1/13/17

I haven't written about Bitcoin on WSO for a long time, and I've seen a lot of questions about it on the site over the past few weeks due to the recent price movements. There's a lot to cover so this might stretch into two posts. We'll see how it goes.

First, the recent price action:

If you follow cryptocurrencies or alternative asset classes at all, it was probably impossible to miss seeing Bitcoin hit an all time high several days ago ($1,141). Then, in typical Bitcoin fashion, it crashed over 20% in a day when officials from the Chinese government paid a visit to the Bitcoin exchanges domiciled in China. It was not a social call.

The digital currency is drifting around $900 at the time of this writing.

It finished 2016 up 122%.

To the untrained eye, that might look like a solid investment. And for the folks who got in at the right price, it certainly is. But you can't afford to sleep on Bitcoin, because its volatility will bite you in the ass. And that's the voice of experience.

I could spend a lot of time explaining what Bitcoin is and how the whole thing works, but I don't think that would be particularly helpful. There is plenty of info available online and, despite what many people would tell you, it really isn't all that complicated. I would start with YouTube, particularly with the Bitcoin 101 Series.

If you're looking to get up to speed on the concept and players very quickly, it's hard to do better than Nathaniel Popper's Digital Gold: Bitcoin and the Inside Story of the Misfits and Millionaires Trying to Reinvent Money. It's a real page turner (not being sarcastic) and at the very least you'll come away with a sense for what's at stake (and what would prompt the Chinese government to pay the exchanges a visit).

Ideology and Evolution

While I won't bore you with the technology, I do think it's helpful to understand how Bitcoin came into being, especially the ideology behind it.

Try to imagine the early internet. I don't mean the World Wide Web, I'm talking about way before that. I got my first modem around 1985. Back then everything was dial-up, and you had to know what phone number to call. We had the early version of ISPs like Compuserve, but they weren't good for much.

Now try to imagine what level of misfit you had to be in order to be accessing the internet at this stage. Pretty much the only people on there were sex workers (always early adopters), uber nerds, and extremists (I ran into what seemed like a lot of neo Nazi and Klan stuff back then).

When you combine the uber nerds with the extremists (both desperately seeking a means to transact with the sex workers), you get the chemical precursor for today's anarcho-capitalists. That was the genesis of Bitcoin.

Alternative currencies were hot almost from day one. Certainly by the 1990s there were entire Usenet groups devoted to unseating the US dollar. Most were whackadoo fever dreams, but some got some legs. One in particular I remember was the NORFED Liberty Dollar, and I remember it mostly because it was a great idea that ended with government jackboots kicking down doors and confiscating all the gold and silver backing the currency.

A lot of the alt currency crowd crossed over with the crypto crowd online. The cryptos were giving the feds their own kinds of headaches. What started out as a ragtag group of phone phreaks eventually became an army of online privacy advocates. Out of this consortium came PGP (Pretty Good Privacy), an encryption program that made the government apoplectic. For a time (and it might still be, I don't know), it was illegal to leave the US with a computer that had PGP installed on it.

Naturally the two groups set about creating an encrypted currency that could give the dollar a run for its money, so to speak. They got close in the late 90s, but couldn't solve for the double spend issue. What I mean by double spend is that they couldn't figure out how to stop someone from using a digital "coin" for a transaction, and then turning around and spending that same spent coin on something else.

On Halloween 2008, a bomb went off in the cryptocurrency community. A short, 9-page document was published by someone named Satoshi Nakamoto which finally solved the double spend problem. He called his invention Bitcoin, and the world would never be the same.

Here's where it gets interesting. It's widely believed that Satoshi is not actually one person, but a group of crypto folks who found the digital holy grail. If they had gone to the government or a university with it, things would be very different.

But they didn't. They released it on the internet and walked away. And the internet saw it for what it truly was: a way out from under the control of the government.

The early adopters of Bitcoin are some of the most virulent anti-government folks you're ever likely to encounter. For them Bitcoin is a crusade; a crusade against the prying eyes of Big Brother, a crusade against capital controls, a crusade against the banks who make ridiculous profits for nothing more than middling the transfer of funds from one party to another.

Believe me when I say that it's a holy war for many of these guys.

But that's not what put Bitcoin on the map. Ideology only gets you so far. Beyond that you need utility, for which there was none. That is, until Ross Ulbricht came along.

Ross either set up or purchased a dark web site called The Silk Road (the origin details are sketchy and it's hard to know who's telling the truth). The Silk Road was an online drug emporium. Well, mostly. You could allegedly buy anything there, including arranging for a hitman, but I only ever heard of anyone buying drugs.

If you're going to buy cocaine or ecstasy or ketamine online, you're not going to use your Visa card. That's where Bitcoin came in. Suddenly there was an overnight need for a currency that couldn't be counterfeited, was totally anonymous, and couldn't be tracked. It was a match made in heaven. What's more, the service worked.

The Silk Road was so successful it eventually earned Ross a life sentence (the only case in history where someone got life for building a website). Before it all went down, though, it drove the demand for Bitcoin and caused the price to rise exponentially. All of a sudden everyone was talking about this cryptocurrency that was doubling and tripling in value.

And that's where evolution took over.

Around late 2012, a whole new class of Bitcoin owners came to the fore: the investors. These were guys who couldn't give a shit about the politics, weren't interested in supplanting the dollar, and were only in it to make a buck.

Naturally, the fire breathers from the early days weren't crazy about the new guys. But they couldn't complain too loudly, because the thousands of Bitcoins they'd mined at seven cents apiece were now worth $100 each. You started reading stories in the paper about guys digging through landfills hoping to find old hard drives with Bitcoin stored on them.

In 2014 the IRS issued guidance saying that Bitcoin was not a currency, but an asset class, and would be taxed as such (capital gains). Which was really kind of a wonky decision, because it's impossible to know who mined Bitcoins or at what basis to assign them. It's even possible to pay cash for Bitcoin, so it's still relatively impossible to track.

If I had to guess at the ratio of investors to radicals in the Bitcoin mix today (based on ownership position), I'd say the radicals still have a healthy edge but it's eroding. Every time Bitcoin jumps or drops 20% in a day, more people get curious about it. And buying it is so much easier and safer these days.

And it's definitely a currency. It's practically anonymous, and you can even print your own Bitcoin cash (I'll go into that next week).

So the question is, should you buy it? The answer is probably.

There are two positions that make a disruptive technology sticky: primacy and recency. Bitcoin owns primacy. Several other alt coins (some arguably even better than Bitcoin) have come and gone, and that's because recency is dynamic and not static. But Bitcoin is the first, and likely the one that will stand the test of time. That means some day in the not too distant future it'll be worth $10,000 or more per coin.

I'll get into some more strategy next week, but if you have any questions or comments about what I've said so far, fire away!

Comments (36)

1/10/17

Very interesting post- I've had a marginal interest in Bitcoin for a while but never quite researched enough to understand the history or technology. A few questions, mainly about the nature of Bitcoin's volatility (perhaps will be covered in future posts):
- Can you go into detail about the supply of Bitcoin (e.g., how it is established, how democratic or autocratic the changes in supply are, potential threats to supply in either direction, etc.)
- What do you think accounts for the volatility of Bitcoin? It seems to a layman like me that a lot of it is political factors and actions, which tend not to be very smooth or predictable. Do you see this getting worse or better in the future? Is there a state that Bitcoin could reasonably get to where governments don't see it as a threat and thus as an owner you don't have to worry every day about a headline dropping your currency by 20%+?

Best Response
1/10/17
  • Bitcoins are created by mining. The mining process consists of computers solving complex math problems in order to be rewarded new coins. This process doubles as the proof of work required to validate the blockchain (which is just a fancy way of saying that it confirms and makes permanent all the transactions which transpired since the immediately previous reward).
  • The overall supply of Bitcoin is increasing but finite. The release of new BTC (the abbreviation for Bitcoin) is on a fairly strict schedule and the last BTC will be mined some time in 2040. At that point there will be 21 million BTC in circulation. There will never be more than that, rendering Bitcoin impervious to inflation.
  • There is no overarching authority in Bitcoin. There is no central bank. There is no central anything, except for the blockchain itself. Just to be clear, the only human oversight of Bitcoin is when an innovation is introduced, at which point Bitcoin owners can either choose to accept or reject said innovation. Just to be clear: there is no central authority controlling Bitcoin. It's all just math.
  • Since Bitcoin is digital, it can be subdivided almost infinitely. Currently the smallest division of a BTC is called a Satoshi (in honor of Satoshi Nakamoto), and it's equal to a one hundred millionth of a Bitcoin (.00000001 BTC).
  • Currently the biggest driver of volatility in BTC is the lack of liquidity. There just aren't that many out there right now, so large purchases and sales cause big swings. The cause of those large purchases and sales are most often political, which is obviously not reliably predictable.
  • I see the volatility evening out over time. That's just nature.
  • There's a point at which it no longer matters whether or not governments view BTC as a threat. That's probably the point at which BTC essentially "decouples" from its relationship to the major currencies and becomes more of a "one world" currency. The reason I believe this has a decent chance of happening is the explosion of FinTech around the blockchain. The lion's share of VC investment over the past 24 months has poured into blockchain technologies, which didn't even exist a decade ago. Before you know it, it'll just be how international transactions work. While blockchain =/= BTC, they're close enough for BTC to become the standard (IMHO).
1/10/17

One glaring problem with bitcoin.
First of all, its limited quantity.
Sure I know the US is the only country with the luxury of unlimited currency because of the dollar being the global reserve currency, but any other country's currency at this point is technically unlimited too--the value of it depends on how its doing in relation to the dollar.
BTC is limited--hence, once those are in sirculation, that's it.
And that brings on the second issue for me.
If its limited, and the coin iscoded in a way whereit can't be used a second time how is it reusable?
In other words, if I can't pay 2 things with the same coin, how can the person who just got my coin pay anything? (since that coin is already spent technically)
Thirdly, probobly a more philosophical thing but I don't buy into this whole 1-world currency thing for a very simple reason--the same reason there is no world government or world religion--differing cultures and ethnic groups have different values and apply said values in different ways.
Basically at this point (with a system that outlaws genocide and has something like the ITC/UN etc. outlawing major crimes that everyone can agree upon--E.G. "war crimes" etc.,internationally) is about as close as a 1-world anything as we're ever going to get.
Personally I think BTC will just get more and more unstable until it crashes and burns--the more limited the supply becomes, the higher priced, the less people are going to deal with it and the more unstable it'll become by smaller and smaller things until it implodes.
Sure, it'll be a perfect opportunity for short-term day trading, but that's about it.

1/10/17

You misunderstand the double spend problem. It's only a mechanism to ensure that the same value isn't spent twice. In other words, you have a soda and I have a dollar. I give you the dollar and you give me the soda. You now have the dollar and can do with it what you wish, so the value has been transferred. In a double spend situation, I would be able to give you the dollar for your soda, and then turn around and give the same dollar to someone else for their soda before anyone was the wiser. That's what the Bitcoin protocol solves for.

1/10/17

"If its limited, and the coin iscoded in a way whereit can't be used a second time how is it reusable?"

It's reusable - just not reusable by the same person once he has spent it.

1/10/17

What sites do you suggest using to purchase Bitcoins?

1/10/17

If you gotta ask, it ain't meant for you to know...

1/10/17

I think Coinbase probably has to be the most user friendly.

1/10/17
Eddie Braverman:

I think Coinbase probably has to be the most user friendly.

Yeah I agree. I don't have much experience--never had enough money to buy a btc, but I did open an account with them just to see how it worked and they were very user friendly.

1/11/17

I use Kraken - great customer support and they allow me to trade in other krypto currencies. SUPER easy to fund! You do have to provide ID for it though - so if you are going to buy drugs etc... Probably not the best website to use. For me I just use it to gamble small sums.

1/10/17

And thanks Eddie, yeah now I understand what you meant--I hadn't understood the problem properly the first time.

1/10/17

Awesome post Eddie, thanks for sharing. I've actually been following Bitcoin since the original Silk Road days, when it was hovering around $25, but never had the balls to buy any. Obviously 10-15 years later now I feel like an idiot, but the biggest thing keeping me out of it at this point is the fear that China and the US government, or either of the two brings the hammer down HARD.

I personally suspect Chinese citizens are using BTC to launder money or simply move it out of China. I also agree with you that while the American user base is changing, the foundation was definitely built upon online drug dealing, and the system continues to benefit from new iterations of SR as well as the attention from headlines. Everyone else is essentially skimming money off of these users and riding the currency's "popularity", but the only true users are illegitimate. Morality aside, this is HUGE motivation for either of those governments to shut things down, especially if BTC starts to actually threaten tax collection in any significant way.

I guess my question to you is, what is your outlook in the short, medium and long term of bitcoin's viability as an investment and currency for legitimate use?

1/10/17

Well, you're talking to one of those anarcho-libertarians, so I actually consider drug purchases a legitimate use.

But to the heart of your question, the underlying technology is getting plenty of "legitimate" use already. Many companies (many being a relative term, obviously) are already paying overseas vendors and contractors in BTC, as it avoids the onerous wire transfer fees, X-rate conversions, and interminable two or three day delays. Who needs that bullshit, when I can transfer virtually any amount to any country instantaneously and without fee?

For those wondering, there are services out there that convert the money you transfer to BTC when you send it, and automatically convert the BTC to the recipient's native currency when it hits their account a few seconds later, thereby eliminating volatility risk.

At this point there really isn't much the US, Chinese, or any other government can do to stop it. It's already in the wild. They could certainly slow down its ascendency, or even make possession illegal (like Roosevelt did with gold in 1933), but you can't kill a good idea.

1/10/17

You didn't really answer my question, and I disagree with you on a number of points. If the Federal government wanted to make BTC illegal all they'd have to do is make it illegal for companies like CoinBase to operate in the US, and give IRS or FBI the ability to seize all assets of any company found to be facilitating the purchase and sale of Bitcoin. While this would not alienate the folks using it for nefarious purposes, it would eliminate institutional players as well as all of the legitimate (I'm going to continue using this term in its traditional sense regardless of your personal political beliefs) users you claim exist. The currency certainly wouldn't cease to exist but without a legal and reliable way to transact with it in the US, I could see 30-50% of its value wiped out at any given time. Is this really a completely unforeseeable scenario for you given the upcoming inauguration?

1/11/17

Because you are right @Maximos , the US is the largest user of bitcoin in the world and everyone is looking at the US government in how they are going to regulate it. It would hurt the bitcoin - but for how long? It's here to stay, it will go through ups and downs but there is a big market for illegal gun trades, drugs, prostitution and you just can't ignore all of that.

As the US is trying to make everyone move away from cash I believe THIS is going to be the biggest driver towards bitcoins. I was shocked coming back to the US after 10 years out at how cash had slowly disappeared from the system in just 10 years. It's in the government interest to destroy physical currencies to better control the flow of money. Bitcoin is going to exceed the $10k level as @Eddie Braverman mentioned, but for other reasons.

1/11/17

This.

The move to cashless by several governments is a big driver and will only increase.

To your point that the US could just make it illegal, could the US make the internet illegal? How has it worked out for those governments who have tried? Bitcoin is the internet of money.

1/11/17

I agree with you - people will still be able to use it regardless of what the government tries to do.

I think it's more to your point of global companies using it to instant FX large amounts. If it's illegal they won't use it. At the moment people are betting on bitcoin to become more prevalent in the "legal" domain, with fortune 500 companies adopting it - it's a slow process and could be derailed very fast by the US government. I think there is a lot of speculators betting on bitcoin becoming a standard, and they would pull out from the market with Bitcoins taking a big hit. It's still going to be very volatile and dependent on government regulations - we are a few years before it all stabilises.
For me I am going long at $600 for the next 5 years as I am a very strong believer for Bitcoin long terms with or without government intervention. I also like Etherium a lot, even more volatile - I got extremely lucky (that's the only way I can describe it) trading it this summer.

1/11/17

I'm not saying that Bitcoin would be entirely phased out if the US government made it illegal, they would just make it cumbersome for the high-volume users, which would effectively and significantly devalue it as a result of the increased obstacles. It's simple supply and demand. The future value of Bitcoin is what we're concerned with here, not its longevity.

1/13/17
Eddie Braverman:

For those wondering, there are services out there that convert the money you transfer to BTC when you send it, and automatically convert the BTC to the recipient's native currency when it hits their account a few seconds later, thereby eliminating volatility risk.

You bring up an interesting point that I've debated with folks creating start-ups trying to do this. In my opinion, there is incredible risk because once the transactions get big enough there isn't enough market liquidity to absorb large buy/sell orders to balance your BTC book. Take the last few weeks of trading as a great example: what do you do if you are a CoinBase and you need to sell 50,000 BTC to balance your position and it is a particularly volatile environment? Do you try to sell the whole block & cry when you drag the whole market down & you take a huge haircut? Do you try to offload it over the course of a week & hope it the price gets back to even? My point is there is enormous tail risk in this business model that is often overlooked.

One more point: for a lot of traditional uses, such as making purchases on Amazon or whatever, there still is a need for a middle man because you can't retrieve coins once they are spent. This is critical for the consumer because they need to be protected if the vendor screws you over, hence why PayPal is still around. There are also countless stories from the Silk Road where a "vendor" would get popular, build up a lot of BTC in backorders, then vanish with the stash & disperse the BTC to a bajillion other wallets.

With all that being said, I am a big believe in the technology & intuition behind Bitcoin and firmly believe it will revolutionize how money moves.

1/14/17

@Eddie Braverman ""Among the 16 million bitcoins already dug out across the world by now, there are around four to five million held by the Chinese. That already caps the total value, while most of the owners are more interested in short-term speculation on the mainland market than exporting them for foreign currencies," he said. Cheung said that although neither the mainland nor Hong Kong financial regulators had included bitcoin in the existing regulatory framework, bitcoin-related activities were "evolving and bearing the features of traditional financial market activities" and overlapping with the traditional financial system. That makes it more important than ever that the regulators start to take notice."
http://www.zerohedge.com/news/2017-01-13/chinas-ne...
For your next article

1/11/17

How replicable in the bitcoin technology. If there is no central authority behind it, does that mean that I can use the source code behind bitcoin and create something similar then call it "butt-coin"? ie what's the barrier to entry for cryptocurrency. I'm assuming the main differentiating factor between bitcoin vs. other cryptocurrency is public acceptance (relatively).

Also, my understanding of the real public benefits of bitcoin isn't really about 'ability to buy illegal shit anonymously online'. Instead, the benefit to an average person is utilizing its its characteristics - bitcoin is a property/asset that can be transferred from A to Person B instantaneously and without friction. That is, you can send your monetary asset (ie bitcoin) from New York to ANYWHERE, instantaneously without incurring any transaction cost. Which is HUGE since Visa, Mastercard, Amex charge a % every time you purchase anything using their cards and transferring money internationally always take ages. [We will obviously need an platform such as Coinbase to make this process user friendly to allow average person to use it]

If government/public acceptance is the biggest barrier for bitcoin, then I hope people would stop concentrating on the fact that we can buy illegal shit using bitcoin. Instead, we should be discussing how bitcoin can actually makes our life easier and save money while doing it.

** I might be describing blockchain rather than bitcoin - I don't really understand the difference so would appreciate it if someone could correct me/explain the difference

*** Am I describing Fin-tech in general?

1/11/17

You're correct on all counts.

Anyone can use the Bitcoin protocol to create their own alt coin, and in fact many have (Dogecoin, Litecoin, of course Ethereum). The barrier to entry is just as you said, widespread acceptance. Ethereum has made the greatest progress here with Ether, and it's more because they're creating an entire ecosystem around it.

You're also correct in the primary benefit, which is instantaneous and frictionless funds transfer.

In the current financial environment, Bitcoin and blockchain are largely interchangeable terms, but for the sake of specifics, the blockchain is the giant public ledger that records each and every transaction, and Bitcoin is the currency used to transact on it. Put another way, you can't have Bitcoin without a blockchain, but you CAN have a blockchain without Bitcoin.

1/11/17

Barclays and a few other banks now use blockchain as part of their transaction systems.

1/11/17

One of the most interesting topics in the financial world these days, I think. Although bitcoin still has a bit of a bad image, I'm sure its usage will explode once that image fades out.

Interesting post, looking forward to the next part.

Gorzaki

1/11/17

Eddie have you been accumulating bitcoin and if so, what's your buying strategy? I think I recall in one of your old bitcoin threads you stated you got completely out of bitcoin, what's changed since?

1/11/17

I've been in and out too many times to count, honestly. I've been lucky trading it, but I didn't call this run up to $1,100 and bailed too early. Probably start buying again here soon. Would like to see it at $600 or below beforehand, though.

1/13/17

I've still yet to wrap my mind around the reluctancy to see the value or future in bitcoin. Bitcoin is something that was predicted far before its inception by brilliant minds like Milton Friedman as you can see in this 1999 video where he predicts the rise of an "e-cash". The amount of value that lies in such a currency is boundless. More importantly is the underlying technology involved in it, which is the blockchain. This is the single most important item when discussing crypto currencies and I encourage you all to read up on it. The introduction of something like Ethereum provides a glimpse into the value added potential of such items and the power the blockchain can actually harness.

My advice for people here would be to not only buy bitcoin, but hold it as a long term investment. I believe we could see it reach a value of 10-20k per coin within the next decade. Even some very intelligent and savvy investors believe it's long term value could be $1MM / coin. That is, obviously, the extreme.

Stick to reliable places to buy currencies like BTC and ETH, specifically Coinbase - although Kraken is reliable as well.

I would suggest avoiding exchanges as most of you would not know what to do with them, it can be the wild west, and you can lose your ass, not only due to BTC price swings, but hackers as well. if you do engage in the exchanges, I would manage them very closely, transferring coins to and from your secure wallets (Coinbase), and never leaving more than one coin unsupervised in an exchange for more than 24 hours.

Good post, Eddie - BTC, crypto currencies, and the blockchain, for the most part, seem to be the dirty little secret most people in finance don't want to talk about, or refuse to accept. It isn't going away, so it would serve you all very well to get educated on it.

You're born, you take shit. You get out in the world, you take more shit. You climb a little higher, you take less shit. Till one day you're up in the rarefied atmosphere and you've forgotten what shit even looks like. Welcome to the layer cake, son.

5/19/17

Wanted to reactivate this thread.

I have recently become interested in this space. Just from a month ago, I have seen BTC rise about $700 and ETH rise from $40 to $123. It is also interesting how company's job descriptions for software developers specifically indicate experience in Blockchain (Microsoft). I'm sure this confirms your original thoughts. However, I am curious if you have begun looking into the other coins as an investment as well.

5/20/17

Yes, of course.

You're born, you take shit. You get out in the world, you take more shit. You climb a little higher, you take less shit. Till one day you're up in the rarefied atmosphere and you've forgotten what shit even looks like. Welcome to the layer cake, son.

5/26/17

Which coins are you looking at? Reasons?

5/20/17

I second your enthusiasm to revive this thread. I just dipped my toe into ETH earlier this month and would like to hear more WSO user's experiences and thoughts of the cryptocurrency space. I'm currently using coinbase, but it's limited to BTC, ETH, and LTC.

What other coins are people interested in these days? Anyone buying into any ICOs? @Eddie Braverman

5/26/17

Golem (GNT) is pretty interesting - buying and selling CPU
Digibyte (DGB) is a coin that is geared toward gaming and should be implemented into Minecraft towards the beginning of June.

5/26/17

It's being talked about in Healthcare circles that blockchain is the future for healthcare as well, due to the fact that the records can't be deleted or altered after they are created.

The answer to your question is 1) network 2) get involved 3) beef up your resume 4) repeat -happypantsmcgee

WSO is not your personal search function.

5/26/17

Interesting. Have a link?

6/23/17

The answer to your question is 1) network 2) get involved 3) beef up your resume 4) repeat -happypantsmcgee

WSO is not your personal search function.

5/26/17
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