Bitcoin, an online-only currency scarcely four years old, is breaking out to new highs this week and now sports a total value of $2.8 billion. Just a few months ago, it looked like this economic experiment as the world’s first decentralized technology-based form of money would crash and burn. Since then, ConvergEx's Nick Colas points out that the U.S. government has shut down a large drug website which accepted bitcoins and promised further scrutiny of its uses; and omputer science experts have warned that bitcoin is neither especially private – one of its notional values – or especially well constructed. The market doesn't seem to care, with incremental demand from U.S. citizens (through Second Market) and Chinese nationals leading the path higher. Could bitcoin still fail? Sure. But, as Colas notes, its success to date speaks to how much the world is changing... Technology – properly packaged – can engender enough trust to develop a new asset class.
Bitcoin will eventually have to develop a lot more infrastructure to be a useful global currency, to be sure. But there’s close to $3 billion of real money to help back that transition.
Via ConvergEx's Nick Colas,
Bitcoin - The Lazarus Currency
Every great religion, or company, or country, or rock band has a dramatic ‘Creation myth’ – the story of its birth. The Judeo-Christian tradition has the story of God creating the world in seven days. Google has the grad-student thesis story. American culture is still informed by the Revolutionary War. And where would the Rolling Stones be if Keith hadn’t chatted up Mick on the train, just because he holding some new R&B albums from the States?
Bitcoin, the online-only stateless currency, has its own creation myth and it is purpose-made to appeal to exactly the kind of people who would find value in it. The highlights are:
The original design for bitcoin comes from a 2008 paper published by a person named Satoshi Nakamoto. Who, by the by, doesn’t actually exist.
Bitcoin’s basic architecture is decentralized – no one is “In control.” People with fast computers and some coding skills compete to solve a puzzle created by the algorithm described in Satoshi’s paper. Simultaneously, they track all the transactions in the bitcoin universe – people and businesses exchanging value for goods and services. Every ten minutes, on average, some lucky coder – or group of coders – solves the puzzle, gets a few new bitcoins, and validates the transaction list. Then the whole thing resets and everyone gets to work on the next puzzle.
In principle, this process leaves everyone exchanging or “mining” (cracking the code gets you 25 bitcoins currently) anonymously in the system. Everything in bitcoin is identified with a nearly-impossible-to-crack coding of letters and numbers. No names, phone numbers, or addresses needed.
Now, who do you think would find this creation story appealing? A few candidates:
Tech savvy people, who by their nature and high-functioning professional skills tend to have a few shekels lying around? Yep – classic early adopters.
Then there might be independence-minded older white males in the U.S., ticked off by the Federal Reserve and government in general. Yes, they like the story as well.
And then there are the criminals – drug dealers and so forth – who might not know a creation myth from crystal meth, but appreciate the potential for secrecy.
Offshore millionaires from essentially anywhere in the world, looking for classic diversification and a liquid investment. All you need to access your bitcoins is that long alphanumeric key and a local bank account which links to a ‘Wallet’ – an online repository to hold the currency. Deposit money in China, write down the key, fly to Monaco and go into an Internet café. Easy-peasy.
The basic appeal of this “Genesis” creation story lit a fire under bitcoin, starting at the beginning of 2012 at around $5 and ending up in a spectacular bubble top at $240 in April 2013. The cause of that peak – overwhelming tulip-bulbish demand for bitcoin – was its undoing. Exchanges where people went to trade dollars or euros for bitcoin couldn’t keep up with the volume. Accounts froze or moved very slowly, and confidence in the currency dropped, along with the price. Just a few days after the $240 high, bitcoin was trading for less than $60.
Creation myths are great anchors for a belief system, but there have to be other parts to the narrative; bitcoin is safely into its own “Exodus” – the second book of the Old Testament. That fall from the highs was just the beginning of its problems.
The U.S. government made it clear that they expect all currencies and their users to adhere to anti-money-laundering laws, including know-your-customer statutes which eliminate the notional secrecy of bitcoin.
The Feds also went after the druggies, shutting down Silk Road – a widely known website for the purchase of illicit substances.
In an odd twist of fate, the U.S. government now owns about 174,000 bitcoins, with a current value of $42 million thanks to the Silk Road bust and other actions.
If bitcoin were a company, the class action lawyers would be circling, fighting for air with the bankruptcy experts. There is simply no way so much legal action, let alone several ongoing problems with security in the system, would have left Satoshi Nakamoto’s creation as anything but roadkill on the world’s economic superhighway.
But here’s the beauty part: bitcoin is making a new high this week, breaking through the spiky bubble levels of April in a pretty controlled and orderly manner. What gives? A few points:
The biggest bitcoin exchange is now in China, displacing Japanese, American and European sources of demand. That enterprise is called BTC China, and its CEO Bobby Lee hails from Yahoo! and Walmart China. Oh, and he graduated from Stanford with a degree in Computer Science. In short, an apparently pretty clever fellow.
Our sources in the bitcoin community also agree that Second Market, the New York based business best known for trading pre-IPO company stock, has become a major player in demand for bitcoin. Earlier this year they started the Bitcoin Investment Trust, an open ended product to buy and hold bitcoins. There’s no way to know how much Second Market has purchased on behalf of its clients, but it must be a popular offering – the banner ad on their site for the trust occupied the top third of their front page.
It’s not all been roses for bitcoin, even in this recent run-up. Back in September computer science researchers from UC – San Diego showed that it was actually fairly easy to track individual transactions in the bitcoin transaction ledger. Just this week, academics at Cornell proposed that bitcoin could eventually be coopted by a handful of “Miners” who could hijack the system.
So why is bitcoin seemingly minted on Teflon? Limited supply, for one reason. There will never be more than 21 million bitcoins, and there are only 12.0 million currently. In the 4-ish minutes it has taken you to read this far, the most new bitcoins that might have been issued is 25, or $6,250. In the same timeframe, the Federal Reserve has pushed another $7.8 million into the financial system with Quantitative Easing. And then there is the undeniable creation-story appeal – a technology based sort-of-secret store of value. If James Bond, Sergey Brin and Paul Volcker all got together and designed their ideal currency, it might look a lot like bitcoin.
At the same time, the story isn’t over yet. If the “Exodus” analogy is to fit at all, then bitcoin is still in the wilderness. It has clearly withstood many challenges, and there are probably more to come. The end of the journey actually has little to do with how much bitcoin is worth, but what it might be good for.
That’s the piece some investors – many made quite wealthy by the incredible increase in bitcoin’s value – are working on now. A few final thoughts here:
Bitcoin is a more efficient method of transferring money than the current global banking system. The transaction ledger is essentially kept for free by the mining community. Want to send $100 to someone in England and have them redeem British pounds? It will likely cost you $5 or more. A bitcoin transfer is essentially free.
Merchants can accept bitcoin payments without paying the typical credit card fees of 1-5%. That’s one reason for the growing acceptance of bitcoin in China – online merchants are starting to accept this online currency.
Bitcoin could become a country’s ‘Second currency’. One of the more interesting conversations with one of our industry sources is the thought that one or more sovereign nations would entertain making bitcoin a parallel currency to their existing monetary system. Keep in mind that our source owns a lot of bitcoin personally…. But it is an intriguing thought nonetheless.