Bitcoin

So yesterday I had two entirely unconnected sets of friends bring up investing in Bitcoin, and a third did so a few weeks ago. I private messaged with one of them about why this is a crappy idea, and then edited into this post to share with the rest.

TL;DR: Bitcoin is in a classic economic bubble and will crash at some point. It is not a good idea to invest in Bitcoin; save your money and invest elsewhere.

Bitcoin was always intended to be an “medium of exchange”, ie: a currency. It’s something that you’d use to buy/sell stuff with. Generally, you’d buy Bitcoin with your regular currencies right before you’d make a purchase, and maybe keep a few Bitcoin around for convenience. AFAIC, this is a fine use of Bitcoin, although it’s still not easy or cheap to exchange them.

Most people, if they’re new to Bitcoin, think it’s an investment vehicle: something that they’d buy low and sell high to make a profit. As an investment, it’s bad for these reasons:

1. It has no intrinsic value. Really, you’re just buying a number. The only reason why that number has any value is because someone else thinks it has value. If someone wants to accept a Bitcoin in exchange for goods and services, that’s OK, because they can then pass that same Bitcoin on to someone else to get goods & services for themselves. Often, those “goods” are other, more common currencies like CAD and USD.

But unless someone is swapping those numbers for goods and services, Bitcoin is entirely valueless. It’s not like a share of company stock, which grants you voting rights and/or a claim on the company assets and/or rights to dividends. It’s not like a piece of land, which you can then grow stuff on or build a house on. And it’s not like a precious metal, which you can make into shiny jewlery or electronics.

It is somewhat like a piece of paper with a dead President on it, and a little note from a stable government that says “You can pay your bills with this.” Fiat currencies like CAD and USD aren’t intrinsicly valuable either. (They used to represent IOUs for gold or silver, but that ended in the 1930s and 1970s respectively.)

But because people accept them in payment for stuff, they have effective value. Now the catch is: who accepts Bitcoin as payment for stuff? The number is small, but growing. That leads us to my next complaint:

2. The current value of Bitcoin has almost nothing to do with it’s intended purpose as a medium of exchange. Instead, people are buying, holding them, and expecting the value to increase (i.e.: treating them as investments.) Because there’s no intrinsic value, the effective value is based entirely on the expectations of people holding them. Bitcoin investors are all trying to “time the market” (another phrase for “predict the future) by buying at one price and selling at a higher price. The only way to predict when the price will be “higher” is to know when everyone else thinks that the price will go higher still, and sell to those suckers… I mean, “new investors”.

This is a classic economic bubble. All the stories you see about “if you bought Bitcoin at $X, you’d be $Y rich now” are true. But what you don’t see (unless you look at history) are the flipside stories: “If you bought at $Y, you’d be $X poorer now.” Because Bitcoin has no intrinsic value (i.e.: it’s not earning any new money), every one of those make-it-rich stories must be offset by an equivalent “make it poorer” story, eventually. Bubbles always pop, and the markets for overinflated assets inevitably crash.

Economic bubbles have happened many times before. Bitcoin is very similar to “Tulip Mania” from the 1600s, where people were trying to make it rich buying and selling actual flowers (and their bulbs). But you don’t have to go back that far to find examples; I’ve personally lived through the Dot-Com Boom & Bust, and the Housing Boom & Bust. There are some differences:

• Dot-Com company stocks at least have hard assets & the potential for dividends (hah!) that you get when you purchase a share.
• Houses can be lived in.
• Tulips are pretty to look at.

That is to say, each of those assets have some intrinsic value. Bitcoins don’t have any of that; they’re just a number. They’re not even pretty numbers!

3. Bitcoin is being hyped in the news a lot. This is why you’ve heard about it on Facebook. The technology itself has been around since 2008; it’s not particularly new. But the get-rich-quick stories have spawned interest, which spawns media attention, which spawns hype.

Remember that Bitcoin’s value comes entirely from people thinking that other people will pay more for Bitcoins some time in the future. So the increase in popular attention directly drives the price increases that we’ve seen over the last few years. But eventually the amount of investors it attacts will hit “saturation”: everyone who ever will invest in Bitcoin will have done so.

At that point, the crazy price gains will stop; no new money will be coming into the Bitcoin market. When the people who have Bitcoin realize this, they’ll want to get their money back. (Bitcoins have no intrinsic value, so they don’t do any good just sitting there.) So the people with Bitcoins will try to sell their Bitcoins. This, in turn, drives down the price of Bitcoins. When this happens, people will realize that the market bubble is starting to deflate, and thus try to sell faster to recoup their investment. This drives the price even lower… …which prompts more sales… …which drives the price lower… …and now you have a full-on crash.

Because Bitcoins have always been a digital asset in the electronic age, this crash can and will happen in seconds. (Electronic asset traders literally spend millions of dollars to get speed improvements of a few milliseconds; ask about that if you don’t believe me.) By the time you even read the news story about the Great Bitcoin Crash of 20XX, it will be too late for you to get your money out.

It’s all based on a game of financial Hot Potato: whoever is holding it when the music stops, loses.

This is why that CNBC video pisses me off so much. Most of what they say is technically correct, but it’s being intentionally misleading in a blatant attempt to get people to put their money into Bitcoin without understanding it fully. This is how they profit: by getting more people to play Hot Potato so that they can pass it on before the music stops. They even say that outright at the end: “I run a Bitcoin fund, so I’m biased… but I really think it’s a great investment for you!” It’s so sleazy it should probably be illegal, and it’s coming from a big name in the news media industry. Fuck that.

This is the same situation that happened with tulips in the 1600s. But Bitcoin has some specific characteristics that makes it even worse than that:

4. Bitcoins are supposed to be difficult to create (“mine”). Their restricted supply helps control their price/value. However, the only reason this is true is because of a) math and b) computing power being limited/costly.

So the math is pretty solid; there’s no obvious way that it could suddenly become easier to mine Bitcoin. However, there’s always a possibility that a flaw in the algorithm is found, and that all of a sudden there’s a new wave of Bitcoins on the market. Any new spike in supply will drop the price, and probably trigger the crash (see above).

What’s more likely to happen in reality: computing power for mining Bitcoins becomes faster/cheaper/more available. We’ve already seen this happen a few times in Bitcoin’s history. We went from desktop applications running on CPUs, to running on racks of GPUs, to custom-built grids of FGPAs. Then we saw malware taking over other people’s computers, stealing their CPUs and electricity to mine Bitcoins for free. We’re even seeing “legitimate” applications doing the same: the Ultimate Fighting Championship’s website included a Bitcoin miner to make money from your computer while you watched their fights.

Looking to the future: quantum computing could absolutely demolish the Bitcoin market by making mining incredibly faster / more efficient. We already know the principles by which this would work; now we’re just trying to build the quantum computer that will make it happen. Bitcoin mining is, in fact, one of the drivers of this field; whoever makes the first successful quantum Bitcoin mining system will make millions of dollars, at the expense of everyone else who has invested in Bitcoin.

5. Bitcoin mining isn’t difficult for people to get started in; you could download the software and start mining for Bitcoins in under an hour. But it’s designed to be increasingly difficult for computers to do. That means that they spend increasing amounts of electricity in order to mine a single Bitcoin. When the price of Bitcoins goes up like it has, it still can be financially viable to do so. But not for you: your computer isn’t optimized enough to make it worthwhile. One couple just spent $100K on a Bitcoin mining setup that occupies a warehouse. Like I mentioned above, one of the most cost-effective ways to mine Bitcoins is just to steal the computing power and electricity from someone else.

All of this electricity has to come from somewhere. Currently, Bitcoin mining consumes more electricity per year than Denmark. That’s a lot of electricity spent that could have gone to better uses, and carbon is being pumped into the atmosphere to create most of it. This is all for a get-rich-quick scheme to create something that has no intrinsic value and could collapse at any moment. Investing in Bitcoin directly supports this waste.

6. Bitcoins are also really easy to lose or steal. They’re just numbers, and if you don’t keep them safe, someone can take them from you without any repercussions. Just yesterday there was yet another story about a big Bitcoin theft, to the tune of $70 million. Individual investors also people get hacked/robbed on a regular basis; there’s automated malware that does just that.

It’s easier to lose Bitcoin than it is even with tulips (where you have a physical good) or a bank account (where you have a government/organization who is out there working to protect their security). Bitcoins are intended to be decentralized and not backed by any government… but that means that they don’t have a government who cares about their security.

Besides being stolen outright, Bitcoins are also easy to simply lose. They’re just data files; have a hard drive crash, or just forget the passcode on your wallet, and your Bitcoin investment is lost forever. You can mitigate this risk by having lots of backups… but every backup increases the risk of someone finding them and stealing them.

7. With all of the people investing in Bitcoin, and the price skyrocketing and becoming unstable, it becomes less useful as an actual currency… which was the point in the first place. As it becomes less useful as a currency, what little real value it had diminishes, lowering the price floor that it will hit when it crashes.

8. With the money you spend on investing in Bitcoin, you could be doing other things. You could buy yourself something that makes you happy. You could buy something that makes someone else happy. You could give it away to someone who needs it. You could invest it in something (or better yet, multiple somethings) that would make you money later on with much less risk. You could try starting your own business that produces something with intrinsic value. You can even take it down to your local casino and spend it playing a fun game. This last one is important: think of Bitcoin as gambling, not as a an investment. If you enjoy that particular way of gambling, that’s great… but don’t use it as a real plan for the future. There’s better ways to invest.

Ok, so that’s my rant. Please don’t put any money into Bitcoin unless you’re immediately using it to buy stuff. If you’ve found value in my writing, please feel free to share it. I’ll post some supporting links in the comments below.