As a follow-up to yesterday’s guest post, here are a few of my own thoughts about the challenges and opportunities. For full disclosure, I don’t currently own or have ever owned Bitcoin or any other cryptocurrency myself. I reached Financial Independence (FI) years ago the old fashioned way with equities and a little bit of real estate. Only a few weeks away from early retirement, I have no need to throw “Hail Mary passes” with my money! But just because I’m interested in finance and technology I should have an opinion, of course, so here are some of my random thoughts in random order on Bitcoin and Cryptocurrencies…
The great opportunity of cryptocurrencies: payment finality
Suppose you sell your used car for $2,000. Would you accept a personal check? Certainly not from a stranger! And I wouldn’t even accept one from a few people I do know, but that’s a different story! 🙂 How about a certified or cashier’s check? It provides more protection but even they have been stolen and forged, more on that below. In fact, even in the best possible case that the check is legit, your bank will put a hold on the deposit, especially for larger amounts. It happened to us after selling our apartment: that extremely big check, the largest amount I’ve ever deposited into my account, has a hold of nine days (!) before we have access to the funds. Seriously? It takes nine days to verify a check? Thanks for nothing, Wells Fargo!
So, after you have already parted with your possessions and signed over the title, you’re still waiting for your money to arrive! But even if the bank removes the hold on the check you’re still not in the clear. There have been documented cases where a check cleared but was later found to be fraudulent. The bank will want that money back! From the Office of the Comptroller of the Currency (part of the U.S. Treasury Department):
When you deposit a check into your account, your bank generally is required by law to make the funds available within a specific period of time (usually, one business day for a cashier’s check or other official instrument). This is true even if the check has not yet cleared through the banking system. Therefore, even if the funds have been made available in your account, you cannot be certain that the check has cleared or is “good.”
Your bank also may not be able to determine that the check is fraudulent when you deposit it. Rather, your bank may learn of the problem only when the check is returned unpaid by the other bank—which may take a couple weeks or more. Scammers try to make the item look genuine, which will delay discovery of the fraud. Once the item has been returned unpaid, your bank, generally, will be able to reverse the deposit to your account and collect the amount of the deposit from you.
[…] If you find yourself in this situation, you ordinarily would have a remedy against the person who wrote the check. However, you will have great difficulty pursuing any remedy against these scammers, especially if they reside in a foreign country or have disguised their identities.
So, Bitcoin and other cryptocurrencies fill an important void: If you receive an electronic payment via Bitcoin it is about as final as it gets. There are no chargebacks and you receive the money instantaneously. It’s like having cold hard cash in my hand but with the convenience of an electronic currency!
Give me your huddled and financially repressed masses…
In the excellent ChooseFI podcast on Monday they had a guest who had his Bitcoin epiphany observing guest workers getting fleeced with high fees when they send money back to loved ones in their home country. Bitcoin would have made those transactions hassle-free and much cheaper than a trip to the local money store. But it’s not just the unbanked and undocumented in the affluent countries that can benefit from cryptocurrencies. Hundreds of millions of people, maybe billions, live in countries with much less liberated financial markets than we are used to. Whether it’s the fear of taxation or confiscation (is there a difference?) or capital controls, or other forms of financial repression. There are a lot of potential users who don’t trust their own currency and/or government and a cryptocurrency might a good way or the only way to move money to safety.
The flipside of payment finality: fraud, hacks, loss of Bitcoins
Of course, finality also bites you sometimes. If your computer gets hacked or your password to your Bitcoin Wallet, or the entire site is compromised (Mt Gox), then the money is gone. Maybe you could have recourse against the exchange but it’s probably defunct and bankrupt after the hack. Good luck getting the money back!
People who don’t trust the exchanges due to concerns that they can be hacked might store their Bitcoins offline. Say on a thumb drive or even on a paper printout. But that’s not foolproof either. Here’s a story of someone who accidentally threw out a thumb drive with 7,500 Bitcoins, now worth over $75,000,000. That money sits in a landfill now! Especially if Bitcoin wants to go more mainstream there would be some security issues to be resolved. But they have to be resolved in a way so as to not throw out the baby with the bathwater, i.e., by preserving the payment finality, anonymity, and convenience of Bitcoin.
A third Bitcoin investment option: Futures
Aside from holding Bitcoin directly or gaining exposure through the “right” equities with Bitcoin/Blockchain exposure, another way of gaining exposure to Bitcoin would be to buy Bitcoin futures. One can trade Bitcoin Futures both on the CME and CBOE. The CME contract size is 10 Bitcoins, while on the CBOE one can trade one Bitcoin at a time. The Futures price tracks the spot (cash) price pretty closely, see chart below. And buying the Future avoids the risk of hackers sneaking into your account and sending Bitcoins on a one-way trip to Pyongyang.
A Bitcoin Best-Case Scenario
So, how big could Bitcoin become? Some pretty jaw-dropping numbers are floating around: $50,000, $500,000, a million dollars? How reasonable are those estimates? How big can a currency become? Well, let’s look around and compare. Let’s look at the M2 money supply of a few countries/regions: I compiled the M2 money supply numbers of the “Big-4” central banks: U.S. Federal Reserve, ECB, Bank of Japan and Bank of England. Note that the M2 supply comprises not just currency in circulation as banknotes and coins (only about a trillion USD, for example) but also the much larger category of “electronic money” such as demand deposits (checking accounts) etc. The total M2 supply is just under 40 trillion dollars for the big 4 central banks. Round that up to maybe 50 to 55 trillion dollars to include the remaining countries (I’m missing China) and we’re talking about a pretty serious number.
So, everybody, you pick what percentage of that $50-55 trillion pie can be shifted to Bitcoin divide by 21 million Bitcoins and we have an approximate exchange rate! Bitcoin at $1,000,000 apiece would imply a total market value of $21 trillion. Thus Bitcoin would have to replace about 40% of the world’s currencies, which seems a bit extreme to me. But a total market cap of one trillion dollars, replacing maybe about 2% of the world’s money, doesn’t seem so outrageous. That would put Bitcoin at $50,000 apiece.
Does a cryptocurrency have an intrinsic value?
Somebody brought this up in the comments section yesterday. Bitcoin and a lot of cryptocurrencies have no real intrinsic value. A computer solved some mathematical problem and spits out a Bitcoin. But that math problem is apparently something without any true value. At least I haven’t heard any cryptocurrency proving the Riemann Hypothesis. Now that would be a nice fat intrinsic value of $1,000,000 because that’s the prize money for anyone who can solve the 150+-year-old math problem.
But I digress. For someone like myself who’s very much focused on value – think earnings multiples, bond yields, etc. – the lack of an intrinsic value should be a problem, right? Well, maybe not. Paper money doesn’t have an intrinsic value either! The value of a cryptocurrency is the value of a medium of exchange that facilitates fast, easy, cheap, safe and anonymous electronic transfers. It’s not an intrinsic value, but a value nevertheless.
Also, remember that for as long as fiat money has been around, people have been willing to hold worthless piles of paper money and see them deflated away by rising price levels. But imagine you lived in the country of ERNtopia that has a fixed money supply of a certain number of ERNcoins. The total value of the money supply should expand roughly in line with the growth rate of nominal GDP. But since the number is fixed it means that the price per ERNcoin has to grow at the rate of nominal GDP! So, here would be a country where money balances in your crypto-wallet effectively pay interest!
Also, don’t get me wrong: ERNtopia hasn’t made money out of thin air. It merely took away the government’s ability to print free money and thus “tax away” nominal money balances through inflation. In other words:
A widespread adaptation of a cryptocurrency would mean the democratization of the government’s money printing profits!
So, instead of money balances being a hot potato I try to get rid of as quickly as possible, I might even hold some extra ERNcoins. I might even have an emergency fund, after all! That wouldn’t be a bad deal!
Could Bitcoin be the Palm Pilot of the Cryptocurrencies?
I’m not even talking about the worst case scenario of some major blowup due to fraud or hacking. Or a virus wiping out the entire ledger! No, much less dramatic, Bitcoin could just wither away and be replaced with another newer and better cryptocurrency. Sometimes being the first and the biggest player in the field is a huge advantage. But sometimes the first iteration of a major innovation is flawed and it takes another try by smarter folks. Just like the Palm Pilot failed and the iPhone succeeded. Amazon is now perfecting what a lot of companies tried 20 years ago but failed. My concern would be that certainly Bitcoin and maybe a lot of other cryptocurrencies were developed by extremely smart engineers and programmers. But they have no clue about the workings of the economy and the requirements of a payment system to run in the real world. In the U.S. alone, the ACH (Automated Clearing House) handled more than 25 billion transactions per year (or about 70 million a day), worth over 40 Trillion Dollars. Add to that all the credit card transactions, cash transactions, etc. and we’re at a number many times larger than the few 100k bitcoin transactions per day. Can Bitcoin handle a much larger volume?
Watch out for capital gains taxes!
Needless to say, if you became a Bitcoin millionaire over the last few years the IRS wants its share. Yup, that’s right, Bitcoin creates taxable events. Some could argue that this will be the undoing of cryptocurrencies. Get the IRS involved and you take the fun out of anything! Maybe… or maybe not. The easy fix would be that your cryto-wallet sends you a consolidated tax form at the end of the year: You made $543.21 in total long-term capital gains and $123.45 in total short-term capital gains. Enter on Schedule D of your 1040 tax form and you’re done. That wouldn’t be a big hassle, right?
Conclusion
So, am I optimistic or pessimistic about Bitcoin and cryptocurrencies? I don’t know! It’s probably both. The whole crypto-hype feels a bit like the DotCom bubble in the late 1990s. It’s not too far-fetched that one or some of the currencies around today will be the dominant player(s) in 20 years. Competing with all the government-run money supply! But which one? Which cryptocurrencies will go the path of Pets.com (bankrupt) and which one will be Amazon.com (worth hundreds of billions)? I can’t tell today. Bitcoin has the early mover advantage but that may also mean some design flaws. If any of the cryptocurrencies wants to take over the world, or even just x% of the global M2 money supply, it better be able to offer the computing power to handle x% of all the world’s monetary transactions, i.e., both cash and electronic. I will let the tech experts weigh in on that one! Before then I’ll stay stick with my current investments!
We hope you enjoyed today’s post. Please leave your comments and suggestions below. Have a great week, everybody!
I agree that there could definitely be some utility especially with instant exchange for goods since that is an area severely lacking in my opinion. Checks take forever to clear and could be fraudulent and accessing large sums of cash is difficult.
I have a similar fear with Bitcoin possibly being the future palm pilot but I have considered putting a small amount of my portfolio into some sort of crypto currency ETF or index fund to possibly capture the coin that does take off!
It might not be ready for primetime. But then again, the CBOE and CME futures on Bitcoin give it some legitimacy…
Thanks for stopping by! 🙂
This is the best and most impartial Bitcoin article I’ve read so far.
You said in your example that “ERNcoin has to grow at the rate of nominal GDP! So, here would be a country where money balances in your crypto-wallet effectively pay interest!” That makes perfect sense for ERNcoin with no other currencies in circulation.
I’m trying to reconcile if this hypothetical you described is the same or different than in the real world where we have both Crypto’s and our money supply today.
I can certainly see why an “investment” in a more stable version of Bitcoin would increase compared to the USD as more dollars are printed and therefore devalued.
I see the argument as a hedge against inflation but I’m not sold on it growing in line with GDP. I’d love to understand more about your perspective. Do you think that a Bitcoin could grow in line with the US or Global GDP? Since it’s not really a finite money supply (there still are fiat currencies and other Cryptocurrencies) I think the real world example is different than ERNtopia.
Oh, my! Thanks for the compliment!!!
Well, Bitcoin is still growing but the total supply is limited to 21 million. Since GDP grows and Bitcoins are limited, one should assume that eventually, the Bitcoins price in dollars could grow at the rate of global nominal GDP.
Of course it could also be pushed out by newer and better currencies. That’s the risk!
This is the article I’ve been wanting to write, but couldn’t because I’m not a good enough writer. Thank you for putting it into words for me….
It’s potential at this point, and we shouldn’t shun potential. It’s far from a scam or ponzi… as so many people think and say.
I think it’s the future – it’s here now – and will continue to grow with more improvements and adoption. I’m excited
Ha, I will make sure to show this to my English teacher! I’m excited too (though not sure that Bitcoin will take over the world). I like the idea of private money taking over and taking away some of the government power!
Even if you end up with the most tech advanced player it might still not be the winner. Beta max comes to mind. A better play is probably data infrastructure or storage. Over time regardless of solution these likely win
Ha, Betmax, I remember that. Some here were probably not even born back then!
Love the idea of tech investments. Eventually, when the winner currency is determined they will all win! 🙂
I’d much rather wait to find out what will happen before investing mula into it – thanks for the write-up!
Wait and see! That’s my approach! 🙂
Shiller likens it to Tulip mania. Those nice flowers are still around but not nearly so expensive. Buffett says it will all go horribly wrong.
My betting money ain’t being put on Bitcoin but with those wise dudes.
My betting money is on the skewness premium: shorting puts. Makes money almost every week with less volatility than BTC! 🙂
I agree with what you say about bitcoin. A lot of things are still up in the air. But one thing you didn’t mention that I am a big fan of that I believe will really change the game is Blockchain technology.
Blockchain is the future. That’s for sure! Any stock tips you want to share?
Invest in low-cost broad-based index funds and ETFs over the long haul. I came across your content in the ChoosFi podcast and I think it is great what you are doing.
Thanks for stopping by!
The supply of Bitcoin is finite, and the supply of dollars keeps growing. This sets up an arbitrage opportunity to sell dollars and buy Bitcoin, then after time passes sell Bitcoin to buy back more dollars. That’s the theory anyway.
But note how this is also the theory of goldbugs. Their investment experience shows that differentials in unit growth do not equal differentials in price. Gold’s historical pricing has little correlation with inflation, M2, or much of anything. It’s simple supply and demand. Theory failed.
The world is full of things whose quantities are growing more slowly than dollars (e.g. 20th century baseball cards). That does not mean they will trade for more dollars in the future.
As far as utility goes, I just sent my wife’s IRA a few thousand via ACH for free. I could have also sent a Western Union – recognized virtually worldwide – for a couple bucks. Hell, a certified check is good enough to buy a house with and electronic checks exist too. A virtually riskless wire is the priciest reasonable way to send money at $25 for even large amounts. I find it far-fetched to think governments will fail to record these transactions. Silk Road would still be a thriving drug market if that were the case. Hell, not even Napster escaped the feds, much less worldwide laundering and remittance operations.
Quite the opposite. The gold supply is not fixed. Gold has been mined for millennials and this feature will make sure that the gold price can never grow much faster than the rate of inflation. If it did it will spur a search for gold in new places with new technologies. Your theory of comparing Bitcoin and gold failed.
As I said before: ACH is great but not foolproof and not 100% final either. You can face chargebacks.
A certified check is only good to buy a house because the whole transaction goes through escrow, title company, title insurance, the whole shebang! Involving hundreds or thousands of dollars in fees. As I noted in the post, certified/cashiers checks have been faked and the buyers found out a month later that the check bounced.
Your comments about Napster/Silk Road are also out of place. It merely means that the eventual winner(s) in the race to become the dominant cryptocurrency will be issued by one or a conglomerate of reputable companies (banks, tech companies, retailers,…)
The risk of the democratisation of the government’s right to control, and profit from, a monopoly on the supply of money seems to me to be the biggest thing standing in the way of cryptocurrencies. Uncle Sam isn’t going to give up his privileges to us schmos!
The government gave up more power than anyone had expected: telecom, airlines, etc.
I’m more hopeful that the government will eventually realize that this monopoly will fall as well. 🙂
To ERN and other readers,
A word of advice.
I was in cryptos between last March and January this year. The reason I got in at the time was that I saw the outcome as bimodal and asymmetric: either it takes off or drops to zero. So I risked an amount I was comfortable losing. Technically, it was when bitcoin exceeded its 2013 high. Note also my approach to bubbles is far from orthodoxy.
I turned bearish on BTC at the end of 2017 when there was around-the-clock coverage but BTC failed to go exponential as I had been predicting and I excited 90% of my positions. The rest I kept in ethereum until mid January.
Blockchain may be a useful technology but there is no revolutionary implementation to speak of. I had a downside target for BTC in the $2-4K range on technical grounds but now think 0 is a real possibility. One more leg down and BTC will be below the cost of marginal miners, putting them out of business. The difficulty will readjust but it leaves the door open for a nefarious character to collect hash power to mount a 51% attack. The industrialization of bitcoin mining means millions of fiat must be extracted every day to pay for electricity while the total fiat that went into the system is only on the order of $10 billion on a peak total market cap of $800 billion.
I won’t even mention the market manipulation that got the prices to where they were.
Folks, the crypto party is ending in 2018. The last call has been heard but some people are still dancing. I continue to visit various forums to see the human drama unfolding. It’s a rare opportunity to observe the mass emotions associated with a bubble. I can tell you that the sentiment is gradually turning.
If anyone insists on getting in, my advice is to wait for the dust to settle. Ethereum gets my vote for surviving to the other side.
Best of luck, you’ll need it.
NR
Disclosure: I have no crypto positions but own puts on OSTK.
Wow, thanks for that cautionary tale. Bitcoin down to 7,400 this morning!
By the way, to answer the question whether bitcoin has “intrinsic value”. I believe it does. The value is its share of the network that processes transactions and maintains trust. (By having the coin you have the right to use the network.) The problem for bitcoin is that as time goes on the transaction fees increase and transaction speed drops, its utility as a payment mechanism vanishes. Its “store of value” became a vehicle for speculation. As soon as the price stops going up even that last value disappears.
Intrinsic value of bitcoin = value of bitcoin network / # of bitcoins = (Utility of bitcoin network – depreciation and maintenance expense)/ # of bitcoins
Meanwhile the fixed cost and electricity cost continue to increase. It’s a good thing that 0 is the lower bound!
That’s the main reason I’m down on proof-of-work coins. I believe other schemes can work. Blockchain used to digitize and securitize otherwise untradeable resources like memory storage or solar power generation may represent the next stage in the sharing economy. In those instances, the intrinsic value of the token is the resources it has a claim to as well as a share of the trading platform.
Cheers,
NR
That’s my concern too. It seems that BTC is already in trouble handling the few 100k of transaction per day. Just the U.S. ACH system handles 70 million per day. Not sure how BTC can get into to that number…
I appreciate this view on crypto currency… Thx Sent!
Thanks ATL!
I own BTC. I bought it as a hedge against fiat currency freezing up as happened during the Greek crisis or when the money market busted the buck during our own financial crisis. In the Greek case there was no money. You could go to the bank and stand in line every day to get out a max of 50 bux. Suppose you wanted a plane ticket out of that place? No ATM, no credit card, no checks. At that time you could do commerce with BTC so I bought some. BTC in many EU domains is free from VAT since it is considered a form of barter and not a currency. It is an ideal concept to bring world wide commerce to deeply third world companies. Effectively you need a wallet and a cell phone to do commerce. It is this last concept that assures BTC survival IMHO. If I have a village in Sri Lanka where the women can sew dresses and I have some means of logistics to get the goods to market I can bypass every shyster who would try to extract value from my transactions and dramatically improve my business efficiency.
I live in FL and their is being created a satellite system that will effectively cover the face of the earth with internet dial tone. Once that happens, once you can access world wide commerce from a rain forest, or a Peruvian mountain peak, peer to peer commerce will be disruptive. It will destroy the gatekeepers. Amazon is an example of peer to peer but it’s model is like AOL from days of old, peer to peer “within” the boundaries of the Amazon servers and service contracts. BTC will allow freedom beyond the walls of Bezos tyranny. It is that creative destruction that will drive BTC and the value of BTC. BTC is infinitely divisible but finitely capped so this to me is the difference between tulip bubbles and dollar bubbles. In both of these providers just spin up production devaluing the “currency”. That luxury to independently manipulate value really doesn’t exist in a capped peer to peer bartering system like BTC. BTC is really just a transfer mechanism not a store of wealth. If the dollar changes value you merely change the denominator in he BTC-USD equation. When you speak of BTC’s value for example it is ALWAYS tied to something else. 2 BTC may be equal to one Honda Accord or $25,000 or 20,000 Sri Lankan dresses. People are afraid of the volatility but that will settle down especially with increased liquidity the addition of the futures market. It used to have historically 80% vol and now it looks closer to 20% vol after the futures market hedging started.
Good case for BTC! I never realized that even in the western world there have been financial impasses where BTC was the only viable payment method!
I think if you’re investing now, you’re essentially gambling on what may someday become an asset class worth investing in. It’s not impossible that those who are in now will reap great rewards(even beyond what we’ve already seen) but it’s also possible that the technology matures and new coins makes the current ones rather worthless in the long run.
I think there’s a ton of question marks right now that make this an asset class I’m not overly invested in but the upside makes me dip my toes into it a little bit. I had a post about a similar thing a few weeks ago that went over my thoughts on the subject. My invested dollars have declined quite a bit since then but I’m still very profitable and having taken out 100% of my original investment, I’m willing to let the rest ride.
Good point! After you already made the initial investment back, just let it ride as play money. 🙂
Reblogged this on Jason Martell.
Dollars have intrinsic value because they are the only way to pay US taxes. That idea is from the Money for the Rest of Us podcast.
If that’s the only value of the dollar we’re in a lot of trouble.
Reblogged @mstechlennialmom
Excellent Read!
Reblogged this on Ms. Techlennial Mom.
I enjoyed this article and started following. I’ll continue to stop by 🙂 Take a look at my blog as well if you have the time
Will do, thanks for sharing!
Hi Big ERN. Long time reader of the blog. With Bitcoin nearly at an all time high again and institutional adoption taking off with GBTC, MSTR, Mass Mutual and others, has your view changed at all? Combined with all the QE going on via Covid stimulus packages, is it time for the average investor to consider allocating a small portion of their portfolio to Bitcoin? Would appreciate your thoughts!
Hmmm, not really. I don’t see the potential for Bitcoin to ever take over the payment system because there are numerical and computational limits to BTC. I’d probably invest in gold before BTC…
What needs to happen for you to change your mind?
Ironically, the higher BTC goes, the closer we get to the point where the market cap of BTC gets close the USD money supply. And now I don’t see how such an inefficient and clunky asset like BTC can replace any sizable portion of the USD money supply with billions of transactions (ACH, Cash, Credit Card, etc.)…
Just checking in, is your position with respect to bitcoin/crypto unchanged?
Still haven’t pulled the trigger on crypto. Back then I thought it was hyped and overvalued, and now even more so.
I’ll hold my bitcoin forever, because when the time is right… I won’t have to sell.
Awesome. You can then live off the dividends in retirement. Oh wait, uhm, let me think about that again! 🙂