Bitcoin – a bubble or Historic Opportunity?

  • Bitcoin – the popular virtual (or digital) cryptocurrency, is discussed everywhere so it is not surprising that its price skyrocketing and attracts millions of investors who dream of getting rich quickly.
  • Is it possible that the blockchain technology on which the Bitcoin is based will expand but the currency itself will disappear?
  • What will happen on the day the regulator decides to shut down this party?
  • And most importantly, is it an amazing technological-financial revolution or the biggest bubble in history that will burn investors’ money?

The preoccupation with Bitcoin reminds me a bit of the child story the Emperor’s New Clothes, in which two crooks claimed to have sawn the king invisible clothes that only the wise could see. Although it is relatively easy to understand the basic idea behind digital currencies (for example, here is an excellent explanation), very few people really understand how the underlying technology works and whether it is suitable for mass use, so it is possible that the king is actually naked and the whole digital coin story is a temporary buzz and nothing more. Unfortunately, there are those who are already taking advantage of the herd’s over-enthusiasm, and we see many companies suddenly announcing entry into the field or trying to raise money to issue new digital coins or technologies whose chances of survival are low and investors’ money will be lost.

An interesting point is the fact that whoever buys Bitcoin immediately feels like he has joined an anti-establishment “cult” whose members are convinced that they are part of a historical revolution that will intensify and replace the control of governments and central banks over fiat currencies (common standard monies). Since I have never bought a Bitcoin or any other digital currency, I am not a member of this Bitcoiners group, so some may argue that it diverts my conclusion into a non-objective direction. It might be true, but on the other hand, when was the last time you saw someone who held a stock and claimed that it was not attractive? In the same manner, the holders of Bitcoin are convinced that this is “the next thing” and they are not willing to take into account that they may be wrong.

Many confuse three different aspects of the debate: first, whether the Blockchain technology on which the Bitcoin is based will become widespread enough in the world. Second, whether the regulators (governments and tax authorities) will approve the use of digital currency at all. And the third is whether the Bitcoin will be the currency that will be adopted by us or that another currency will take the lead in the future. This is very reminiscent of the dot-com bubble, hundreds of billions of dollars of investors’ money went down the drains. Shares were traded at exaggerated valuations, although now, 15 years after the bubble burst, the key technological ideas that drove it are widely used in almost every aspect of our lives. Will the Bitcoin ‘s fate be the same as the dot-com companies, or is it worth buying? In this review, I will try to answer these questions.

By the way, most of the review will mention the Bitcoin, but most of the statements are also correct for the other digital currencies that exist today.

In general, what are Bitcoin and Blockchain?

Attempts to produce digital currency have existed since the late 1980s, mainly behind the scenes. The development of the Internet infrastructure and new computing technologies has enabled the breakthrough in the field in recent years.

Actually, it’s funny that it’s called a coin, but Bitcoin is not a coin in the ordinary sense of the word. The first Bitcoin was born in 2008 by a person (or group of people) who call themselves Satoshi Nakamoto, and holders of the coin hold in their digital wallet a long list of numbers created by a computer program based on the technology of Blockchain. This technology has special characteristics: it is distributed over thousands of computers, it can produce more Bitcoins by solving mathematical problems in the area of encryption that requires increasing computing power, and it is limited to 21 million units of Bitcoin at most (half of the quantity was already created).

Being an open-source computer program, there is no limitation to create other digital currencies in the same technology, and indeed there are already tens of them, among which are the popular Ethereum and Litecoin.

Strangely enough, although the Bitcoin is supposed to be the currency of the 21st century, it is quite difficult to buy it, so people stand in long lines in front of ATMs to buy their units and pay a high commission for it. Even stranger is the fact that it is also difficult to sell it, especially in large amounts. It may be birth pains, but at a time when cash usage is fading and we are doing all our payments with credit cards on the net, we must admit that these difficulties seem odd.

Still, the field of digital currencies has created a tremendous buzz not only in social networks but also in leading economic media. Today it is difficult to open a financial news site and not to see in the main headline something about Bitcoin or Blockchain. This is one of the reasons why prices have risen by thousands of percents in recent years.

Who holds Bitcoin and what is it used for?

Despite the rise in the price of the currency in recent years, it turns out that the demand for it is not dramatic, at least not in large amounts of money. According to bitinfocharts.com, there are a total of 20 million people who have Bitcoins in their digital wallet. Of these, only 920,000 holds more than $10,000 worth, and only 25,000 people hold worth over $1 million. In the United States alone, there are over 15 million people defined as millionaires, so there are very few people who have chosen to gamble on this digital currency, and most of the Bitcoiners hold less than $100, indicating that they are not really planning to shop with the currency; they treat it as a lottery ticket. In other words, those who claim that this is a revolution apparently have a crystal ball to predict the future, because at least at the moment it is a nice story that makes waves in the media but nothing more than that. To be a revolution, the usage volume of this currency should expand much further.

Recently, the trading in Futures on the CBOE and CME exchanges in Chicago was launched. This means that institutional and sophisticated investors are now able to bet on the future of Bitcoin without buying the currency itself. The entry of the big-money pros can give a significant boost to the trading volume in Bitcoin, but it could also be that Wall Street pros, as usual, will make money at the expense of small investors, and then smash the price down.

The Bitcoin story has some scary things. One of them is the fact that most of the Bitcoins are held by a very small minority, apparently large mining companies in China and the US. In addition, it seems that many criminal entities find the anonymity of the currency to be exactly appropriate for financing their illegal activities and laundering their capital. This is how a huge virtual black hole can be created and the authorities can’t do anything to supervise it.

What is so good about Bitcoin that excites so many people?

The vast majority of the writers on Bitcoin focus on the question of whether it is worthwhile investing in it, but only a few people delve into “why do we need it at all?” The truth is that I have not found many things that require a new coin to be launched right now (I would be happy if you would help me with this in the comments…). Still, on Coindesk – the most popular place for Bitcoin enthusiasts, there are a number of reasons why you need it, and here they are:

  1. The world’s central banks have lost control of world economies. Since the crisis of 2008, central banks around the world have printed trillions of US dollars, Euros, Yens and more, but quite a few economies have not yet recovered. Inflation has also not been within the target range of the governments (1-3%). According to Bitcoin fans, digital currencies are the solution – transferring control of the currency to the public itself. You have to admit that there is a problem with the long-term quantitative easing programs implemented in the world, but on the other hand, they did the work both in the US and in Europe. There are still economic problems in the world, but I do not see how the Bitcoin helps to accelerate global economic activity.
  2. Lack of privacy. Anyone who has seen the (very successful) movie Fight Club or the TV series Mr. Robot (which also features the Bitcoin) should be enthusiastic about the digital coins. Why? These currencies are not produced by central banks and clearing details do not pass through credit card companies or banks. Alternatively, everything is operated by a decentralized and anonymous system, so that our personal information and the details of our transactions are confidential in the Blockchain. There is no doubt that this is an advantage for the private person, the question is whether governments and tax authorities will approve of this over time.
  3. It is fast. A confirmation of payment in Bitcoin is apparently immediate, and this is an advantage. On the other hand, credit card payment is also processed in a few seconds, even in the case of international payment, so I do not see a substantial advantage for Bitcoin in this aspect.
  4. It is cheap. Credit card or debit card fees are not high for consumers, so the fact that the commission will be reduced to almost zero is not dramatic for them. On the other hand, clearing commissions are quite high for merchandisers – 3%-4% of the transaction amount. Thus, the transfer to Bitcoin payments reduces these commissions dramatically. However, at least for now, the conversion fee of Bitcoin to the standard Fiat currencies is very expensive, even more than the fees the credit card companies are charging from retailers, so even here the advantage of Bitcoin is still not expressed.
  5. It is safe. The decentralization, the anonymity and the difficulty of stealing Bitcoins increase the security of our money. However, we have seen more than once how sophisticated hackers are able to steal money from digital wallet holders, so that money protection is not perfect. By comparison, credit cards are insured, so if you are charged for a transaction that you didn’t do, the credit card company will refund the charge. I don’t see how a similar insurance mechanism applies in digital currencies where there is no possibility to track money.
  6. We can also make coins ourselves. Each one of us can buy a lot of computers, learn how to mine Bitcoins, and make coins himself. Cool right? In practice, this is a very complex and expensive task, so entry into the field has a very high barrier that only a limited number of companies can meet. In addition, think of a world in which new currencies are emerging every day and their exchange rates rise and fall sharply. Would you like to live in such a rollercoaster economical world?

Why are Cryptocurrencies not that good?

Alongside the advantages, Bitcoin and the rest of the digital currencies have many disadvantages and limitations that, without being solved, cannot become mainstream currencies.

  1. There is no regulation and no supervision. Bitcoin is a distributed currency and transactions are executed anonymously. This is a significant problem for the tax authorities. They will not be able to collect taxes properly, they will not be able to use the money to build infrastructures, to provide public health services, to finance the public justice system, and more. In short, this creates anarchy. With all the political and economic problems in the world, I think that the current structure is preferable over such a chaotic situation.
  2. World governments and central banks are becoming irrelevant. They will not be able to control the economy, regulate the currency and control inflation. True, since the crisis of 2008 they printed trillions of dollars and many countries have not yet recovered from the crisis. However, it must be admitted that the economic situation in most of the world has recovered, and inflation in the US and parts of Europe has already returned to a normal level of around 2% per year, so that the quantitative easing programs have done the work The Bitcoin can’t do that since there is no central entity that is able or in charge of stabilizing the economy.
  3. Anyone can produce a new digital currency. Have you heard of the JPcoin? Well, Jamie Dimon, JP Morgan CEO, does not believe in the Bitcoin, but one day his bank may decide to enter the field and create its own currency, the JPcoin. JPM is a reliable bank so everyone rushes to their currency and the Bitcoin price crashes. A week later, Mark Zuckerberg also decides to enter the field and creates the FaceCoin. Google and Apple also want to join the party with their currencies and the world enters an economic chaos. As said earlier, since the technology is open, who’s to say that it would be the Bitcoin that will triumph?
  4. The price is too volatile. None of us wants to hold a currency whose value is likely to drop sharply in the near future and neither retailer will accept payment in that currency. Since the currency is decentralized and not issued by central banks, it is not possible to regulate or control its volatility, which is a big problem. As long as the price of digital currencies continues to be quite volatile, none of them can be used to buy and sell products, to provide loans, and so on.
  5. A limited number of units. Bitcoin is limited to 21 million units that will be fully mined approximately by 2140, making it rare relative to the global market potential. Therefore, many are willing to pay a high price to buy it before the deadline, which pushes the price up. Since the computational power to produce one Bitcoin increases over time, future units mining will be more costly and rare, which can continue to push the price further up. In such a situation, people will prefer to hold a Bitcoins instead of consuming or investing in other assets, which will slow economic growth and weaken markets such as real estate and other investments.
  6. Bitcoin mining requires a lot of energy. The surge in Bitcoin’s popularity is leading to a devastating result that its developers probably have not thought of – generating the currency requires a huge amount of electricity, something that could hurt global efforts to reduce the use of polluting energy sources. In my understanding, the cumulative computing power of the Bitcoin network is close to 100,000 times that of the world’s 500 fastest supercomputers together. It is estimated that to operate this network, a power consumption of about 31 terawatt-hours per year is required. This is more than the annual electricity consumption of over 150 countries in the world. The problem is that the power consumption of the Bitcoin network is increasing by about 450 gigawatt-hour per day, so by the end of 2019 the power consumption of this network will exceed the total US electricity consumption and will exceed the electricity consumption of the entire planet in 2020. If you do not believe these calculations, take a look at this article. If that’s true, then it’s not only scary but also making the Bitcoin mining inapplicable in the long run.
  7. Limited transactions per second (The Scalability Problem). The Bitcoin network is very reminiscent of the early days of stockbrokers 30 years ago. As then, the network is also unable to process a large number of transactions in a short period of time – the maximum is 3.3 to 7 transactions per second. By comparison, Visa’s system can process 47,000 transactions per second. This is a limit that cannot be solved because a block in the Blockchain is limited to 1 megabyte. In such a situation, it is hard to see how the Bitcoin becomes a currency used by hundreds of millions of people to pay online. There are other digital currencies such as the Etherium, for example, where a certain improvement in the number of transactions is expected, but since they are also based on Blockchain technology, they also operate under this problematic limit.
  8. A too high concentration of money. 2.7% of the Bitcoin holders hold 96% of the available bitcoins out there (!). It is mainly a number of huge mining companies operating in the US and China. This is not exactly the free market revolutionary economy that the founders and supporters of Bitcoin dreamed of. Such high concentration is granting an unlimited power to those rich holders, giving them the power to manipulate the price through supply regulation, which is very reminiscent of the OPEC cartel’s control over the supply and price of oil, which is unhealthy.
  9. Not so simple to buy it and even more difficult to sell it. To purchase Bitcoin you need to install a digital wallet application, open an account with one of the brokers, transfer money from your bank account to your broker, and then convert it to Bitcoin. Even if it sounds simple to you, it is no trivial procedure for most of the public. The simplest proof of this is the fact that there are long lines at Bitcoin ATMs. This is not the end of the tribulations of those who bought Bitcoin. If you want to sell, and especially large amounts, you sometimes encounter the slow and failure of the Bitcoin network in converting currencies to standard money. Moreover, in some cases, your bank refuses to transfer the dollars back to the account as they fear of money laundering. At the moment, the main money flow is from dollars to Bitcoins and with small amounts of $1-100 per person, so most people do not see this sell issue, but if and when the trend is reversed, the bottleneck on the network could lead to a very sharp crash in price.
  10. A Bitcoin can be stolen. Despite the complexity of the technology, it turns out that even your digital wallet can be stolen. Recently, we have seen few robberies from mining companies and brokers which in some cases lead to a bankruptcy and Bitcoin holders losing their money. For comparison, when was the last time someone has broken into your bank account and stole money from there? There’s another problem – if you happen to lose your wallet’s unique address, which consists of 26-35 letters and numbers, it cannot be recovered, so your money goes down the drain.
  11. Frauds are easy with Blockchain. When you buy on eBay or Amazon and pay by credit card or Paypal, your money is safe – if you do not get the goods you get your money back. It is hard for me to believe that someone will guarantee this in case of payment in cryptocurrency since the transfer of the payment in the Blockchain is anonymous (the seller who receives the money will immediately transfer it to another wallet and then the money cannot be returned back to the buyer). This could lead to increased fraud activity.
  12. Paradise for criminals and drug dealers. As stated above, everything is done anonymously, under the radar of the regulator, and therefore it is a very attractive place for criminal entities and money laundering activities. It’s hard for me to believe that the regulator will allow it for the long haul.
  13. The number of investors in the currency is much greater than the number of users in it. This is reminiscent of the commodity futures bubble in 2008. We all recall how it exploded when commodity prices plummeted. Anyone holding a Bitcoin must take into account that his investment is at a very high risk.
  14. The “stupid” money begins to be tempted to invest in the currency. Recently, it seems that the buzz around the digital currencies is leading more than 100,000 people a day to purchase Bitcoins for investment purposes. Some of these gamblers sell properties and even take loans to buy Bitcoins, all to take part in the party. We have seen in the past how such things end.

I can go on with a lot more drawbacks and problems, but I think you’ve got the idea…

Can the price of Bitcoin continue to rise forever?

There is a well-known saying that when the taxi driver talks to you about investing in something, this something is probably a bubble. This is a known psychological phenomenon called Fear of Missing out (FOMO) – the fear of seeing your friends gain from an investment you have not made. This is exactly the case with the Bitcoin. Everyone is talking about it in the news, on the street, at dinners, everywhere. That still does not mean that Bitcoin’s price cannot go up even more, but that implies expensive pricing, even after the current 30% drop from the previous peak.

Still, at least at the moment, there are a total of about 20 million people holding Bitcoins, most of them at small amounts of $1-100, so it seems that this bubble still has quite a bit of room to expand, especially if the big money from Wall Street will decide to join the party (and this could happen now after the start of futures trading on the Chicago commodity exchanges). In addition, it should be borne in mind that the more Bitcoins are mined, the less potential bitcoins remain and the more difficult it is to produce new Bitcoin, so at least on paper, the demand for it will increase.

Another backwind can come from China. China is in financial trouble (a slowdown in growth, a huge bubble of loans and a real estate bubble) and to ease the problems the Chinese government has shown more than once that it is also ready for a currency war by devaluing the yen. China may adopt the Bitcoin and encourage its use to raise its value and weaken the US dollar. Thus, it will weaken the American economy and will be able to take the lead. The Chinese government has endless financial resources, so if they really want to strengthen the Bitcoin, its price will skyrocket. It will not happen tomorrow morning, but this is a possible scenario in the more distant future.

What is the highest price the Bitcoin can get?

If you really want to dream, you can imagine how much a Bitcoin would be worth if it replaces all the money in the world. It is estimated that the total (Narrow) money in the world is $36.8 trillion, and if the 21 million Bitcoins at the end of the mining process will replace it, each unit will be worth about $1.75 million. This is 125 times the current currency price (about $14,000).

But what are the chances that the world’s population will use only one currency? Probably not too high. If for example, we assume that the Bitcoin will exchange money similar to the money supply in the US, about $3.1 trillion, each currency will be worth $147,000 at the end of the process, i.e. only 10.5 times the current price. In other words, if you want to dream you’re invited to do so, but in a reasonable scenario, the Bitcoin potential return is no longer as phenomenal as it was a few years ago.

What can lower the price of Bitcoin?

  1. The Regulator. Over time and in large volumes, it does not make sense for governments, central banks, tax authorities and law enforcement agencies to allow the use of a payment method that cannot be controlled and the amount of tax need to be paid for it is unknown. This will be the end of democratic-economic governance in the world as we know it. At the moment, despite the media noise, Bitcoin is a drop in the world’s money sea, but if it gets stronger, the regulator can immediately stop using it and the price will quickly collapse to zero.
  2. The rise of another digital currency. The Bitcoin was the first and so he gained so much popularity, but on the other hand, he also suffers from birth pains that other currencies may not suffer from. Therefore, the blockchain technology itself may become mainstream but the Bitcoin itself can lose its lead to another currency. In addition, as Warren Buffett has said, the Bitcoin today is actually the check of 30 years ago. In a few years, it is possible that the digital coins will be so common that the right to hold a Bitcoin will cost only a few cents, as it is today the cost to print a check.
  3. Launching of digital currency by central banks or public banks. In Mr. Robot, the financial world dominates a giant conglomerate called E-Corp, and after the collapse of the world banking system (sorry for the spoiler…), they get approval from the regulator to start issuing digital coins. Of course, in return for approval, it allows the regulator free access to all information about the transactions that are taking place in the system. In the series, it kills the Bitcoin, and in the real world, in the future, it can also happen. In this scenario too, the blockchain technology survive but the Bitcoin vanishes.
  4. Manipulations of the price by sophisticated investors. The launching of Bitcoin futures trading on the Chicago Exchanges puts institutional investors, hedge funds, and sophisticated investors into the field. These investors have infinite funds, so they can do anything they like with the coin – push it upward or downward as they please. For the most part, they make a profit and the small investors lose.
  5. Increasing the supply by the mining companies. As mentioned, the mining companies hold most of the currencies and therefore, if they wish, they can reduce the supply in the market and the price of the Bitcoin will increase or accelerate the rate of mining to make more profits, and then the price will drop.
  6. Breakthrough of improved technology than that of the Blockchain. As a matter of fact, there is such a thing and it is called a Hashgraph. It also has its limitations, but it solves many of the problems in BlockChain, especially about scalability, speed, and high fees. The Hash is not open source as the BlockChain, it is protected by a patent, so the regulator may prefer to approve the extensive use of it, rather than the distributed and anonymous blockchain.

Bottom line: buy or not?

Don’t buy Bitcoins.

Any conclusion I write will be a guess. No one really knows what will happen with the Bitcoin in the future. Still, it feels like a duck and looks like a duck, so it’s probably a duck, which means that the Bitcoin is a bubble. It does not make sense that the price of something will go up without a thorough understanding of its implications, the problems it creates, the many risks it will not grow on a large scale, and especially what is its true value. Thus, most of these digital coins will eventually collapse to a more reasonable price level.

Personally, I don’t hold any units of Bitcoin and I do not intend to buy in the future. I may miss the hottest revolution in history, but I prefer to stick to the principle of not buying something that I do not fully understand its business model and its fair value, and in Bitcoin I do not know the answers to these questions (but I do know how much any of my portfolio stock is worth…).

If, however, you have decided to invest for the long-term in crypto-coins, I think the most logical way to do this is by dividing your money between a large number of digital currencies. Do not put all your eggs on the Bitcoin – no one promises it will be the winning currency in the future. Alternatively, build a basket of digital currencies, similar to the purchase of an Exchange Traded Fund tracking a broad stock index and you will get exposure to the field with a higher diversification, thus at a lower risk.

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