The Case For (and Against) Bitcoin…
Two weeks ago, I wrote my weekly commentary on why I would not touch Bitcoin (BTC) as an investment. That was before Tesla invested US$1.5 billion and Bitcoin shot up. I have not changed my mind. But today, I would like to examine the intellectual arguments FOR bitcoin as an investment, as a speculative instrument, and as a “currency” or medium of exchange, as promoted by its fans.
BTC as an investment
After the Tesla uptick last week, I am even more reluctant than two weeks ago, to put my money into Bitcoin as an investment. Investment is not about having a view, an expectation or a forecast about the direction of price movement in a particular asset. You may think that BTC can rise in price to US$100,000 and you want to put your money there. That is not investment.
Investment must ALWAYS consider the risk of the price forecast being wrong – it is risk versus return expectation that makes something “investable”. If two weeks ago, I had expected the price of BTC to rise from US$43k to US$50K, with 75 percent probability, then today, if that probability of it rising further from 53k is rated to be say, 5 percent, then I would not be a Buyer; I would be a Seller. Disinvestment.
Conversely if today, I expect BTC to rise to from $53K to $100K, with 50 percent probability, then I would be less willing to buy it today than two weeks ago when the risk return ratio (based on the lower price of 43K) was better. There is always a risk vs return analysis in investment. Expectations of risk vary from person to person. And you can figure that out on your own. There is never such a thing as a sure thing. A good investment is when you can get returns without taking intolerable risks. And if you cannot accept even an iota of risk, ie, cannot afford to lose any money at all, you would not be able to invest in anything. Anyone who thinks that there is no price risk in BTC is blind.
But my main reason for not favouring BTC as an investment is not just based on price risk vs return expectations. There is also this very key thing about its security risks.
I did say two weeks ago that I would not touch this investment personally because BTC involves the need to safekeep the asset with a unique password which completely determines ownership and access. If you cannot trust yourself with that long and complex (basically impossible to commit to memory) password, then you do not have a secure investment. You will have to find a way to secure that password. I suppose one way is to engrave it on a dog-tag around your neck, but then your life would be at risk, once muggers find out what that dog-tag carries. Put it in a safe or a hard drive? Under your mattress? You all know the problems with those methods. A simple human error will bring your BTC investment to zero.
If you have to trust another person on this planet with that unique password to safeguard your BTC for you, it is the same as giving your BTC away and then trying to get it back later. The bigger your BTC stash, and the more valuable it gets, the more likely you will lose it when your trustee decides not to return it. Entrust it with more people? Even worse. Each of those can do you in.
Of course, you can commit that rather lengthy alphanumeric password to memory but you may get to the age of dementia when you need to cash it in. So however I think about security risk, BTC is not viable for me. You may want to think deeply about this security risk problem if you wish to be a long term investor.
The final reason for my not liking BTC as a personal investment is based on a simple reality check that I am not a whale in a market dominated by enormous whales (a whale is a very large investor like Elon Musk whose actions can affect the price). If you are a whale, you have nothing to worry about, and you might find joy in cavorting or competing with other whales. My advice is that if you are an ant like me, stay out of markets where elephants and whales play. Getting trampled or crushed is a horrible way to die.
But hey, that’s just me… I am not saying that everybody should have the same attitudes towards investing. It’s just that with those three fundamental characteristics – the risk vs return problem, the physical security problem and problem of being overwhelmed by whales, BTC is not an investment asset in my book. Don’t ever call it an “asset class”. It is no such thing.
BTC as a speculative instrument
Of course, BTC can be considered a way to speculate. As a matter of fact, since it has high volatility, it is a perfect speculative instrument. Trading speculatively in BTC is fine, if you know what you are doing. Just have a stock of dog-tags, ready for numerous BTC passwords as you buy and sell.
You should however know that to speculate successfully, you need superior intelligence (as in information) and talent (as in brainpower) over most of the other players. In most speculative markets, starting with casino games, the track record for laymen is a 90 percent chance of losing money. Of course, you could be in the top 10 percent. Trading is one of the hardest of human endeavours. It requires supreme control over one’s emotions to be successful. Most people cannot succeed at this greed vs fear mental game.
And you need better information than your competitors. If it has been announced that Elon Musk has bought BTC and you heard it on the news, you are too late. For example, we all now know that Tesla bought US$1.5billion of BTC. Do we know since then that it has not sold out of part of it, or even all of it, as prices rise in its favour? We don’t. There is no obligation for anyone speculating in BTC to tell you their positions. Whales will not tell you. So how would you know? If you don’t know, how would you win?
With that said, the odds of winning at this speculative game has to be framed in its proper context. In the current BTC market, it has all the features of a mania. It may not be a bubble, but its behaviour is no different from any other mania, meaning the volatility is of the same heightened degree. Based on flimsy arguments about it becoming nirvana in a dystopian future. Like in GameStop just a couple of weeks ago.
Speculators involved in a bubble have a problem with controlling greed and fear. As it goes up rapidly, buyers have a problem knowing where to take profit. If they get out too early, and the price rise continues, they generally jump right back in with a larger amount of money so that they won’t “feel left out and stupid”.
It’s human nature.
If you convince yourself that you would be disciplined and hold for the long term, then you might end up in the GameStop situation. All the Redditors held on to their positions and watch the GameStop price go up. And then crash down. In just about a week. They might as well have stayed out of it. This pattern is so familiar in all speculative bubbles that you need to be supremely confident you are superman, to be different. Superman? Haha hah....
If you are speculating on BTC, recognise that to be what you are really doing and don’t love BTC so much that you don’t know how to sell. Speculators typically get emotional over their trades, and when they are right, it gets to their heads, and that the trade becomes an endearing everlasting investment. The small price movement in their favour usually ends up in a drastic fall. It is so predictable. Bad speculators don’t know how to get out of a bad trade.
BTC as a currency
If you get on social media, especially Youtube, you will be overwhelmed by the views of promoters of BTC telling you why it is the best investment since sliced bread. Solves all the problems of the money world. Does it really?
1. A Peer to Peer Monetary system
BTC is heralded as a solution to corrupt governments and politicians who take power and invariably debase the value of your money (through money printing, excessive borrowing etc). That is a familiar argument. They claim that with the keys handed to a peer-to-peer system, your money is safeguarded.
The argument goes like this. Fiat currency is controlled by the banking system, which is most interested in skimming money off you, and by governments, which will take your money and waste it after your wealth is declared and then taxed. BTC holdings are unknown to government, and all transactions, holdings and wealth are taken out of the hands of banks and governments and safeguarded by the public at large. Without information released to banks and governments, you are safe.
What a lame idea!
You want to get out of government scrutiny and put your money into the hands of people you don’t know on the premise that unknown persons in aggregate won’t cheat you. Wake up. BTC cannot really run like in a true “peer to peer” fashion, without intermediaries who can be far worse than banks and governments. You should know that the first ever BTC intermediary, called Mt Gox, was based in Tokyo and once handled 70 percent of all BTC transactions in the early days. It was the big fish in a small pond, the incipient BTC market.
Mt Gox went bankrupt in 2014, lost $450million dollars and its founder(s) went to jail. Other intermediaries in BTC’s early days have also collapsed and some people ended up in prison. As of today, lawsuits related to Mt Gox are still active.
BTC did not have a great start, and this is not like all this criminal activity happened a hundred years ago. It was just about half a decade ago and legal cases are ongoing. And suddenly, now is a time to expect all intermediaries of BTC to behave like angels? I am not that naïve.
Peer to peer safeguard of wealth using cryptocurrencies is a flimsy excuse of a promotional tactic. Period.
2. The Security of Blockchain
BTC is a technological breakthrough in IT. That is true. Promoters will sing praises of what is called “blockchain” technology, which is a highly sophisticated publicly administered database of all BTC transactions, so that nobody, absolutely nobody can create a “double spending” problem. In other words, since BTC is based only on the internet, and there is actually no physical manifestation of its existence, users are at risk of someone spending the same batch of BTC twice. This is the central technical problem that needed to be solved for BTC to be viable.
The “white paper” that created the mechanism of blockchain to solve double spending was written in 2008 by an unidentified person named Satoshi Nakamoto. Nobody knows if this individual actually exists but he wrote a brilliant paper. Here it is:
https://bitcoin.org/bitcoin.pdf
In a day and age when talent can be translated into enormous wealth, why wouldn’t anyone own up to be Satoshi Nakamoto? Maybe there is altruism in the world after all. On the other hand, do we have to believe that Satoshi Nakamoto is not a real person and is in fact the largest whale around? There is either an idealistic ghost or an enormous whale. It’s all very fishy. Take your pick on what you want to believe. Both are just as bad because it is not transparent.
Imagine what you will have to tell a judge if you are the victim of a scam involving your holdings of BTC:
You: “Your Honor, I have been cheated out of a huge amount of money…”
Judge: “How much did you lose?
You: “I really don’t know because its value changes every second by large amounts. So it could be x million or y zillion dollars…”
Judge: “The bank cannot confirm the amount?”
You: “I didn’t trust a bank or anyone else…nobody except the cheat…”
Judge: “He took off with your stash?”
You: “No, I put it into the internet, in something created by an anonymous person who does not really exist, and somebody on the internet gave me a unique but complicated password I cannot remember, and so I left it with a trusted friend as an insurance to my bad memory, and now he says the money is his.”
Judge: “Can you prove that the asset is yours to begin with?”
You: “No, because it does not have physical form. A ghost created it, and found a way everybody on the planet can verify that my stash of the asset cannot be used twice. And then I gave up hard dollars for this claim of ownership of an intangible.”
Judge: Who tells you that the stash is only owned once and you now own it?
You: “Computer geeks…”
Judge: “And are you a computer geek?”
You: No
Judge: “Since you cannot prove you own the asset and your friend cannot prove he owns it either and all the computer geeks prevent both of you from double spending/owing it, then let’s just cut it in half and you two go your separate ways. Tell me who will do the split.”
You: “Other geeks.”
Judge: “The same geeks whom you don’t know and who created the problem in the first place?”
You: “Yes, your Honour”
So blockchain is a highly sophisticated piece of software technology that enables nobody you actually know to become people you completely trust. Over and over and over…
Brilliant, isn’t it?
3. The Mining Problem
The blockchain prevents double spending through an audit process which then organizes completed transactions of BTC into unalterable blocks chained together in a complete paper trail, for anyone geeky enough to then inspect. But which geek is going to do all that work?
The arrangement in BTC by the founders (whoever they really are) is for the public (actually, geeks) to do this auditing. For a fee.
This auditing process is called “mining”, since the verification of a set of BTC transactions creates each new BTC block and rewarded by the issue of more BTC by the BTC geeky network until 21 million have been finally issued. These miners need to use heavy duty computer hardware to first solve a complex mathematical problem to earn the right to do the verifications, and then actually do the intensive work of the verifications. Each time they do it, they need huge amounts of intensive computing and lots of electrical power. The details of how much power is used is detailed in most internet articles explaining BTC mining.
This is often lauded as a good thing as it is seen to help maintain the integrity of BTC. It makes blockchain secure because only highly intelligent geeks can do this. They need to start with plenty of money to invest in specialized hardware.
I would not agree it is a good thing. BTC mining is both expensive, time consuming and power hogging. It cannot be easily done really by anyone. It is now the exclusive preserve of a handful of teams of such miners, that have locked everyone else on the planet out of this task. It is like a mafia of geeks. Does this sound like a peer to peer system to you?
Furthermore, these miners use so much power that it affects global energy sustainability. None of the miners are “green”. It is so expensive that they are all coal-fired, the cheapest way to do it.
The rate of new BTC issuance is nearing zero, as the number of 21million is being reached in an asymptotic manner and no new payment or incentive to do this auditing (blockchain creation) will be available. Which means the incentive for doing the work ends. Does this mean that “blockchaining/auditing” ends? No more verification of double-spend? No more BTC?
Nobody actually knows the answer to this fundamental question. There are no promoters who ever talk about this issue. They pretend that this merry circus goes on indefinitely forever. The question is stark – mining is running out of incentive payments to pay the geeks, so who is going to do blockchain that will sustain BTC in the future?
This is the experience so far when BTC is only used in speculation. It is just a small minority of people on earth engaged in this non-productive activity. Nobody has even begun to use BTC in actual transactions, to buy stuff, in a way anywhere close to fiat currency is being used. The more verification is needed, the less incentive is there for miners to do so. Then what? If you know the answer to that, pray tell me.
There is also an environmental disaster in the making if BTC becomes widely accepted as a medium of exchange. As a matter of fact, I believe that blockchain technology in sustaining BTC as a speculative vehicle is on a path that will eliminate its use as a medium of exchange. If BTC were to be so used, with tens of thousands of times the volume of transactions it is being used now, it will destroy the planet’s energy sustainability faster.
Most whales should know this. Why then do they not foresee this happening when BTC is promoted as a medium of exchange? This convinces me that the BTC market is being manipulated by the whales. Or the geeks. There is no intention of using BTC as a medium of exchange because it cannot be done. This is all a game to suck non-geeky people in and it will have to collapse before reality sets in.
Of course, it can be argued that block chain technology can be vastly simplified so that it does not require the vast amounts of power to drive BTC transactional capabilities. If that happens, the product will no longer be BTC as it is currently defined.
Mining sites are readily identifiable on the internet. If I were to be an investor, how do I influence the geek mafia to have security against sabotage, terrorism or simple fire and theft. Governments and the establishment are not to be involved or it would not be BTC. Only geeks in their exclusive community can ensure all that security. This product is full of holes.
5. BTC and price volatility
In addition, the very volatility of BTC cannot sustain its role as a medium of exchange. Most people on the planet will always benchmark prices off traditional currencies, and BTC’s volatile prices will be translated into volatile prices of everything. Everything on the planet priced in BTC becomes a casino.
History has shown that a volatile currency is unsustainable as a medium of exchange. Currency volatility has been seen in recent history during the 1980s to early 1990s when the world was on a freely floating exchange rate system. It was quickly recognized by the world’s central banks that such a system won’t work. BTC is even more volatile than the currencies during the post Plaza Accord era from 1985 to 1992.
6. BTC and credit
A currency is useless unless it can sustain credit facilities. The global economy runs on credit, such as mortgages, student loans, business loans and credit cards. This is only possible if the resultant debt is run on rules that have been developed for at least a century, placing a central bank at the center of it. Without using a central bank to organize an economy’s credit system, the currency itself is not functional. Nobody talks about this obvious problem. Is it because they don’t understand very basic economics or is it that the promoters are choosing to ignore it? Well, it is obvious to me that people are being played when the most obvious of features in a payment system is being glossed over, brushed aside and not actually worked on.
7. BTC and government economic management policies
All modern economies require government participation to even out the booms and downturns. That’s how we get stability in economic management, in the absence of which there will be a serious breakdown of order. It is Economics 101.
The BTC adherents have argued that this is why current monetary systems are broken. Central banks print too much money, and especially in the last ten years. Governments use deficit spending to also inflate their roles in the economy and borrow too much, cheapening money in that way. Proponents of BTC say that by going crypto, central banks and governments would be barred from all their excesses.
This is exactly like saying that banning guns would not solve the problem, because people using them are the problem. The form of money is also not the problem, people are. If there is no fiat currency, there will still be economic cycles of booms and busts because people are what they are. It is facile to think that no government participation in a modern economy will eliminate business cycles. In a BTC dominant world, economic depression cannot be mitigated, and cycles will be more severe and prolonged. War caused by economic disparity may ensue. It would be a far worse outcome than today’s inflation-prone global economy.
Conclusion
I have laid out the arguments heard from an endless number of promoters in favour of BTC and pushed back on them. On Youtube, there is a load of garbage being put out by pro BTC interests. I have never read or heard about a proper analysis of BTC functioning as a medium of exchange in terms of the sustainability of blockchain and mining. Or as a monetary or fiscal policy instrument that evens out the excesses of capitalism in a modern economy whether you prefer the John Maynard Keynes approach or the Milton Friedman school of thought. Pro BTC arguments are inadequate – a system expanded beyond speculation would not work. The arguments are meant to justify the speculation.
I am afraid it is just a tulip mania.
The redeeming grace of it all is that BTC is a great speculative instrument. That will work. Good luck if you really like to play a game with the odds stacked against you.
Wai Cheong
Investment Committee
The writer has been in financial services for more than forty years. He graduated with First Class Honours in Economics and Statistics, winning a prize in 1976 for being top student for the whole university in his year. He also holds an MBA with Honors from the University of Chicago. He is a Chartered Financial Analyst.
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