Would You Buy Bitcoins?

thKKDZXN8RThe world of cutting edge technology always has some risks. A device may have bugs, or you may pay top dollar for a cool gadget that sells for half your cost a year later. Investing in Bitcoins raised the stakes this week when a major exchange went bankrupt, taking significant assets down with it.

Are these growing pains, or a sign that Bitcoin is too risky for the average user?

For those who may not be familiar with Bitcoin, Wikipedia has a detailed explanation. In a nutshell, though, Bitcoin is an electronic currency. Unlike sovereign currency (backed by a country) or precious metals (backed by the physical precious metal, like gold or silver), Bitcoin is a cryptographic string of numbers. Each Bitcoin is unique, and there’s a cap on how many will be generated. So this is a purely virtual commodity/coin. Think of it like this: you have one US dollar in your pocket, and that’s always accepted as long as our Treasury is still in existence. You have one US silver dollar in your pocket, and it’s worth both $1 AND it has a numismatic value, or the value it is worth as a coin made of silver, because silver has a value. In some ways Bitcoin chases its own tail — it has a value because people give it value, but they give it value because they believe it has value. There’s nothing holding a floor under it besides a loose collective with no regulation.

The reason risk has been such a big buzzword around Bitcoin is because one of their major exchanges went bankrupt this week. Bankruptcies happen all the time, especially in new and volatile fields, but Mt Gox going under isn’t like a normal bankruptcy. If I own a store, and I go bankrupt, then I lose my money. Mt Gox went bankrupt and took other people’s Bitcoins down with them. If you were holding Bitcoins with Mt Gox and couldn’t get your money out before they went under, then you’re out of luck. Remember, a traditional bank or credit union can go bankrupt too, but depositors are protected. The bank can’t close up shop and wander off without releasing your funds (and an investment bank can’t close up without releasing your investments), a fundamental change that has yet to come to Bitcoin.

Right now, the people who use Bitcoin are aware of those risks. But if Bitcoin wants to be a real currency, and not just a novelty or speculative investment, it needs to form some sort of internal regulation to protect against this sort of implosion in the future. If Mt Gox had been audited by any outsiders, someone would have flagged the hacks that caused the thefts long before they ballooned to millions of dollars in losses. But there’s no external regulation or even internal agreement on regulation. I saw a contributor on the news suggest that investors in Bitcoin should “use money they aren’t afraid to lose”, and I think that’s great advice. Great advice for a speculative investment, but terrible advice for a protocol that wants to be a global currency.

The argument for Bitcoin, honestly, is a bit murky. Wikipedia has a good explanation for the mechanics of Bitcoin and how cryptocurrency works, and the argument is that transaction costs using Bitcoins are lower and more private than with credit cards, hence the draw for online retailers like Overstock. It makes for an intriguing speculative investment, but there’s nothing so far that indicates it is or should be used as a replacement for sovereign currency. The privacy and secrecy also leads to issues like Silk Road, a marketplace for illegal goods. Even if Silk Road and marketplaces like it are a tiny piece of the Bitcoin market, there’s a reputation issue here. Bitcoin can lose you money, and it’s popular with web-savvy smugglers. Not exactly the endorsement of the century.

Bitcoin needs some level of regulation, whether internal or external, before it can become a competitive mainstream currency. The Mt Gox implosion can be a positive catalyst if it leads the rest of the Bitcoin players to control the message. They should be out in the media discussion a plan to self-evaluate or cross-audit, they should be reassuring and educating consumers. Right now Bitcoin is being discussed everywhere, mostly in a negative light, and if ever there was a time to change the conversation, this is it. As it stands now, though, Bitcoin is something I’m content to watch from a distance.

Have you invested in Bitcoins? Would you in the future?

Categories: Editorials

2 replies

  1. One thing that I want from currency is stability rather than volatility. I want to know when I am exchanging something for currency (whether selling or purchasing) that the currency will retain it’s relative value in both the short term and long term. I don’t want to sell my car for bitcoin today to find that the value has dropped suddenly tomorrow, nor do I want to buy a car with bitcoin today to find out that the currency is worth far more tomorrow and the automobile is suddenly undervalued compared with the bitcoin I spent today.

    That’s the problem. If the currency stabilizes compared with other sovereign currencies, that’s great. Until it does, I have no interest in speculating.

  2. Personally I prefer dogecoin. We’re much less serious about the whole cryptocurrency thing, and if you want to get in on it it’s a pretty cheap way of experimenting; we’re talking thousand of dogecoin per dollar. The relative worthless nature of it doesn’t really bother us; it trades around the same level as the Korean won, and nobody slams that, do they? =P But the great thing about dogecoin is the community. We’ve banded together to donated tens of thousands of dollars for many notable causes. One of the more headline grabbing feats was sending the Jamaican bobsled team to Sochi.

    A few comments, though:

    “Remember, a traditional bank or credit union can go bankrupt too, but depositors are protected.”

    This only applies to retail banking. If you have your money in a private bank—which are quite traditional too—and it goes belly up, you could be just as out of luck as Mt. Gox depositors. Also, deposit insurance has a fixed limit that varies from country to country depending on banking regulations. Any money over the limit will not be reimbursed in the event of a bank collapse. But the unspoken reality is this: given a large enough series of collapses, you will not be reimbursed regardless of where you put your money. At a certain point the FDIC simply wouldn’t have enough money to cover everyone.

    “you have one US dollar in your pocket, and that’s always accepted as long as our Treasury is still in existence.”

    Yes, it’ll certainly have SOME value, but will that dollar always have the same value? Does it have the same purchasing power it does today as twenty years ago or twenty years from now? No, it doesn’t, and at a fundamental level it’s because the amount of value that people ascribe to it changes—that is, because people BELIEVE it does. Now certainly the US Treasury—with the IRS on its side—has quite a bit more “belief power” on its side than you or me. But one only needs to examine the history of the Brazilian Real (one of the most amazing feats ever accomplished by four economists!) or the Zimbabwe dollar to see that even a government-backed currency’s value is still heavily dependent upon what its users believe it to be. The fact that black market exchange rates differ from the official rate demonstrates that quite well: a currency is only worth as much as the transactions you can make with it, and that’s inextricably tied with belief.

    “You have one US silver dollar in your pocket, and it’s worth both $1 AND it has a numismatic value, or the value it is worth as a coin made of silver, because silver has a value.”

    Again, why does silver have value? Because people believe it does. Silver certainly has some intrinsic value in terms of usefulness to industry, but if that were the only reason its price wouldn’t fluctuate as much as it does. That’s caused by people going into precious metals as investments or for stored value. This is more obvious when you look at something like the $10 eagle; over a relatively small span of time, its gold content has tripled in value!

    At the end of the day, ALL money is make-believe. It’s a convenient abstraction that means you don’t have to carry around a cord of wood or five chicken eggs to trade for a danish and a cup of coffee. Bitcoin and dogecoin certainly aren’t as stable as the world’s reserve currencies, but that doesn’t make them any less real.