Bitcoin valuation review

Here is a chart of milli-Bitcoins to US dollars over the past month:

2014-10-04-BitCoinChart

Anybody having bitcoins over the past month has seen a 1/3rd drop in their US-denominated equity. (As a side note, investors in precious metal gold would have seen a 5% drop in the same time period).

However, the gist of this post is that Bitcoins has long since moved away from the “novelty” factor where people would speculate on them just on the basis of being collectibles (think of Beanie Babies in the late 90’s) and now the market is pricing in true economic worth of Bitcoins – in this case, it is far, far less than what it has been trading for.

Companies and entities that are collecting bitcoins for payment (Overstock.com!) inevitably have to liquidate them or they will continue to face currency risk in transactions.

In addition, it is perfectly obvious at this point that using bitcoins as a currency medium for illicit (silk road, etc.) transactions is just inviting the relevant authorities to digitally track the transactions and make the appropriate associations with the wallets to the identities of the people holding such wallets – the illicit marketeers might as well be writing paper cheques to each other. These illegal trades likely constituted a high amount of the initial bitcoin traffic but this has now ceased.

The only transactions I would see at this point that are economically viable for the medium are currency transactions to avert low denominations of capital controls in countries that are constrained by such measures (think of examples like Argentina, Venezuela and most African dictatorships). I do not see this being particularly viable considering the liquidity of bitcoin markets is nowhere close to institutional levels. In addition, such transactions are indeed illegal in their host countries!

There are structural issues with bitcoin that will continue to hamper its viability, of which I have addressed in earlier posts on this site.

One is that as the blockchain gets bigger and computational difficulty rises, it will become more incumbent upon large digital processors to maintain the transactions. I have already written about the well-known 51% risk where somebody with sufficient computational power over the rest of the network can subvert transactions and simply ruin it for the other 49%. In addition, computational difficulty of Bitcoin continues to increase to levels where it makes no sense except for industrial data-center levels of computational power to operate Bitcoin networks. Ironically, this is not what was envisioned by the pioneers of Bitcoin, which preferred a much more decentralized mechanism to arbitrate the transactions. Instead, concentration will be leading to an obvious state of the union where the 51% owner to the network will be, in effect, the central bank.

Large scale data centers such as ghash.io have pledged to keep under 40%, but why kill your golden goose so prematurely by scaring away dumb money from coming into the marketplace?

There are also more and more other digital currency schemes (Litecoin, Dogecoin, etc.) which continue to trade, but are simply there just to be an alternative to bitcoin – most of the mindshare out there is on bitcoin compared to the alternative currencies. However, with all of these new digital currencies, there are always incumbent advantages – the group establishing the coins will have all the advantages of mining them first, and then with the hopeful attempt to build a marketplace for it so they can just dump it for real currency. Bitcoin has some inherent advantage than other digital currencies simply because the implementation of this was relatively “innocent” compared to most crypto-currencies being created today that are simply there to steal money from other gullible people.

There is the casino-type element of currency trading. I continue to read the Reddit thread and continue to see people with less financial knowledge give out wisdom on Bitcoin. I would be very curious to know the total amount of bitcoin float out there that is simply being held for speculative (i.e. nothing other than for the reason they believe others will believe it is going up) purposes. Now we are reading threads like this or like this, both of which remind me of Canadians that said “I have shares in Nortel purchased at $80, what do I do?”.

Finally, there is the risk that the cryptographic features of Bitcoin that make it very difficult to access other people’s wallets, may be cracked. While this is unlikely, if such a discovery were to be made, it would clearly cause a collapse in the entire Bitcoin system. The only analogy I could make to this in the central banking fiat currency system is having other people being given access to your own bank account at any time without any reversibility (although you can go and find their wallet and spend it right back if you know the algorithm to doing so!). The system would simply collapse.

I can’t see any reason why any Canadian would want to purchase Bitcoins at this time other than for the novelty factor. If you’re planning on buying currency to prepare for the end of the world (whether it be war, hyperinflation or alien abductions), I would not buy something that depended upon a reliable electrical connection, let alone internet connectivity!