Vo intizār thā jis kā ye vo sahar to nahīñ — Faiz Ahmed Faiz.
A couple of days back I wrote a long piece on bitcoin. As expected the backlash was huge, though a couple of people did engage very nicely and in a fact-driven way (You know who you are, so, thanks a tonne for that).
But a bulk of the response from the bitcoin believers was like we know everything about bitcoin and this guy doesn’t know what he is talking about. Of course, they didn’t say this in as polite a way as I am putting it here (or as one believer put it, it was 5,100 words of potty).
In this piece I wanted to list out a random list of points which I have been thinking about over the last couple of days since I published the bitcoin piece. Some of these points have got to do with investing in general and some with bitcoin in particular. Of course, there are points about the bhakts, the bitcoin bhakts, as well.
The conclusion at the end of this piece is the same as the last bitcoin piece, which is that, the life of bitcoin started with an ambition to become a cryptocurrency which wanted to replace the global paper money system. But it has ended up becoming an object of pure speculation and nothing else. (I can already see the bitcoin bhakts going: good you have mentioned this upfront, we don’t need to read beyond this. Our beliefs are safe).
So, here we go.
1)I had been postponing writing the bitcoin piece for a while now. This was probably my way of coping with the backlash I was expecting once the piece was published. But I am glad that I wrote it. What it told me was that bitcoin bhakts like bhakts in general and investing bhakts in particular, are a petulant lot. You don’t agree with them and they are ready to get you.
In a way it’s like god, religion and parents. My god is the best. My religion is the best. My daddy is the strongest. My mother is the sweetest. And my bitcoin is the best. And if you don’t agree with me then you don’t know anything and you are going to get it from me.
2) A very strong unwavering belief hurts when it comes to investing. I have now spent nearly two decades, starting in 2002, writing about business, economics, finance and investing. And I have seen this sort of behaviour before. When I first started writing about a bubble in real estate, sometime in 2013, I got a similar response from real estate investors all over India, like I have from the bitcoin believers, over the past two days.
Real estate prices in 2013 had been rallying for more than a decade and almost no one was ready to believe at that point of time that they could fall or stagnate for a long period of time. Many didn’t even believe there was a bubble.
In fact, many people still don’t, holding on to their investment in the belief that the happy days of pre 2013 will be back. (Now only if these people knew how to calculate the internal rate of return on any investment, which they clearly don’t). Of course, the reason for holding on to real estate can always be an emotional one as well.
So, yes, the bitcoin bhakts aren’t the first believers. There have been believers before them and there will be believers after them. This time is no different.
3)One response that came over and over again was that this guy (that is me) has no idea what central banks have been up to over the years. They have printed so much money, you know. What is he even talking about.
Well, to set the record straight, anyone who has followed my writing over the years would know the number of times I have written about money printing and central banks and how it is a bad idea. I have also written three books on this issue. I mean I have almost made a career out of it.
But the more important point here is that just because central banks have been printing money doesn’t mean that the paper money system is going to come to an end quickly and bitcoin will takeover. This is a great example of lazy thinking, and the fact that the human mind is not built to think through complex multi-dimensional issues. This is bounded rationality at work and the bitcoin bhakts have also become a victim to that.
We all need reasons for doing something and more often than not the reasons are very simplistic. Like the case here. Bitcoin will take over the world because central banks have been printing money and now that I have bought bitcoin I need to firmly believe in this. Really
As I explained in my previous bitcoin piece there is a huge status quo which is a powerful force and which benefits from the paper money system in its present form and they aren’t just waiting there to rollover, once the bitcoin bhakts come attacking.
The paper money system that bitcoin bhakts keep talking about has the American dollar at the heart of it. The world trade happens largely in dollars, giving the United States an enormous exorbitant privilege. While every other country in the world needs to earn dollars, the US can simply print it.
And given this, this is a privilege the United States isn’t really going to let go in a hurry. Why do you think US consumption is around a fourth of the global economy, while the country has only 5% of the world’s population? Which US politician in his or her right mind, is not going to worry about this dynamic?
Yesterday, someone on Twitter, shared a news-item which said that an American Senator was in favour of bitcoin as money. I am sure random American Congressmen support random things. Take the case of former Congressman Ron Paul, who supported gold as money for years on end. That does not mean that the American financial system will move to gold as money. So, we are talking change at a systemic level here, not some random guy supporting some random thing, please understand that.
4)I was also told repeatedly that bitcoin is an anonymised peer to peer network and I was making the mistake of looking at it as a centralised system. Well, that is really rich coming from guys who are buying bitcoin from brokers and giving away all their identity details. The moment you are doing that you are buying a speculative asset and not a future form of anonymised money.
5)When I said that barely anyone accepts bitcoin as a payment, two people wrote to me to say that they did. This is precisely the point I was trying to make. They were the exception that proves the rule.
In fact, as the American journalist James Surowiecki wrote in a recent post on bitcoin: “The blockchain analysis company Chainalysis, for instance, found that in the first four months of 2019, just 1.3% of total transactions involved merchants.” A bulk of bitcoin payments were used to pay for illicit goods and services like drugs and online gambling. (This is not to say that paper money isn’t used for these things. It is. But then the bulk of payments are for regular everyday transactions).
Also, even with these payments, bitcoin payments form an insignificant part of the overall whole. As Surowiecki writes: “On average, there are now around 325,000 Bitcoin transactions — including trades — per day. There are roughly a billion credit card transactions per day.” Over and above this, there are debit card transactions, cash transactions and digital money transactions, to consider. Bitcoin is nowhere in all this.
This is primarily because the bitcoin system is very slow to process transactions. It can process seven transactions a second. Visa, on the other hand, processes 6,000 transactions a second.
I can go on and on why bitcoin is not a medium of exchange, like a good form of money should be, but I will leave it at this.
6)The main reason why very few businesses accept bitcoin as payment is the volatility of its price, Surowiecki points out. Let’s say a business takes payment in bitcoin. Chances are that the next morning the price falls majorly, then the business can end up with a loss on the transactions it made a day before. (Of course, the price can go up as well… but then this is business not gambling).
The volatility of price comes from the fact that most people buying bitcoin are in it, in order to make a quick buck. They see an asset whose price is going up, they buy it. When they see an asset whose price is going down, they sell out. Of course, there are believers as well.
7) This is an interesting one. I learnt yesterday that you identify a bitcoin bhakt, the moment he says HFSP to you. For all the Boomers out there, HFSP stands for Have Fun Stay Poor. Apparently, this is something that bitcoin bhakts say often when people question their core beliefs. It’s an easy, slightly humorous way to get back without necessarily having to think through what the person questioning their core beliefs is basically trying to say. (It’s all potty you know).
Also, it is important to understand, different people are mentally built differently, when it comes to how they look at money. In my scheme of things return of capital is more important than return on capital when it comes to money and investing. Money has never come easily to me and whatever I have I would rather protect it than take a punt with it. If that means staying poor in the eyes of bitcoin bhakts, then so be it.
But then that shouldn’t stop you from buying bitcoin. If you feel it needs to be a part of your investment portfolio and if you feel that you are okay taking the risk, then please go ahead. It is your hard earned money at the end of the day.
8) The recent interest shown by hedge fund managers basically should tell everyone very clearly that bitcoin as an object of speculation is now entering the mainstream. Of course, this means that the price of the thinly traded bitcoin can go up even further. So, there might be more money to be made. But then do remember that hedge funds are a mercurial lot. They can go out of a trade much faster than they get into it.
Hence, the oldest cliché in investing, don’t put all your eggs in one basket, applies to bitcoin as well. If you want to speculate, please go ahead and do it. But don’t bet your life on it.
9)Many bitcoin bhakts believe in anarchy when it comes to the money system. They seem to be okay with different forms of cryptocurrencies competing with each other, a few dying in the process and the best ones continuing to exist.
It is important to understand here, that there is a difference between money and mobile phones. While mobile phone brands can keep changing, depending on customer preferences and specifications on offer, the same argument applied to money doesn’t really work.
A major reason for the evolution of standardised fiat paper money lies in the fact that there were too many forms of money going around and this caused needless confusion and built huge costs of doing business into the system. A lot of this standardisation happened through the centuries and made lives easy for business and normal mortals. Of course, there are problems with this system.
10) I also understood something all over again. As the American novelist Upton Sinclair once remarked: “It is difficult to get a man to understand something, when his salary depends on his not understanding it.” When the price of an investment asset is going up at an extremely fast pace, all people can see is that it’s going up, without realising that it’s going up because it’s going up.
To conclude, the life of bitcoin started with an ambition to become a cryptocurrency which wanted to replace the global paper money system. It has now become a speculative asset at best and nothing more.
As The Economist recently put it, rising prices of bitcoin “may be good news for those holding bitcoin that others are piling in, but speculators’ enthusiasm suggests that cryptocurrencies will fall far short of their founders’ lofty aspirations”.
Satoshi Nakamoto, the mysterious inventor of bitcoin, whoever he is, wherever he is, must be a rich man today. Nevertheless, he must be a terribly disappointed man as well. This wasn’t what he was trying to engineer.
The sad thing as always is, in life, things rarely go as planned.
Kyon Dare Zindagi Mein Kya Hoga Kuch Na Hoga To Tajruba Hoga. — Javed Akhtar.
The actual writing of this piece took around six hours, though I have been thinking on this issue for at least the past nine years since I started writing my Easy Money book. I have been told that the backlash from the bitcoins believers will be huge. All feedback is welcome, as long as you don’t abuse. And if you choose to abuse at least read the piece first. You will be able to abuse better.
Bulbulon ko abhi intezar karne do. (Let the bubbles wait for now). — Gulzar, Vishal Bhardwaj, Usha Uthup and Rekha Bhardwaj in 7 Khoon Maaf.
Let’s start this one with a small story.
Salvador Dalí was a famous painter who lived through much of the twentieth century. He was a pioneering figure in what is known as Surrealism.
Other than being a fantastic painter, Dalí was also a sharp businessman. The story goes that once Dalí had treated some friends at an expensive New York restaurant. When the time to pay for the meal came, Dalí instead of paying in dollars, like anyone else would have, decided to carry out a small experiment.
On the back of the cheque Dalí had signed to pay for the expensive meal, he drew a sketch in his inimitable style. He signed it and handed it to the waiter. The waiter passed it on to the manager.
The manager realised the value of what Dalí had given him and decided to frame the cheque and hang it on the wall, making sure that anyone who came to the restaurant saw it.
Of course, this meant that Dalí’s cheque wasn’t encashed and he didn’t really have to pay in dollars for the expensive meal he had taken his friends out for.
This trick worked for Dalí. He was delighted and he used the same trick at different New York restaurants to pay for meals. The managers of all these different restaurants framed the cheque and hung it on one of the walls in their restaurants, so that everybody who came to the restaurant could see and realise that the famous painter Salvador Dalí had dined at the same place as they were.
Now what was happening here? If I can state this in simple English, Salvador Dalí, had turned his art into money. As Guillén writes:
“The money offered to pay for the meals was never deposited, as the cheques were transformed into artworks and took on a separate life. For Dalí, this maneuver was a stroke of genius. He could print his own money (his drawings had value), and people were willing to accept it as a form of payment.”
The trouble was Dalí went overboard and paid for one too many meals using this trick. In the end, the restaurant managers wised up and Dalí probably had to start paying real dollars for the expensive meals he took his friends out for.
What’s the moral of this story? Anyone can create his or her own money as long as others are willing to accept it, though one thing needs to be kept in mind. As Guillén writes: “As with national currencies, any money can be felled by the laws of supply and demand, as an excessive supply depreciates its worth and reduces people’s willingness to use it.”
What Dalí ended up doing in a very small way, governments have done over and over again, over the centuries. They have gone overboard with printing money and spending it, created high inflation, as too much has chased the same set of goods and services, and in the process destroyed the prevailing form of money. (If you are interested in details, I would suggest that you read my Easy Money trilogy).
Dear Reader, you must be wondering by now why am I recounting this story in a piece which is headlined to be about the bitcoin bubble. Have some patience, everything will become clear very soon. Read on.
Bitcoin is a digital currency that does not use banks or any third party as a medium or at least that is how it is conventionally defined. It is governed by a string of cryptographical codes, which are believed to be military grade and very tough to break.
The price of a bitcoin has rallied big-time over the last few months. It rose from a little over $10,000 per bitcoin in early September to more than $40,000 per bitcoin in early January. As of January 8, 2021, the price of bitcoin touched an all-time high of $40,599.
One of the core selling points of bitcoins as well as its raison d’être is that unlike paper money they cannot be created out of thin air. The number of bitcoins is finite and the code behind it is so written that they cannot go beyond a limit of 21 million tokens.
Interestingly, mining, or the generation of a bitcoin, happens when a computer solves a complex algorithm. Anyone can try to mine bitcoins, but with a finite number being generated at regular intervals and with an increase in the number of people joining the mining race, it has become increasingly difficult to solve the algorithm and generate bitcoins.
As of January 11, 2021, the number of bitcoins in circulation stood at 18.6 million units. The rate at which bitcoins are being created has slowed down over the years and the last fraction of the 21 millionth bitcoin will be created only in 2140.
The larger point here is that unlike the paper money system (or to put it slightly more technically the fiat money system) which can be manipulated by central banks and the governments, the bitcoin system can’t.
Hence, there is an overall limit to the number of bitcoins that can be created. This is the main logic offered in support of buying and owning bitcoins. Unlike central banks or governments or Salvador Dalí (in case you are still wondering why I started with that story), money in the form of bitcoin cannot be created out of thin air and beyond a certain limit.
In fact, this core idea/message at the heart of the bitcoin was built into the first fifty coins, now known as the genesis block, created by Satoshi Nakamoto, the mysterious inventor behind it. The beauty of bitcoin is that even not knowing who really Nakamoto is, doesn’t impact the way the system he created, works.
The genesis block contained a headline from The Times newspaper published in London dated January 3, 2009. The headline was: “Chancellor on brink of second bail-out for banks”. The headline and the date are permanently embedded into the bitcoin data.
As Nakamoto wrote on a message board in February 2009: “The root problem with conventional currency is all the trust that’s required to make it work… The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts.”
Bitcoin was supposed to be this grand idea meant to save the world from the way the central banks and governments manipulate the paper money system. As William Quinn and John D Turner write in Boom and Bust—A Global History of Financial Bubbles: “To its advocates, bitcoin was the money of the future: it could not be devalued through inflation by a central bank, you could spend it on anything without having to worry about government interference or taxes, and it cut out the middleman, namely commercial banks.”
The question is, in these times of easy money, has bitcoin reached anywhere near its original goal or is it just another way of pure speculation.
Let’s look at this pointwise.
1)Here is a chart of the price of bitcoin in dollars since July 18, 2010 (I couldn’t find the price of bitcoin before this in the public domain, hence, the random date).
It doesn’t take rocket science to understand that if you have been a long-term investor in bitcoin, you would have made shitloads of money by now. But the fundamental question is, is bitcoin money or even the future of money, as it is made out to be, by those who are in love with it, or is it simply another form of speculation.
One of the key characteristics of money is that it is a store of value. The recent rally in bitcoin has led to many bitcoin believers telling us that bitcoin is a store of value. This comes from a very shaky understanding of what the term store of value actually means.
A store of value basically means that something has a stable value over time. As Jacob Goldstein writes in Money: The True Story of a Made-Up Thing: “If $100 buys your family a week’s worth of groceries today, there is a very good chance it will buy approximately a week’s worth of groceries a year from now. The dollar is a good store of value (it tends to lose about 2 percent of its value every year).”
Let’s look at what has happened to bitcoin over the last few months. It rose from a little over $10,000 per bitcoin in early September 2020 to more than $40,000 per bitcoin in early January 2021.
As of January 8, 2021, the price of bitcoin touched an all-time high of $40,599. As I write this early in the morning on January 14, 2021, the price of a bitcoin is around $37,329. The price has fallen by 8% in a little over five days’ time. So, where is the stability of value? And this isn’t a one-off event. Bitcoin has moved rapidly up and down on many occasions.
But this is a very simple point. Here’s the more complicated point . The price of a bitcoin as of September 5, 2020, was $ 10,092. On January 8, 2021, it reached $40,599, a rise of 302% in a matter of a little over four months.
If bitcoin really was money, using which we could make and receive payments and borrow and lend, the recent rally would have created a havoc in the economy.
What does the rise in the value of any form of money really mean? It means that the price of everything that money can buy is falling. And in this case prices would have fallen big-time. As Goldstein puts it: “This rise in the value of bitcoin would have caused a deflation far worse than the one in the Great Depression.” Deflation is the scenario of falling prices and is deemed to be dangerous because people keep postponing their consumption in the hope of getting a lower price. This hurts businesses and the overall economy.
Now take a look at the following chart which plots the price of a bitcoin in dollars between December 2017 and December 2018.
The price of a bitcoin as on December 16, 2017, was $19,345. A year later on December 15, 2018, it had fallen by 83% to around $3,229. What would this have meant if bitcoin really was money? It would mean that the price of money has fallen and hence, the price of other things has gone up. In this case, it would mean very high inflation, even hyperinflation.
In its current form, bitcoin is no store of value. If it was to be used as money, the world would hyperventilate between deflation and inflation.
2)Another key characteristic of money is that it is a medium of exchange or to put it in simple English, it can be used to buy things (like Dalí bought meals at expensive restaurants).
According to financial services company Fundera 2,352 American businesses, accept bitcoins as a payment. The United States is the mecca of bitcoin believers. As per the US Census Bureau there were around 7.7 million companies in the US with at least one paid employee. This statistic doesn’t inspire much confidence. Barely anyone takes payments in bitcoins even in the United States.
Of course, it takes time for any new form of money to be adopted, but for something that has been around for 12 years, the rate of adoption seems quite poor.
Personally, I don’t know of any business that accepts bitcoin as a payment in India. Maybe, there is some coffee shop in Bengaluru that does. Dear reader, if you know of it, do let me know.
3)The bitcoin believers like to compare it with gold. The reason gold has acted as a hedge against the proclivity of the governments and central banks to create paper money out of thin air, is that it cannot be created out of thin air. While alchemists, which included Isaac Newton as well, have tried this over the centuries, no one has been successful in developing a chemical formula that converts other metals into gold. Bitcoin works because of a similar dynamic, the believers tell us. There is a limit to the number of bitcoins that can be created and as time passes by it becomes more and more difficult to mine bitcoins. That’s how the code behind bitcoin is written.
But the thing is that the code behind bitcoin is freely available. Anyone can take it and tweak it and come up with a new kind of money. Over the years this has happened and many of these new forms of money have ended up as shitcoins.
As Quinn and Turner write:
“In August 2016, one bitcoin was trading at $555; in the next 16 months its price rose by almost 3,400 per cent to a peak of $19,783.3 This was accompanied by a promotion boom, as a mix of cryptocurrency enthusiasts and opportunistic charlatans issued their own virtual currencies in the form of initial coin offerings, or ICOs. These coins had, on the face of it, no intrinsic value – to entitle their holders to future cash flows would have violated laws against issuing unregistered securities – but they nevertheless attracted $6.2 billion of money from investors in 2017 and a further $7.9 billion in 2018.”
A lot of this money never came back to the investors. There is no way to make sure that this won’t happen in the future.
Also, at a broader level, a free market in money is a bad idea. The United States went through this situation sometime in the nineteenth century (Something I discuss in detail in the first volume of Easy Money). It was very easy to get a banking license and banks could print their own money.
As Goldstein writes: “Not all banks were shady. Not even most banks were shady. But the notes printed by the shady banks looked as legit as the notes printed by the honest banks. And there were a lot of notes—at one point, the Chicago Tribune reported that the country had 8,370 different kinds of paper money in circulation.” Imagine the confusion this would have created.
It was also easy for counterfeiters to manufacture their own paper money. In this scenario, a guide called Leonori’s New York Bank Note List, Counterfeit Detector, and Wholesale Prices Current was published once a month. An issue of this guide, dated 18 November 1854, shows that 1,276 such banks were in operation in various states and 825 different kinds of forged notes were in circulation. The financial system was in a total anarchy.
While it is easy to make a case for a non-government decentralised money system, what may lie in store isn’t something we may want in the first place. The sad part is very little thinking has happened on this front. Saying, let the best money win is a very insensitive way to go about it.
4)The bitcoin code which limits their number to 21 million units is written in C++. As Sean Williams writes on Fool.com: “Last I checked, code can always be erased and rewritten. While it’s unlikely that a community consensus would be reached to increase the circulating supply of bitcoin, the possibility of this happening isn’t zero.” Anyway this possibility isn’t going to arise until 2140, when the last fraction of the bitcoin will be mined, and by then you and I, won’t be around. So, it doesn’t really matter.
5)Let’s talk a little more about paper money. Why do others accept it as money? Because they know that the government bank/central bank deems it to be money and hence, still others will accept it as money as well.
As L Randall Wray writes in Modern Money Theory – A Primer on Macroeconomics for Sovereign Monetary Systems: “The typical answer provided in textbooks is that you will accept your national currency because you know that others will accept it. In other words, it is accepted because it is accepted. The typical explanation thus relies on an ‘infinite regress’: John accepts it because he thinks Mary will accept it, and she accepts it because she thinks Walmart will take it.”
While this sounds correct there is a slightly more nuanced answer to the question.
There are three main powers that any government has: 1) The right to “legal” violence. 2) The right to tax. 3) The right to create money out of thin air by printing it.
As Wray writes:
“One of the most important powers claimed by sovereign government is the authority to levy and collect taxes (and other payments made to government, including fees and fines). Tax obligations are levied in the national money of account: Dollars in the United States, Canada, and Australia; Yen in Japan; Yuan in China; and Pesos in Mexico. Further, the sovereign government also determines what can be delivered to satisfy the tax obligation. In most developed nations, it is the government’s own currency that is accepted in payment of taxes.”
What does this mean?
As Wray puts it:
“Ultimately, it is because anyone with tax obligations can use currency to eliminate these liabilities that government currency is in demand, and thus can be used in purchases or in payment of private obligations. The government cannot easily force others to use its currency in private payments, or to hoard it in piggybanks, but government can force use of currency to meet the tax obligations that it imposes… It is the tax liability (or other obligatory payments) that stands behind the curtain.”
Hence, the government creates demand for paper/fiat money by accepting taxes in it. This has ensured that the paper money system has kept going despite its weaknesses.
What this also means is that for bitcoin to become popular and move beyond the nerds, it needs a use case as solid as paying taxes in what government deems to be money, is.
It is worth remembering here what Wray writes: “For the past 4,000 years (“at least”, as Keynes put it), our monetary system has been a “state money system”. To simplify, that is one in which the state chooses the money of account, imposes obligations (taxes, tribute, tithes, fines, and fees), denominated in that money unit, and issues a currency accepted in payment of those obligations.”
This is not to say that governments haven’t destroyed money systems in the past. The history of money is littered with examples of kings, queens, rulers, dictators, general secretaries and politicians, representing governments in different eras, having destroyed different money systems at different points of time. But the government has always comeback and controlled the money system the way it has wanted to.
And unless governments and central banks start taking a liking to bitcoin, there is no way its usage is going to spread to a level where it can hope to challenge the prevailing paper money system. It is worth remembering that if governments start taking interest in bitcoin, it in a way beats the entire purpose behind its creation.
Also, every government will want to protect its right to create money out of thin air. Right now bitcoin is too small in the overall scheme of things for governments to be bothered about it and hence, they have largely humoured it (not in India though).
The market capitalisation of bitcoins (number of coins multiplied by the dollar price) as of January 8, peaked at around $759 billion. The global GDP in 2019 was around $88 trillion. So the price of bitcoin even at its peak was lower than 1% of the global GDP.
Hence, the bitcoin story is like that of a rich Indian father basically allowing his son to play around, until he thinks that the son now needs to grow up.
6)There is another point that needs to be made here regarding the paper money system. This is something I realised while writing the third volume of Easy Money and it makes me sceptical of anyone who wants to write off the paper money system in a hurry. (Before you jump on me for being a blanket supporter of the paper money system, I am not, but then that doesn’t mean I don’t see logical arguments when they are offered).
Many years back, in one of my first freelancing assignments, I happened to interview the financial historian Russel Napier. He explained to me the link between paper money and democracy. As he told me on that occasion:
“The history of the paper currency system, or the fiat currency system is really the history of democracy … Within the metal currency, there was very limited ability for elected governments to manipulate that currency. And I know this is why people with savings and people with money like the gold standard. They like it because it reduces the ability of politicians to play around with the quantity of money. But we have to remember that most people don’t have savings. They don’t have capital. And that’s why we got the paper currency in the first place. It was to allow the democracies. Democracy will always turn towards paper currency and unless you see the destruction of democracy in the developed world, and I do not see that, we will stay with paper currencies and not return to metallic currencies or metallic-based currencies.”
Back then bitcoin wasn’t really on the radar. The reason people with savings liked gold back then, is why many of them like bitcoins now.
The twentieth century saw the rise of both paper money and democracy. Pure paper money started coming into being after the First World War. The reason for this is very straightforward. In a democracy whenever there is a crisis, the politicians and the technocrats advising them need to be seen to be doing something.
As an ex-RBI Governor once told me, do nothing cannot be a strategy. And this need to be seen to be doing something, can most easily be fulfilled by manipulating the paper money system that prevails in a democracy. It gives central bankers the option of printing money and driving down interest rates in the hope that people will borrow and spend more and businesses will borrow and expand.
Of course, this has its own problems (as I keep highlighting in my pieces over and over again). But then, the prevailing system does really allow politicians to show that they are trying. Any other system would take this option away from politicians. Hence, the paper money system is not going to be replaced in a hurry. No government is going to let go of this privilege.
7)This is a slightly technical point, but I think it needs to be made. As I have mentioned through this piece, over the years it has become more and more difficult to mine bitcoins. Now bitcoin farms with giant racks of mining computers, are needed to mine bitcoins. The days when bitcoins could be mined using the processing power of a PC are long gone.
The bitcoin farms, as they are known as, need a lot of electricity. Hence, mining operations have moved to countries where electricity is cheap. They have moved to countries like Iceland, Mongolia and primarily, China.
This has created another problem. As Goldstein writes: “By the beginning of 2020, Chinese miners had grown so large that they controlled most of the processing power on the bitcoin network. And the way the code for bitcoin was written gave them control over the system.”
While, bitcoin might be a decentralised democratic system running on code, but it’s people who ultimately control the mining of bitcoins and hence, can direct its future.
So, will the future of bitcoin be driven by China? And if that turns out to be the case, what does this do to its chances of spreading as actual money, used in the selling and buying of things? There are no easy answers to these questions.
8)One of the key points of bitcoins was that it was a non-government decentralised money system which promised freedom from the middlemen. But that hasn’t really happened. As Quinn and Turner write: “[Bitcoin] had promised freedom from middlemen, but trading it without a third party was cumbersome unless the user was expert in cybersecurity.”
If you are using a broker to trade bitcoin it beats the entire idea of freedom from middlemen. Also, the moment you convert your money into fiat money and the money comes into your bank account, the entire idea of remaining unknown and the government not knowing what you are doing goes for a toss. Hence, you may have your reasons to buy bitcoins, but basically you are speculating.
9)You might want to ask why you haven’t heard all this in the mainstream media. The reason for that lies in the fact that the incentives of the media are misaligned these days. Most investment related news is presented as a money-making opportunity. Hence, in this case the bitcoin believers have gotten more space and screen time in the media.
Many of the bitcoin believers are like the original investors in a Ponzi scheme. They have an incentive to talk up bitcoin, get more investors into it, drive up its price and make more money in the process. (In fact, these are precisely the kind of stock market investors that you get to see on TV and read in the media most of the time, but that is another topic for another day).
Also, given the extremely short attention spans that people have these days, the written word doesn’t find much of an audience. As Quinn and Turner put it: “More fundamentally, the move away from the written word to television financial news, docusoaps and social media may corrode the ability of investors to think clearly and understand the complexities of the financial system.”
You cannot understand economic history and the complexities of the financial system by watching TV or watching stuff over the internet or even listening to extremely detailed podcasts (podcasts can just give you a flavour of things and a feeling that you are actually learning a lot). The only way to understand complex issues is to read, read and read more.
In an era of short attention spans, bitcoins are just the right asset to speculate on. Their price goes up or falls even before you can say Virat Kohli. (This is another reason to support my writing).
10)We live in an era of easy money. Central banks have printed trillions of dollars during the course of 2020 to drive down interest rates in the hope of encouraging people to borrow and spend and businesses to borrow and expand. Interest rates are in negative territory in some of the European nations.
In this scenario of very low interest rates, investors are desperate to earn returns. Hence, a lot of money has been invested into stock markets all over the world, driving them to levels not justified by earnings that companies are expected to earn in the years to come.
Some money has also found its way into bitcoins. As The Economist puts it: “The current surge seems to have been spurred by interest from the financial establishment, most of which had long scorned it.” In simple English, hedge funds are buying bitcoins. Given that bitcoins are thinly traded, this has driven up prices by astonishing levels. Hence, like stock markets, bitcoin is also in bubble territory.
And as we have seen over the past few decades, hedge fund money can be quite mercurial. They can drive down prices faster than they drove them up.
To conclude, the fact that the price of bitcoin is so volatile tells us that most people investing in it aren’t really bothered about the long-term story of bitcoin as money, the bitcoin believers try selling all the time. If they did believe in this story they would have bought bitcoin and held on to it. But as the crash of 2018 showed that is clearly not the case.
“Buying a Bitcoin token today can be considered an investment in the fast growth of the network and currency as a store of value, because it is still very small and able to grow many multiples of its size and value very quickly. Should Bitcoin’s share of the global money supply and international settlement transactions become a majority share of the global market, the level of demand for it will become far more predictable and stable, leading to a stabilization in the value of the currency.”
(Ha ha, this is to show that I also read stuff I don’t really agree with).
I am not clairvoyant. This may happen. This may not happen. My reading of economic history tells me it won’t. But then I might turn out to be wrong. What do they say about history not repeating itself but rhyming? But what if it doesn’t rhyme as well?
There are no guarantees when it comes to economics. The trouble is that while you are waiting for all this to happen, the price of a bitcoin is at the level of a very very very very expensive large cap stock and its volatility is that of a small cap penny stock.
So, if you do invest in bitcoin, do understand that you are taking a punt, you are speculating, you are hoping that the price goes up and does not fall. Also, don’t go looking for fundamental reasons for investing in it.
Given that investing in bitcoin is equal to taking a punt, please don’t bet your life on it. As the old cliché goes, don’t put all your eggs in one basket.
PS: This doesn’t mean I don’t believe in digital money. I do. But I also believe that it will be controlled by large corporations and the governments.