretty hard already in the last few months.

However, MAS has come out to warn that interest rates are on their way up and that households need to “be prudent”*. For some months now, I’ve been saying the same thing. That if mortgage holders aren’t able to service their loans with an interest rate of at least 3%, then they need to be very careful.

The STI is going to fall much further if an economic downturn happens and interest rates in the U.S. continue to march upwards as that will directly impact defaults in the loan sector. I mean, what could be worse than losing your job while your loans get more expensive?

Having said that, valuations on the STI are not demanding. If you ask me, it’s on the cheap side (but not dirt cheap!) but the macro headwinds seem to be blowing hard.

Notes:

*It’s nice that MAS gives a mention that interest rates in SG are closely linked to rates in the U.S. If you want to know why, here was my take on it.

close up of coins

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Just read this (Skyscrapers Too Pricey for Bankers Are Full of Crypto Startups) on Bloomberg and it’s another clear sign of where money has been going and I’ll comment more as I go through relevant bits of the article.

Crypto exchanges and investment funds are leasing space in several of the most prestigious buildings in Hong Kong, home to the highest rents anywhere. Companies from BitMEX to Diginex Ltd. have signed up for a combined 72,000 square feet (6,690 square meters) of grade A space in Central and Causeway Bay this year, according to Colliers International Inc.

The important thing here is that rent is a cost to any firm and space is space. The fact that crypto firms are renting space at prices that investment banks think is expensive is a red flag to me. It’s obvious that these funds have either so much money thrown at them that they can afford to splurge on prime office space or they are severely optimistic about the kind of money they are going to bring in.

Interestingly enough,

Colliers said all five leases were signed after Bitcoin peaked in December and then nosedived. These days, $1.3 million will get you approximately five floors in New York’s One World Trade Center.

It’s interesting that the commitment to space came right at the (most recent?) top for bitcoin prices. The jury’s still out whether bitcoin prices will return to those levels and even if they do, the question is when?

The article also points out that the traditional big spenders are moving away from such spaces.

Not even some of the city’s more traditional tenants like investment banks are prepared to stomach such stratospheric rents.

Goldman Sachs, meanwhile, is relocating its people in The Center in Central to Lee Gardens Three in Causeway Bay after the lease ends. That will save about 30 percent on rent, local media reported in April. The investment bank will however retain its headquarters in Central’s Cheung Kong Center.

It could be a hangover from the Global Financial Crisis (GFC) but it’s pretty obvious that the new money is in crypto and that new money didn’t experience first-hand the horrors of the GFC when credit was scarce.

Once again, I’m not saying that a crash in these asset classes is imminent or that a crash in those asset classes will cause a systemic collapse. What I’m saying is that this pursuit of prime real estate is a clear sign that:

  • New money has/is flowing to crypto.
  • Investors in crypto are pretty optimistic.
  • Credit is loose.
  • The system as a whole is more optimistic than pessimistic.
  • Cashflow constraints haven’t hit yet.
  • I wouldn’t want to be anywhere near crypto or moonshots right now.

Now, the main question is whether crypto firms are already regretting their decision to rent prime office space or whether they still have their rose-tinted glasses on?

It’s the weekend! There was a public holiday, mid-week, in Singapore so this feels like déjà vu. Anyhow, here are my picks for the week.

 

coffee magazine

Some great reads to start your Sunday

After the Bitcoin Boom: Hard Lessons for Cryptocurrency Investors (New York Times)

I hate to say I told you so but…I told you so. (here, here and here for example. For a complete list, see here.)

It’s not surprise that some people have been burnt quite badly by the Crypto boom last year. Also not surprisingly, the ones hurt bad (i.e. relative to their income or net worth) are the ones who can least afford it. These are usually the least informed people in investing and when these people come onto the bandwagon, please get off.

That aside, I’ve noticed how many people are writing about their portfolios these days. It’s a trend that Financial Horse (whom I’ve never actually heard of until a few months ago but is pretty famous) has written this. I’ve been investing and writing about these things for almost 11 years now so I don’t think I qualify as new blood.

Of course, most of them write more about Financial Independence rather than investing per se so I don’t think that qualifies as a sign that we’re at the top. Valuation-wise, the STI is nowhere near exuberant levels.

 

A VISIT TO THE LAND OF A MILLION SHOKUNINS (The Food Canon)

While the subject of the article is about food, the idea of craftsmanship applies to all professions. I’m probably the worse person to tell you about craftsmanship because I’m impatient and lazy.

However, craftsmanship is probably going to be more and more important in the future. Why? Because machines are getting much better at doing the tasks that are routine and mundane. This isn’t a new phenomenon. Mechanization started with the industrial revolution and now, with A.I, I suspect it’s going to move into the realm of white collar jobs.

All the routine and mundane administrative jobs can (and should) go. I love the people in the admin department in my school but seriously, most of their job revolve around filing paper and “copying and pasting” stuff in emails.

The good education Minister actually has a point about emphasizing skills over paper qualifications. The problem is that most parents still have this mindset that qualifications matter. I suspect that that will change quite soon because we now have more and more people who are graduates (thanks SUTD, SIT, SUSS, and all the other private education providers!) but will not be able to find jobs that (1) pay well and/or (2) are interesting to do over a long period of time. It’s not really the fault of anyone but that’s what the world’s going to be like.

If I were a graduate today, I would make sure that I’m also a craftsperson of some sort. I might make good food, good beer, woodworking, an artist, photographer etc. Just make sure you’re really, really good at something that few people are good at. Just like this guy — The Secret Instagram Account Selling Black Metal–Inspired Biryani.

That said, damn…I need to make a trip to Hokkaido.

 

Steve Einhorn’s Bear Market Checklist (The Big Picture)

Recently, I wrote about having an investment plan. Part of the plan is having criteria to know when you should buy or sell. Howard Marks has also written about this before and I can’t wait for his new book to drop in October. Steve Einhorn, an investor and hedge fund manager, has this version which looks nice and simple to follow.

Long story short, it doesn’t look like we’re anywhere near a recession in the U.S. And I guess by now, we all know what that means for Singapore.

Markets in this region have been tanking and the STI has fallen below the 200-day EMA to the point that it’s about to pull the 50-day EMA below the 200-day. While this isn’t a perfectly reliable indicator in itself, this could present a good buying opportunity if this trend continues for another 6-9 months.

Anyway, if you’ve had a tough week, here are some reads to make it better.

 

‘Stingy’ millionaire donates S$3.35 million from S$20 million fortune to charity after his death (TODAY)

I’ve written about people like Agnes Plumb and Ronald Read. Finally, there’s an example from our local shores. Mr. Low Kum Moh was a sub-accountant who was born into a family of fishmongers. The secret to his wealth? Frugality and investing in the stock market over a long time-frame. This is pretty much the same story as the other ones I’ve featured here. The point of it all is that great fortunes can be made by people that most would consider very normal. The trick is to find a strategy that works and keep plugging away at it.

Which brings us to the second read.

 

In Praise of Incrementalism (Rebroadcast) (Freakonomics)

Freakonomics was the book that convinced me that economics could be interesting and that probably saved my university life.

In this episode of their podcast, they make the point that lots of progress in this world are based on incremental progress. The problem with most of us is that we tend to view great events or inventions as if they happened miraculously.

In particular, I love this example that their guest, economist David Laibson points out:

LAIBSON: One has the impression that it’s impossible to save enough for retirement — and to a certain extent, it is impossible if you start at age 50. But if you start early in life, and every year, you contribute let’s say 10 percent of your income, and maybe there’s an employer match, so now we’re up to maybe 15 percent, and you invest that savings in a diversified mutual fund, stocks and bonds, and you have low fees, and you keep going at that year in and year out, and you don’t decumulate prematurely — it’s amazing how that process produces millions of dollars of retirement savings. So it’s kind of hard to imagine how you go from what seems like a little bit of money each year to being a millionaire but that’s exactly the way it works when you work out the math.

Instead, most people often aim for that lottery ticket like buying bitcoin. Most people who do this put very little at the beginning (like a lottery ticket) and when it starts to pay out in a substantial way, they then proceed to bet the farm thinking that what has happened will go on indefinitely.

Unfortunately, this is almost always precisely the time when things start to go bad. Think of someone who bought bitcoin at $500 or $1,000. After seeing the price of bitcoin go to $10,000, they feel like a genius and proceed to place even bigger bets. Well, the bet may have paid off temporarily but look at how it’s turned out.

Which brings us to…

 

Bitcoin Bloodbath Nears Dot-Com Levels as Many Tokens Go to Zero (Bloomberg)

I’ve been writing about the problems with Cryptos since late last year (see here, here and here). To be honest, I’m not as pessimistic about crypto now as I was last year. Of course, there’s nothing fundamental to base my thoughts on but buyers are surely not as euphoric about cryptos as they were late last year.

I suppose the article compares the crash in cryptos to the crash in the tech sector during the dot-com era as prices in both situations have nothing fundamental to support them but I would argue that bitcoin is in a worse situation because, in case of the dot-com stocks, you could at least see if things were getting better based on a turn-around in cashflows and profits.

For bitcoin and cryptos, you have to track whatever these cryptos are meant to replace and see if those things are getting replaced at all.

Anyway, here’s the million-dollar picture from the article above.

bitcoinCrashJun18

 

Have a great week ahead!

close up of coins

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Today, a friend brought to my attention my calls on bitcoin.

To be fair, I didn’t call anything. It’s not like I had a price target on bitcoin or a specified timeframe for the collapse in prices but I did say that it was a mania and the whole damn thing was overhyped as an asset class.

When I began writing about bitcoin (see here and here) in November of last year, bitcoin was approximately US$7000. As of today, bitcoin is roughly US$6,400. In the span of just a few months, Bitcoin has reached a high of US$20,000 and fallen back to slightly less than when I started writing about it.

I don’t know if bitcoin and other cryptos will continue to fall but I’m pretty sure the naive, retail investors aren’t really in the thing any longer. The good news is that unlike the US housing market, I don’t think the institutions are levered up to their eyeballs with derivatives related to crypto. It’s too soon for another financial crisis and crypto seems unlikely to be the kind of asset class that would lead us to one.

I wrote a whole bunch of stuff on crypto which you can read as well.

If the value of a thing can vary so widely in just a few months, can you really use it as money? Can it hold value? Was the fervour speculative?

I think the answer to those questions is pretty obvious.

I’m pretty sure all the students and common folk in South Korea who put their life savings in crypto are regretting it now. They regret their folly which was fueled by greed.

It’s sad that people who obviously don’t know what they’re getting into, lose money on things like this. It’s not much different from those ‘investors’ who bought into structured products during the GFC.

Unfortunately, these things are as old as the hills. We would be wise to know the difference between investing and speculation.

So, the price of bitcoin and other cryptocurrencies have taken hit once again.

I’m not surprised at how things have turned out. I can say that I’m kind of glad that the vindication in my view that it’s a mania has come so quick but who knows, bitcoin and other coins could easily bounce back up 50% from here.

Some signs that cryptos as asset (*cough cough) have been been much too popular of late:

  • A colleague and I are supposed to give a presentation for the economic and financial aspects of cryptos tomorrow.**
  • I recently heard (from two different sources, no less!) that Singaporean civil servants have been punting on cryptos.*** It’s literally a punt because these people are just putting in a few hundred to a few thousand dollars, at best and monitoring the prices a few times a day.
  • Bitcoin and strip club? Anyone remember the days before the GFC when bankers were throwing parties in Las Vegas?
  • Lastly, anyone remember this guy? I was just telling my colleagues how people like Roubini and John Paulson have fallen off the radar since the GFC. It’s quite telling that the bears have been mostly forgotten which shows how positive it’s been for investor sentiments.****

I’m not saying that financial markets are any safer but let’s not deny how overhyped cryptos were in 3Q and 4Q of last year. If cryptos were in a bubble and that bubble has now burst, then I suspect the prices of cryptos should have a lot more room to fall.

Notes:

*Any sound financial advisor wouldn’t advise his/her client to take this on in a portfolio in a huge way.

**When Singaporean pseudo-academia is interested in something, it should set alarm bells ringing.

***These aren’t public servants who have any expertise in the matter by the way. They probably have no idea what’s the difference between each coin and at the moment, it’s not like the differences matter much anyway. If more than a handful of public servants are into something, it’s probably the end of the party.

****Even the latest drop in the financial markets (minor relatively to history) are being framed as a good thing. That’s how positive things are right now.

I was going to do a piece of bitcoin as an asset class but this morphed into a very long piece so I’m splitting this up into two parts. This part covers how to value bitcoin and a guess on what the future holds for bitcoin speculators. Catch up on part 1 here.

Putting a value on bitcoin

If bitcoin is unlikely to be the next form of a widely accepted currency, then why has the price gone up so much? Well, the short answer to that is that the price has gone up because the demand for it has done up relative to the supply.

In economics, the theory goes that there are three reasons why people demand any sort of money:

  1. Transactional purposes
  2. Precautionary purposes
  3. Speculative purposes

The above is for money in general but it’s useful to think along those lines for the demand of any particular form of money. And since almost all societies already have an accepted form of payment (the local currency or a foreign one), the demand for bitcoin is mostly confined to the last purpose- the opportunity cost of holding money is low, therefore, let’s hold in the form of a moonshot such as cryptocurrencies.

The next question, then, is whether buyers of bitcoins are buying it cheap, fair or at ridiculous prices? The only way to answer this question is to figure out what is the intrinsic value of a bitcoin and what is the price today relative to the value.

With asset classes as such bonds, equities or real estate, the typical way to value these assets is to ask ourselves: what are the payoffs (coupons, dividends, rental) over the remaining life of the asset, the associated probabilities of those payoffs and arrive at a value of the asset as it is today. Comparing that with the price one would pay for the asset, we can then determine if the asset is priced fairly or not.

In contrast, valuing an asset class such as commodities or foreign exchange is inherently more tricky. After all, before bitcoin, there was another commodity that was a darling for some “investors”. Unfortunately, this is what Warren Buffett has to say about it:

“I will say this about gold. If you took all the gold in the world, it would roughly make a cube 67 feet on a side…Now for that same cube of gold, it would be worth at today’s market prices about $7 trillion – that’s probably about a third of the value of all the stocks in the United States…For $7 trillion…you could have all the farmland in the United States, you could have about seven Exxon Mobils (NYSE:XOM) and you could have a trillion dollars of walking-around money…And if you offered me the choice of looking at some 67 foot cube of gold and looking at it all day, and you know me touching it and fondling it occasionally…Call me crazy, but I’ll take the farmland and the Exxon Mobils.” – Warren Buffett on CNBC, March 2, 2011 (source)

If you think about the amount of utility by investing in an asset that doesn’t provide any income, then you better be darn right about the capital gains. Unfortunately, none of us are time travellers (if you are, please get in touch!) or have a crystal ball so betting the farm on an outcome that is speculative in nature is a fool’s errand.

Don’t misunderstand, I think gold has some utility. It has served as a hedge against inflation, is used in jewellery and as insurance in the event you need to escape your country but the price of gold beyond the costs associated with those options is pure speculation. bitcoin, I believe, has even less utility apart from being a conversation at a cocktail.

Prof. Aswath Damodaran has a fantastic post on bitcoin and cryptocurrencies and how to think about the definitions of various asset classes (read the full thing here) but I present his brilliant summary of my point:

 You cannot value Bitcoin, you can only price it: This follows from the acceptance that Bitcoin is a currency, not an asset or a commodity. Any one who claims to value Bitcoin either has a very different definition of value than I do or is just making up stuff as he or she goes along.

In short, what a bitcoin is worth is only as much as the next person willing to pay for it.

Will it end well?

This is where things get interesting. What I’ve covered so far shows that bitcoin has value only insofar as people’s willingness to pay for it and the willingness to pay for it, right now, seems to be pretty much only because people think that it’ll continue to go up further. Why would it go up further? Simply because it may gain widespread acceptance and be the currency (amongst many others, crypto or otherwise) of choice.

The last line hints at a plausibility of reality or what Howard Marks calls a “grain of truth”. Unfortunately, Marks was referring to how bubbles form and in his checklist, he listed nine bullet points that lead to a boom/bubble:

  1. A benign environment
  2. A grain of truth
  3. Early success
  4. More money than ideas
  5. Willing suspension of belief
  6. Rejection of valuation norms
  7. The pursuit of the new
  8. The virtuous cycle
  9. Fear of missing out

Of course, Marks was referring to the investment climate in general but when applied to just Cryptocurrencies, I think 2, 6 and 7 have either already been covered or are pretty obvious. What some people don’t realise is that 1, 3, 4, 8 and 9 have played out in some fashion.

The general investment environment has been pretty positive since Trump’s election with equity markets all up substantially since the beginning of the year (point 1). The price of bitcoin going up 700% in one year has already given plenty of laypeople some success (think bitcoin jesus and Ms bitcoin Mai) and that the feeling that the only way for bitcoin is up (point 3 and 8). After all, when civil servants (that’s referring to me, by the way) in the education sector start about bitcoin, beware.

As for point 4, the whole concept of Initial Coin Offerings (ICOs) just underscores how there is too much money floating around that people are willing to part with money* for nothing more than a digital representation to an idea. The worst part about the idea is that the startup is practically joining a space that is already crowded with a thousand other similar ideas. And that’s just in the cryptocurrency space. Softbank has a 100 billion dollar venture capital fund which just shows how much money there is floating around to fund ideas that are probably more moonshots than sure things.

As for point 9, there are now traditional Wall Street firms getting in on the boom (admittedly, they are just dipping their toes there) and there are cryptocurrency hedge funds and even fund-of-funds. If you don’t know what those mean, no worries. Basically, it just means that more money is being channelled towards cryptocurrencies.

Closer to home, just a few months ago, a student of mine was looking into buying bitcoin and while my school may not be looking to buy the currency, the fact that suddenly interest in the subject has increased drastically shows that no one wants to miss out on knowing what this exciting, new thing is all about. News about Google searches for buying bitcoin getting more popular than buying gold just strengthens the point that there are many people who are trying to get on board a ship that (perhaps?) has sailed.

Well, that’s just Howard Marks’ checklist. I saw a chart (it’s a little dated) that compared the rise in the price of bitcoin to other bubbles that have come before it.

 

bitcoinVsBubbles

The thesis here is that most bubbles increase a 1000% over 10 years before popping.

Well, from the chart, bitcoin rose a 1000% in just three years. And with the benefit of hindsight, we now know that the bubble hasn’t burst but has expanded further to 3700% since 1 Jan 2015.

So, that’s it from me. I think I’ve pretty much convinced myself that while the technology underlying bitcoin has its use, I’m not so optimistic on the token itself given the competition from existing currencies as well as new cryptocurrencies. And it’s ironic that the price of bitcoin is still quoted in USD so that says a lot about what our anchor still is.

Furthermore, the psychology behind bitcoin has pretty much fueled a buying frenzy (as evidenced by the exponential increase in price) and has checked off a lot of boxes that have plagued other manias before it. I’m not sure if the bitcoin/crypto boom is over but I’m pretty sure it’s not going to end well.

 

 

snarky notes:

*remember, money can be used to consume goods today or invested for surer returns.

I was going to do a piece of bitcoin as an asset class but this morphed into a very long piece so I’m splitting this up into two parts. This part covers what bitcoin is and the economics of money as applied to bitcoin. Part 2 is up.

First of all, bitcoin (or any other cryptocurrency) isn’t blockchain.

My thoughts are on bitcoin* which refers to the unit of currency and not Bitcoin which refers to the blockchain technology that the currency rides on. There is a difference and I believe blockchain has its uses but what I’m more interested in is bitcoin (as a proxy for cryptocurrencies) because that’s where people are putting their money into which has caused the price of bitcoin to be up some 700% this year alone.

First, what is bitcoin?

bitcoin is a digital token created by an unknown person or person(s) with the alias Satoshi Nakamoto. bitcoin can be used for electronic transactions and is created when computers (mining rigs) solve complicated mathematical problems.

As such, no one controls the supply of bitcoin and the theoretical maximum number of bitcoins is 21,000,000 bitcoins. Facilitating the transfer of bitcoins is the decentralised network that bitcoins transact on. People with mining rigs power the network in the same way people distribute content via a torrent file. Their systems provide the computational power needed to update the records anytime someone transacts using bitcoin. For this, the quickest one that solves the computational problems needed to confirm the transaction get bitcoin. This is essentially the process of mining bitcoins.

Bitcoin is set up to reward users for verifying transactions. Miners who package transactions into “blocks” receive two kinds of rewards: The additional Bitcoin they produce by using their hardware to solve mathematical problems (an income stream that will eventually cease since 21 million bitcoins are the maximum that can be mined) and the transaction fees paid by users to get their payments into blocks. – Bloomberg

In short, bitcoins are a digital form of currency just like how you would spend cash (e.g. USD or SGD) to buy virtual currencies in a game (e.g. “gold” in the mobile game, Candy Crush) which you can then use to purchase things. The only difference here is that it’s possible to use bitcoin to pay merchants that accept them rather than being restricted to only using “gold” (the candy crush currency) to buy power-ups or items in Candy Crush.

When making payment using bitcoin, the Bitcoin (deliberately using capital “B” here) network facilitates the transaction and every computer on the network gets updated with the same record of which account the bitcoin now belongs to.

Supporters of bitcoin champion bitcoin as a new currency for the following reasons:

  1. No one entity controls bitcoin and hence, can’t cause a debasement of the currency through undisciplined expansion of the money supply.
  2. It’s relatively anonymous because bitcoin addresses aren’t tied to a real-world address or name, although the public ledger will show how many bitcoins are held by a particular bitcoin address.
  3. A transaction is supposed to be fast and low-cost.

The economics of bitcoin

The problem with bitcoin is that being a digital currency, there is no shortage of other competing currencies. Existing competitors include all the other currencies in the world and there aren’t many technical barriers to entry for other digital currencies to enter the space. At last count, there were more than a 1000 cryptocurrencies in circulation.

bitcoin’s only advantage is the first-mover and top-of-mind recall when it comes to cryptocurrencies. In order to become a viable alternative, it will also need existing currencies to become shaky enough that they find alternatives. What comes to mind are countries that are experiencing bouts of inflation due to the government mismanaging the local currency. Even then, bitcoin has to contend with major currencies like the USD and Euro.

As a form of money, bitcoin may be portable (all you need is to connect to your digital wallet) and divisible (see here) but the first point requires internet access which could be stumbling blocks in countries where internet access is expensive.

Also, transaction costs for bitcoin do not seem to be as low as it’s touted to be. Due to the nature of how transactions get recorded, much computational power is required to solve the mathematical problems needed to record a transaction. Depending on the volume of transactions (which vary), this can cause bottlenecks and those with the computational power are starting to charge different prices in order to facilitate transactions. As I write this, the median transaction fee for a size of 226 bytes is 103,960 satoshis** or 8.30 USD. Try convincing merchants to accept or people to pay for a coffee, beer or sandwich using bitcoin if that’s the processing fee.

The biggest issue so far is whether bitcoin qualifies as a store of value. In economics, anything considered money should be a good store of value. Simply, this means that if I can buy 10 beers with 1 unit of this currency, I should be able to buy roughly the same amount of beers with the same unit of currency a week, month, or even, a year later.

And this is where bitcoin truly fails. In fact, the only reason most people have suddenly sat up and taken note of bitcoin is due to the fact that bitcoin has increased some 700% relative to the USD within this year alone. And within weeks of hitting 7000 USD, it fell to 6000 USD and then within a few weeks, shot up to 8000 USD.

While the increase in the price of bitcoin is good for holders of bitcoin, we have to remember that those who sold their bitcoin is kicking themselves in the foot. From a medium of exchange point of view, someone who used a bitcoin to buy a computer earlier in the year is kicking himself because he or she can now buy 7 while the merchant who accepted bitcoin (hopefully he/she didn’t use it to pay off a supplier) has now seven times more profit as compared to the start of the year by doing absolutely nothing! What kind of viable currency causes such changes in purchasing power?

While bitcoin, if accepted, will reap network economics (one phone is useless on its own but as more people have phones…), it seems unlikely to me, at this point in time, that bitcoin is going to be a viable alternative to a shitty currency.

Stay tuned for part 2.

Update: Part 2 is up.

snarky notes:

*Or any other cryptocurrency for that matter but bitcoin is probably the most prominent and manic example right now.

**Another reason why bitcoin is a terrible currency is due to the notion of divisibility. People hate decimals and having to come up with names like ‘satoshi’ for a fraction of a bitcoin just makes everything more confusing when thinking of the value of one thing relative to another. i.e. which looks like a better price for a pint of beer? 10 USD, 126,105 Satoshi or, 0.00126105 BTC?