Bitcoin crashes already?

Yesterday's TechCruch post points out that Bitcoin is trading around the $300 mark down from its peak of $1,150 last year, with Paul Krugman, Dealbook and others questioning whether this is the crash. If this is indeed the crash then it's come awfully fast. In today's world where news headlines finish their cycle in 24 hours, perhaps it's only fitting that speculation and crashes run through ever shorter lives as well. 

From AVC Blog: The Bitcoin Hype Cycle

Fred Wilson of AVC blog has a great piece about the Gartner Hype Cycle, which lines up rather nicely with the price history of Bitcoins.  Bitcoin enthusiasts should definitely check it out. 

Can you spot Satoshi Nakamoto?

Courtesy of Dealbook. http://nyti.ms/1pLezBz 

Are you a miner of Bitcoin without even knowing it?

Two apparently popular Android apps were reportedly using the phones of users who downloaded their apps to mine for Bitcoin without informing them.  ZDNet has more details about the alleged scheme. The two apps, called Prized and Songs, were removed from Google Play as reports circulated about the apps but they are reportedly still available on App Brain.  Something to be said for Apple's gatekeeping role for iOS apps. 

NYT DealBook: Facebook Stock Not So Different Than Bitcoin

The title of Rob Cox's post says it all, except perhaps for the money laundering angle.  Easier to launder money using Bitcoin or put it differently, I'm not aware of any federal criminal cases where prosecutors are alleging money laundering through the use of Facebook stock. 

Fatal Flaw in Bitcoin Programming?

Dealbook reports that Mt. Gox has detected a previously unknown software glitch in Bitcoins requiring it to halt trading. The chief scientist at the Bitcoin Foundation disputes this and said the problem is with Mt. Gox's software.  The Bitcoin market now has to reckon with the possibility that the software may have glitches or worst, that it could be hacked.  Will Satoshi Nakamoto will release a patch? 

Forget Bitcoins, Do You Take iPhones?

Courtesy of BusinessWeek, I now know that instead of Bitcoins and Louis Vuitton handbags I can buy iPhones to bartering for services. Apparently Hermes is quite popular too, but I don't really want to carry a USD$10k saddle around with me.

Doubling Down: Bitcoin Evangelist Won't Back Down

Dealbook reports that Charls Shrem, one of the most visible advocates of Bitcoin, has not backed down from his support of the virtual currency, despite his arrest and accusations of money laundering.     The post mentions Mr. Shrem's dreams of a Bitcoin debit card, different business such as a private charter jet company or a bar taking Bitcoin.  In particular he noted that "Bitcoin really allows you to have such a global life — it allows you to be able to move anywhere within days if you want to."  Let's see, I can travel internationally now at a moment notice, use debit cards, buy drinks and charter a jet (if I had the money).  So what exactly does Bitcoin provide that real currencies cannot? 

Bitcoin’s Emerging Price "Stability" via TechCrunch

TechCrunch has an interesting piece about Bitcoin's price volatility, or rather, that its price has reached a new stage of stability, looking at the month of January, 2014.  

I think the jury is still out on Bitcoin and to have true statistical value, we need more than 1 month's worth of data to determine whether there is price stability.  That's assuming we agree on what we mean by "stability." 

How does Bitcoin help criminals? Let him count the ways.

Dealbook reports that law enforcement officials testify as to how virtual currencies like Bitcoin help criminals. 

Access to capital and banking services to become restricted

As expected, certain types of people and entities will find limited access to capital and banking services.
WSJ reports that U.S. banks like JPM are ending banking relationships with potentially troublesome customers like virtual currency firms and legal marijuana businesses rather than put up with the additional compliance work involved.  Will this drive these types of capital flows underground?  

Purpose of Bitcoins to avoid paying bank fees?

Dealbook reports on the hearings today called by NYS's top financial regulator, Benjamin Lawsky.  Reading the post it appears that the major benefit for Bitcoins as provided by those testifying, was to avoid bank fees and move "money" around faster. But there are reasons for why money should not move so fast. Why is a person's life improved if they can move money from one account to another in 2 days as opposed to 3?  And there is a cost to ensure that the movement of capital is not being used to facilitate illegal activities. 

Bitcoins: Bonanza for the regulators?

Given all the noise about Bitcoins I can't resist another post today.  Regulators are apparently jostling to be among the first to regulate Bitcoin businesses as money transmitters following the announcement by the U.S. Treasury Department’s Financial Crimes Enforcement Network.  Assuming that no federal regulatory framework is proposed, I expect a handful of the states looking for "impact regulation" will be the first to propose specific regulations.  But then I also expect that eventually, the federal government will preempt all state laws and regulations involving Bitcoin. Until then, Bitcoin will provide a rich source of laws and regulations (and potentially fees and taxes) for state governments.

You say marijuana, I say Bitcoin?

According to Bloomberg, the SEB AB Bank has refused to set up Bitcoin accounts due to concerns about money laundering.   The news about Silk Road getting shut down and prominent Bitcoin speculators being arrested for money laundering comes at the same time that legal marijuana businesses appear to have no access to banks due to the same money laundering concerns.  Except of course that legal marijuana business can transact in cash whereas Bitcoin only has value if it can be converted into another currency.  Unless one were to shop at Overstock.com where apparently they still take Bitcoins, money laundering concerns be damned!  Does anyone know if Overstock's Vice Chairman, Jonathan Johnson, is as worried about Bitcoin and money laundering as he is about gay marriage?

Bitcoin miner beware!

NY Times's Dealbook has reported that 2 executives of Bitcoin business have been arrested, accused of facilitating drug transaction on the now defunct website Silk Road.  Investors looking to profit from Bitcoin should tread carefully lest they be accused of being a part of a money laundering scheme.

Bitcoin is NOT Money !!

Yes, bitcoin is fun.  But it’s not money.  It fails the most critical and basic test of “money.”  Along with many other people, we wish it could be money.  The problem is NOT that bitcoin exists only in electronic (or virtual) form.  The problem is also NOT that bitcoin is independent of governments and banks.  In fact, we love these properties!  We’ll say it again:  Bitcoin fails the most critical test of money.  To explain, we digress.

Role of Money

Let’s start at the beginning.  Every adult must acquire the survival necessities of food, shelter, and clothing.  The most direct means of acquisition is to grow one’s own food, build one’s own shelter, and make one’s own clothing.  Free people, however, choose otherwise.  Just as baking two pies is little more effort than baking one, production of food, shelter, and clothing admits vast economies of scale.  A farmer can double the size of her “garden” to feed two families rather than one without doubling her labor or investment in tools.  By doubling her production, the farmer will exchange the excess crops, perhaps, for the clothing and firewood that her neighbor provides.

The superior efficiency of this exchange, or “barter,” system is indisputable.  All participants in this barter system earn their necessities with less time and effort.  Direct barter is potentially manageable in small communities but suffers from the complexity of innumerable “exchange rates” among the barter items (e.g., vegetables, meat, clothing, livestock, lumber, barn construction, medical services, et cetera).  The establishment of money simplifies the barter system tremendously.  People exchange their goods and services for money that they use, in turn, to exchange for items they need from others.  Money becomes the pre-eminent barter item but has meaning only in its ability to facilitate free market exchange of goods and services.

Money is an extraordinarily simple and elegant solution to the barter exchange rate problem.  Further, the size and scope of the barter market increases astronomically due to our ability to save money for future years, borrow money for future repayment, and transmit money easily over long distances.  All human societies invent money, just as they discover fire, in their pursuit of survival and advancement.

Yet what particular barter item could serve as money?  The requirements “to save money for future years” and “transmit money easily over long distances” eliminate most candidates.  Crops and cattle, for instance, are of great value and some historical accounts consider them as early forms of money.  But they are not well suited as money.  The dominant money of the thousands of years of recorded history has consisted of coins of metals and alloys such as copper, bronze, silver, and gold.

The requirement that trumps all others is the certainty people have that whatever serves as money has enduring value.  A man will agree to accept copper coins for his bushels of wheat only if he is confident in the value of other goods he can purchase with the same coins – whether now or next year or within the same village or many days’ travel away.

Gold and Silver through the Millennia

What substance or physical item could possibly inspire such confidence simultaneously in almost all people?  What would all people agree has value “now” and will have significant value at all future times?  There is nothing tangible on Earth that can provide this certainty of value.  Surprisingly and with no strong explanation, however, the metals gold and silver are history’s best answers to these questions.

Gold, and to a lesser extent silver, has smitten human beings through all of recorded history and across a wide range of cultures.  No society rejects gold.  (Lenin may have said “we will make public toilets out of gold,” but neither he nor his successors in the Soviet Union followed through on this promise.)

The history is clear.  Human beings have always regarded gold and silver as “valuable.”  This persistence and confidence are precisely what one needs for viable money.  But there’s a counter-argument:  why should this work?  If a society bases its money on gold or silver and then, suddenly, a large fraction of the society realizes one “cannot eat” gold or silver and that there is no evident value other than “shiny and pretty,” what happens then?  The monetary system would fail.  But it has never happened.  There is no certainty gold or silver will always work as money, but the world has thousands of years of good experience.

Fiat Money

Earlier we stated that the dominant requirement for money is the people’s certainty of “enduring value.”  Yet we then expressed the view that there is nothing tangible on Earth with this certainty.  Gold and silver are merely the best candidates.

Fiat money consists of tokens such as coins or paper certificates with little or no inherent value that a government decrees has stated value.  The enduring value of such money, then, stems from the people’s confidence in the government to maintain the value and validity of the money.  One critical aspect of maintaining value of the otherwise worthless money is that the government mandates that businesses and people accept the fiat money in all payments.

Like many ideas in life, fiat money can certainly work as intended in one’s imagination.  If our employer pays us for our labor with colorful pieces of paper and we know we can exchange this paper for immediate or future purchases, then the money is functioning.  An evident risk is counterfeiting of the colorful paper, so the government must take pains to produce the paper money in a manner that is difficult to emulate.  The government will also create and enforce laws to forbid the counterfeiting.

Since fiat money has no intrinsic value, the citizen implicitly relies on government to maintain the money’s value relative to goods and services in an economy.  We don’t like fiat money – we see it as a disaster waiting to happen.  But at least fiat money has a premise:  “trust government to create and supervise money.”

Bitcoin has No Enduring Value

The big problem with bitcoin is that there will never be widespread, popular certainty that it has enduring value.  We may be able to buy food or clothing or pay our college tuition today with bitcoin, but what about tomorrow?  Proponents of bitcoin might argue that there’s a plan to cap the total bitcoin supply and such fixed supply should maintain stable bitcoin prices.  But why trust that arrangement?  Why trust the unknown and unaccountable group of people that manage bitcoin?  While there may be arguments for trust, public behavior does not derive from carefully parsed arguments.  There’s no stability if people need to think about their money and wonder why it has value.

Perhaps the “easy fix” to this problem is to get government to enforce (or compel or otherwise support) bitcoin somehow.  Yet the existential point of bitcoin is to move away from government control of money.

We’re not economists here at Financial PESTs!!  This is not an argument from the musty library of “Economic Theory.”  Good economists know that they don’t build the theories first and then expect people to follow them.  It works the other way.  Observe how free people pursue their own self- and communal interests.

(We excerpted portions of this essay from J. M. Pimbley and L. E. McDevitt, Banking on Failure at Lehman, to be published in 2014.)

Why is Bitcoin sucking all the oxygen out of the room?

One of our other bloggers, Joe Pimbley, is currently working on a book that we expect will touch upon the topic of Bitcoin.  While he is Financial PEST's resident Bitcoin expert, I couldn't resist posting something about it.  The New York Times Dealbook features a critical piece by Edward Hadas about the virtual currency while Bloomberg Business Week recently published a feature story about the virtual currency and the economy that has erupted in pursuit of this "fool's gold." I wonder, however, whether Bitcoin fits into the classic definition of a "currency" and whether, perhaps, there may be more similarities to the Great Tulip Mania of 1633-37 in the Netherlands.