The Mysterious Allure of Bitcoin

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Bitcoin has had a wild ride.  It entered 2018 roaring up more than 280 percent from a little over $4,500 a coin late in 2017 to $17,429 by the first week of the new year.  By week two, it had fallen some 35 percent to $11,403.  From there it fell farther, some 48 percent, to $5,903 by late June, not much above where it was toward the end of 2017.  It then climbed some 42 percent to $8,424 by late July and then fell some 27 percent to $6,184 by the middle of August. It has bounced around near that price since.

The initial 2018 gain sparked much interest.  The word, Bitcoin, seemed to be on everybody’s lips.  CNBC reported on it almost hourly.  It was the first question from anyone who knew I was in the investment business – friends, relatives, the man behind the counter at the Madison Restaurant on Manhattan’s East Side, where I go for breakfast, the fellow at TSA who asked my profession.  I gave everyone the same warning, not about this particular investment but rather about anything that soars as fast as Bitcoin.  I also asked if they knew what Bitcoin was besides something that had gained value very fast.  When it became apparent that no one had the slightest idea, I could offer another warning: never invest in something you do not understand.

What is Bitcoin

Some say this is a new kind of money.  Some journalists call it a crypto-currency, apparently because it is created through an encrypted algorithm.  The U.S. Treasury classifies it as a commodity, though unlike tin or gold or wheat, it is created entirely through its algorithm.  I suppose we could call it a synthetic commodity.  It certainly behaves more like a commodity than money: During periods of enthusiasm, its price skyrockets only to fall precipitously in response to investor doubt.

Bitcoin and other similar but less famous creations are products of a remarkable mathematical innovation.  Referred to as blockchain, it can control the supply of something made entirely by people.  Its algorithms also allow participants to verify trades as well as Bitcoin ownership even as they ensure anonymity.  This is why the system is also often described a distributed ledger.  (The mathematics behind this system are complex, and even if I could master them, this is not the place to go into their intricacies.)

Suffice it to say that because of these characteristics Bitcoin and its blockchain competitors are described and often offered as substitute money.  The prospect of them as money has appeal to many.  Until the advent of blockchain, the only way to control the supply of money and verify ownership came through the centralized record keeping of the banking system, which in the United States includes the Federal Reserve, the Treasury (which itself includes the Office of the Comptroller of the Currency.)  These institutions might not know just who has cash in hand or what he or she is doing with it, but they do know to the penny how much exists and they control that amount of currency in circulation.  At the same time, the banking system knows who owns which account and how much is in it.  Blockchain, with its unique distributed ledger, offers an anonymous alternative. 

Its Use and Its Future

 Because Bitcoin and other crypto-currencies offer this anonymity, they are especially attractive to those who would rather not have their dealings recorded in any government-related system.  Blockchain currencies are untraceable, like $100 bills or gold bars, but they’re even more attractive because they have none of the clumsiness (or possible drama) of a suitcase full of bills.  They can move in the millions even billions through the Internet — an impossibility with paper money and gold bars, at least not with anonymity. It speaks to these qualities that Russian and Venezuelan officials have expressed hopes that such virtual currencies will enable their countries to end run American sanctions.

Many people forecast that Bitcoin and its kin will soon replace today’s national currencies – dollars, pesos, pounds, euros, and so on.  Bitcoin(s) could become money as long as everybody is willing to accept payment in them and believes them to be “safe.”  At the very least, that day will have to wait until Bitcoin leaves behind the wild price swings that have marked it so far.  To become a dominant currency Bitcoin must also jump significant political hurdles. Governments have no desire to lose control over their ability to create and verify the ownership of money.  Several countries, fearful of just such substitutions for their currencies, have already banned the use of Bitcoin and other crypto-currencies.  The United States, Japan, and the European Union have not gone this far — yet.  But should a day of reckoning arise, it’s a good bet that governments will impose control, and Bitcoin, whatever its future as a synthetic commodity, will fail as a substitute for money.  For the investor, then, Bitcoin becomes another potential addition to his or her portfolio, but one with more risk than many, and less predictability.

 

 

One thought on “The Mysterious Allure of Bitcoin

  1. ZANE BROWN says:

    Thank you, Milton, for a succinct summary of Bitcoin, its attributes and shortcomings. Thank you also for not trying to include the math behind it.

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