BITCOIN:  BUYER BEWARE

Here is our attempt to try to uncover the mystery of this crypto currency.  What is it?  Where did it come from?  Where is it going?  Is it all a fantasy?  Who accepts it as payment?

As the last decade’s financial crisis worsened consumers began to wonder if their bank account balances were safe and if the slips of printed cotton in their wallets still held value, Satoshi Nakamoto was busy devising a currency regime that totally bypasses governments and banks.

What started as an experiment among a few computer geeks has become an international sensation, drawing in everyday consumers.  As more people get involved, the price of Bitcoin climbed higher, which pulls in more people, perpetuating the cycle.

As recently as December, one Bitcoin cost $18,000, up from less than one cent in 2009.  This week, the value is about $14,500.

It’s easy to find people who forecast Bitcoin to rise past $20,000, $100,000 and even $1 million.  Their message is simple.  Get in now before the price goes higher, and enjoy the thrill of making money for nothing.

Many, however, don’t agree.  They see Bitcoin as a great idea on paper, but nothing more than a glorified Ponzi scheme in practice.  While the cryptocurrency will probably survive for many years, it’s more likely that the price moves closer to zero than $100,000.

Caveat Emptor, or buyer beware, should be the call of the day.

Bitcoin’s Arrival

Imagine holding your wealth in a currency that the government could never devalue, a currency that was never checked at the border.  As long as you have access to the internet and remember your passwords, you could access your currency anywhere in the world.

And as long as vendors accepted it (big question), you could immediately purchase anything, anywhere, with no conversion or exchange required.  You could also send money to anyone, anywhere, with a few keystrokes.

No more Western Union.  No need for bank wires.  No government-issued IDs required.  No stating the purpose of the transfer.  Nothing, just send what you want, where you want, when you want, with zero interferences from anyone.

Nakamoto (or they, we don’t know for sure who or how many are behind the pseudonym) developed a closed environment for creating a set amount of a new currency.

New Bitcoins are created by computer operators, called miners, who use their computers to verify Bitcoin transactions.  Every transaction is added to other transactions to form blocks, which are then linked to create the blockchain.

The blockchain contains every Bitcoin transaction that has ever taken place.  Miners reverify the entire blockchain, and then several miners must independently verify new transactions to form blocks.  Through this process, the full ledger of all transactions resides on many computers and can be downloaded and reviewed by anyone at any time.

If someone tries to add a fraudulent transaction, say moving Bitcoin from a fake account to a real account, then it would not be independently verified and the miners would reject it.  This methodology keeps bad sectors from counterfeiting new Bitcoin.

As miners verify transactions, they are awarded small amounts of Bitcoin, which is how new currency enters the system.  The original program will only allow 21 million Bitcoins to be created, and the goal is to create them in a steady stream for years.

Over time, Bitcoin has attracted many users.  Not all of them are striving for the libertarian goal of using currently untainted by government interventions.  Some simply want to operate outside of government control because they’re criminals.

Enterprising people set up exchanges like Coinbase where you can buy and sell Bitcoin.  And most of these exchanges also serve as online “wallets,” which allow you to store your Bitcoin so that you don’t have to go through a lot of hassle to do it yourself.

The online wallets and exchanges make using cryptocurrencies easier, no doubt, but they’re not free.  The going rate for an exchange is about 3%, which torpedoes another main reason to use a cryptocurrency.

Once you have some, you run into another problem—where to spend it.

Using Bitcoin

Recently, a Subway franchise in Pennsylvania started accepting Bitcoins, and so did a Maserati dealership in California.  But not many establishments accept it and the list isn’t rapidly expanding.

Most transactions involving Bitcoin are either people purchasing to hold it in the hopes it will go up, or purchasing it so they can use it to buy other online coins called tokens.  Precious few people use, or even want to use, Bitcoin for transactions involving everyday living.

As the price of Bitcoin appreciates, people hold them, which highlights one of the biggest issues with the cryptocurrency.  People aren’t treating it like a currency at all, they are treating it like an investment.

Bitcoins are not productive assets.  They don’t create anything.  If they are a currency, then they should  represent a medium of exchange that is divisible, accepted by the population, and be a storehouse of value.  But because people are bidding up the exchange rate, they are driving the perception that the price will go much higher.

Today’s Bitcoin buyers hope that tomorrow’s buyers will pay much, much more.  What if they don’t?

Bitcoin Today

While the government is not involved (yet!) and banks are sidelined, Bitcoin is expensive to buy and sell, almost always requires intermediaries unless you are a computer whiz, and, so far, it’s not treated like a currency.  Buyers don’t intend to pay their electric bill with it or use it to buy gas.  They only have one goal:  sell it to someone else at a much higher price.

Even though Bitcoin’s price has not gone up in a straight line, it has rocketed higher in the last several years.  What if the situation reverses?  What if buyers lost interest in holding the cryptocurrency?  What if the government gets involved?  At that point, most current owners would rush for the exits, driving the price even lower.

Given that Bitcoin has no natural market, it can go to zero, erasing all value for current holders.  The same can’t be said of government-issued currency.

The IRS is fairly certain that many people buying and selling Bitcoin on Coinbase aren’t reporting any of their transactions on their taxes.

Coinbase is fighting the warrant, but they’ll eventually lose.  The IRS has a compelling case.  When it eventually demands back taxes, penalties, and fees from Bitcoin buyers and sellers, it could send a chill through the markets.

Bitcoin’s Economic Bite

Let’s say I’m wrong.  Instead of meeting an ugly and untimely near-death, Bitcoin gains strength and eventually becomes the currency that Nakamoto envisioned.

The transition would shift money out of U.S. dollars, driving down the value of the buck.  On the flip side of that, higher-priced Bitcoin would aid those who own the cryptocurrency, but penalize those who still operate in dollars.

That would include the growing population of Social Security recipients, as well as anyone receiving transfer payments, such as Supplemental Nutrition Assistance Program (SNAP) credits.  Essentially, we put the elderly and the poorest among us at an economic disadvantage.

It’s easy to see how the government, in addition to compelling the use of greenbacks through taxes and government spending, could proactively limit the use of crypocurrencies so as to stop bad outcomes.  In one fell swoop the Feds can protect their turf and argue that they’re acting in the best interest of the most vulnerable members of society.

Frankly, it’s still a bit of a mystery.  Bitcoin has failed, or rather not even been tried, as a true currency.  To date, it simply appears to be a Ponzi scheme with zero assets, zero productivity.

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1 Comment

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One response to “BITCOIN:  BUYER BEWARE

  1. Great piece Art. I’ve been minimally researching cryptocurrencies for a few months now and you’ve crystalized it well. However, I may differ from you subtly, in that I believe that cryptocurrencies are here to stay, not so much as a replacement currency, but rather as a “token” that can be used as a compliment to government currencies. We’re already seeing this with certain countries that have experienced rapid currency devaluations and natural or man-made disasters that have hampered access to financial institutions. In these instances we’ve seen people running to cryptocurrencies. It’s also important to note that in the 9 years that Bitcoin has been around no one has been able to hack it. Anyway, here’s a lengthy, but quite fascinating article from the New York Times Magazine you may enjoy – https://www.nytimes.com/2018/01/16/magazine/beyond-the-bitcoin-bubble.html?hp&action=click&pgtype=Homepage&clickSource=story-heading&module=first-column-region&region=top-news&WT.nav=top-news

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