Gil’s Musings

So You Want Bitcoin?

Bitcoin is all the rage with prices up a whopping 900% for 2017. One bitcoin breached the psychologically important $10,000 mark Tuesday for the first time and then shot up to $11,000 by Wednesday.

As a primer, bitcoin is a digital currency, which means it has no central bank or government that backs it. Given worldwide budget deficits, the lack of backing may be bitcoin’s most desirable attribute. Yet, brokerages have been hesitant to make a market in something so new, volatile, and unproven.

Bitcoin is created in a mining process, where a mathematical algorithm essentially solves a puzzle in an open-source-code environment. This process was invented in 2009 by an unknown group of people operating under the name of Satoshi Nakamoto. When the puzzle gets solved, new bitcoin are created and the history is logged in successive chains until one fills up and a new block is created. These are called blockchains. The links’ creators are unknown, and only the numbers associating the blocks and chains are known. Imagine the value of such anonymity in nefarious activity. Governments will struggle to regulate it, but they are certain to try since power normally doesn’t like competition. The most valuable part of bitcoin may be the proving of the dependability of blockchain technology, and not necessarily in the bitcoins themselves. Changing technologies can often eat the early iterations; case in point: Myspace.

Volatility has now entered the sphere with talk of a Bitcoin Exchange-Traded Fund (ETF) sponsored by the Winklevoss twins. You might remember them as the brothers who sued and won a $65 million settlement with Mark Zuckerberg over the pair’s claimed ownership of the original idea for Facebook. The listing of an ETF would lend an air of legitimacy and provide liquidity for bitcoin holders. The daily pulse on such ETF news provides continuous drama, glamor, and appeal, which seem to be riding on the news of this development.

Bitcoin has seemingly taken hold, and it likely competes with gold for a spot in an investor’s portfolio where there is supposedly no counterparty risk. Maybe not, but there’s likely counterparty risk when you want to sell, and there may be no buyers. Liquidity or lack thereof is counterparty risk in and of itself. Similar daily volatility in prices exceeding 25% has previously been associated with manias, panics, and crashes. I won’t predict such an outcome since I’m no authority on cryptocurrencies. However, this does have a similar aroma to the pair of emus I was offered in 1990 for $25,000. I was later offered the opportunity to bow hunt a “trophy emu” for $50. Bitcoin may be legitimate, but I’m steering clear.

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