Thursday, June 2, 2016

All That Glitters

I’m not by nature an early adopter of technologies, fashions, products, or processes. I’m seldom at the very back of the line, but seldom in front either. I didn’t have a personal computer until the early 1990s, 15 years after they became available. I connected to the Web somewhat on the early side for general users: 1994, which is why I still have a Prodigy address (Prodigy was absorbed by Yahoo in 2001). This was for business though – not because it was the trendy thing.  I had no cable or satellite TV connection until 1998 and no cell phone until 2000. There are some advantages to this. The format wars are usually over by the time I buy a product, so I didn’t find myself with a Beta VCR or an HD DVD player. The disadvantage is that pretty much everything I own is already obsolescent. A parallel mix of positives and negatives turn up in my work and investments, which also tend to exclude the latest things. In consequence, the direction of my financial fortunes has closely tracked that of the S&P 500 – neither beating the market nor lagging it.

While this habit sometimes saves me from bad mistakes, it also causes me to miss golden opportunities. One of the latter was the electronic currency Bitcoin. The first purchase to use Bitcoin was 10,000 Bitcoins for a $25 pizza in 2010, which established a value of US $0.0025 per coin. Today a coin trades at $529.20. Not a bad appreciation. One reason I long ignored the quasi-currency even though it has been in the news for years is that I didn’t really understand it – always a good reason to be cautious. So, latish in the day I’ve read up on it. In atavistic fashion I did so in a paper and ink book rather than online: Digital Gold by Nathaniel Popper. I still don’t pretend to understand the algorithms and codes underlying Bitcoin, but at least I have some idea what they do.

The notion of a fully digital currency has been around for more than half a century. The problem always has been a vulnerability to hacking. After all, what computers do best is copy, manipulate, and move around data. If your money is nothing but data – well, you see the problem. In 2008 a workaround for this weakness was described in a white paper by Satoshi Nakamoto, a pseudonym. The real identity of Satoshi Nakamoto never has been established definitively, though he is probably a Californian. In that same year, in order to put the white paper ideas into practice Neal Kin, Vladimir Oksman, and Charles Bry filed for an encryption patent and registered the site A number of other enthusiasts contributed to the project. The originators were not primarily motivated by riches; most were libertarian ideologues who wanted to create a secure private unregulated cryptocurrency independent of central banks that could be used online as anonymously as physical cash or gold can be used in the real world – unlike standard online banking and credit which leave clear records open to government supervision and taxation. Later users and developers (including the Winklevoss twins of Facebook fame) liked the anonymity, utility, and investment potential without concern about ideology.

What gives a Bitcoin value? After all it is not backed by anything. Ever since the end of the gold standard, the same question can be asked of any government sponsored fiat currency including the US dollar. In the case of the dollar, the force of law is the big factor; by law dollars are legal tender for all debts and taxes. In the case of Bitcoin the value lies in the secure accounting system. For the details of how this works, I refer the reader to Popper’s book. Suffice to say that individual coin “wallets” are anonymous and that the blockchain of what coins are in what wallet is distributed among the computers of all the users. Any glitchy (or malevolently inspired) disagreements among computers are resolved by majority computer rule. There is no central data center to hack as there is in a bank: there are millions, thereby creating a robust and secure trading system. Users of Bitcoin are able to create coins through mining (arbitrary intensive computer processing), which provides an incentive for new users to sign up, but there is a hard cap of 21,000,000 coins. Once this number is reached no more may be mined, which eases concern about future runaway inflation. Despite a few well-publicized problems with Bitcoin exchanges (online Bitcoin trading places that by their central nature are more at risk of hacks), the fundamental system works well. Direct trading between individuals – one wallet to another – is well-nigh incorruptible. There is no central registry of owners of wallets. Each wallet is identified only by two 64 character codes. Users of coins value them for anonymity and security.

There are limits to anonymity, of course. If you buy something online with Bitcoins the product still has to be delivered somewhere. This is what brought down the infamous Silk Road, a site which sold illegal drugs for Bitcoins. You can’t deliver drugs to a digital wallet; they are delivered to a physical address, which was all the authorities needed.

Official reaction to the cryptocurrency has been guarded. Some countries simply ban it, though bans are hard to enforce. Ben Bernanke, past head of the Federal Reserve, has spoken positively of it. The most common reaction by law enforcement and regulatory bodies has been to try to subject it (mostly through the exchanges) to the same regulation as the banks and financial industries. If this succeeds it may make Bitcoin more mainstream but would undermine the purpose of the founders.

Other than regretting having missed out on an investment that increased in value by a factor of more than 200,000, I’m not really sold on Bitcoin or its competing cryptocurrencies at current prices. The value of digital gold might not have a ceiling, but there is no floor beneath it either. Besides, it still troubles me somehow that Bitcoins don’t consist of anything I can hold in my hand. Yes, fiat currency is mostly digital in practice too, but in principle you can hold it as pieces of paper. I suppose that means I’m a dinosaur. Ultimately, I still prefer physical gold (atomic number 79), not that I own any of that at present either. But I’m beginning to think I should.

The Black Keys – Gold on the Ceiling


  1. Betamax here, as well as Quadraphonic stereos. Remember those? I also had to get an 8-track for the car too. I was always fascinated by electronic gadgetry growing up, but like you said there's a downside to it: bugs to be ironed out with the newer releases, or newer trends push older ones aside.

    I never could understand the Bitcoin thing either. I looked into it, more out of curiosity, but it seemed a bit too nebulous for my understanding or liking, plus when it comes to finance, silver and gold, I think regulation and watchdogs are beneficial. The whole angle of Bitcoin being sort of clouded and hazy leaves my curiosity out of the picture. As Peter Lynch has said about investments: Buy what you know or use in your daily life. I don't use Bitcoin, but at the same time, I never had a cell phone either (I do now) at least when the trajectory of the stock was rising. Still it's good advice.

    Plus the fact that it seems like Bitcoin was being used for shady underground type transactions: buying and sell drugs, and who knows what else kept me wary. It wouldn't surprise me to know that some terrorist type organizations use it as well. It just seemed like to much of a pyramid scheme to me.

    Sometimes you might miss an investment that in hindsight you wish you had bought into, but at the same time you can loose your shirt that way too. Better safe, than sorry.

  2. I have no doubt Bitcoin is and will be used in the same way as cash in hand – which is to say in ways both legal and illegal. But this is true of any fungible good whether paper euros, gold coins, or barrels of oil. That is part of the original idea of Bitcoin: to keep some transactions private and out of government control and oversight. Still, as in the case of Silk Road, illegal physical goods (whether weapons or drugs) move from one physical address to another and so are not invisible to authorities. Avoidance of taxes and capital controls is a bigger issue, but, as the saying goes, “that’s not a glitch, it’s a feature.” Those who use it know the risks of an absence of regulation and take it on willingly: no bailouts when the price drops.

    Still, like you, I hesitate to touch it, at least at current prices. Besides, I worry that coordinated international tax, regulatory, and prosecutorial bodies may yet come down hard on it. I’ll still opt for golden nuggets.

  3. ...and quadraphonics were great. Keep that system.