"You aren't the same when you lose money as when you make money. Just ask those who took a beating on bitcoin this past week." - Jason Zweig, WSJ, Weekend Investor column, May 22-23, p. B5
In his column remark on bitcoin, Jason Zweig was referring to the massive selloff of the cryptocurrency ending Friday, seeing it dive 12 percent to $35, 253. But investor losses in this gimmick virtual money - also used in a lot of ransomware attacks - is only one aspect of why it's time at the pinnacle of the money food chain may soon be up.
In the same WSJ Investment- Business Exchange section we also learn, for example, of a possible "regulatory clampdown" on this pseudo currency. This followed a meeting led by Vice Premier Liu He, who "pledges to crack down on bitcoin mining and trading behavior."
For the uninitiated in the esoteric realm of cryptocurrency, "mining" is a loose metaphor for what is going on. Indeed, there is no actual mining as in extraction of precious ores - like gold - to make bitcoin. It is rather the continuous use of powerful computers to keep solving numerical - math problems and conundrums, in 10 minute stretches, to create the basis for generating bitcoin. According to the website "Investopedia":
Bitcoin mining is the process by which new bitcoins are entered into circulation, but it is also a critical component of the maintenance and development of the blockchain ledger. It is performed using very sophisticated computers that solve extremely complex computational math problems. Cryptocurrency mining is painstaking, costly, and only sporadically rewarding. Nonetheless, mining has a magnetic appeal for many investors interested in cryptocurrency because of the fact that miners are rewarded for their work with crypto tokens.
In other words these investors, like the millions mesmerized by the DOW, are drawn by the baubles to get neck deep in the whole bitcoin game. Wherein we learn of the following takeaways:
- By mining, you can earn cryptocurrency without having to put down money for it.
- Bitcoin miners receive Bitcoin as a reward for completing "blocks" of verified transactions which are added to the blockchain.
- Mining rewards are paid to the miner who discovers a solution to a complex hashing puzzle first, and the probability that a participant will be the one to discover the solution is related to the portion of the total mining power on the network.
- You need either a GPU (graphics processing unit) or an application-specific integrated circuit (ASIC) in order to set up a mining rig.
What's not to love? Hell, it's almost as entertaining as 3D computer chess, except this fanciful B.S. is consuming billions of gigawatts each year in its endless number crunching - so its mesmerized minions can grab more bitcoin. Specifically, the amount of power consumed by this number crunching is equivalent to all of that consumed by Finland in one year, or 5.1 gigawatts. Obviously, this stupid exercise is also consuming tons of computer microchips in the process- partly accounting for the existing global scarcity. In the same WSJ piece we also learn (ibid.):
"Much of the global supply of bitcoin is created in China. This industry causes Beijing headaches because of the electricity - intensive process to create it."
Well, yeah, because these "miners" (sic) receive bitcoin as "rewards" for solving the gnarly mathematical puzzles - which are burning up the power equal to all of that consumed each year by Finland (or Ohio). For those who can't be bothered with solving puzzles to get bitcoin they have another option: "just buy it using fiat currency". In other words, real money, like dollars in the form of "Benjamins" or whatever.
Let's be frank here that bitcoin's power as any kind of currency for exchange only exists on account of accepting its adoption as a store of value, and of course as a payment system. (Some bitcoin buffs will also refer to its finite supply and role in decreasing inflation.) But alas, not all finance experts are biting. The Chinese Vice Premier Liu, for example, has also expressed concerns (WSJ, ibid.) over "the risks posed by a volatile investment product authorities can't control". (For reference, bitcoin dropped 25 percent for the week "with the worth of all bitcoin valued at $650 billion")
So of course the Chinese would be worried, but others are as well. To the point that bitcoin can even be regarded as real money like those $100 Benjamins. Enter now Financial Times columnist Brendan Greeley ('Bitcoin’s design tarnishes its value as money', Weekend FT). He writes:
"It is certainly true that even with this week’s drop, over the long run the value of a bitcoin has appreciated. In 2008, it was nothing more than a PDF that contained an idea. The PDF traded at a spot price of zero, considerably lower than current levels. That’s an impressive 13-year performance for any asset. It is an Amazon or Apple level shoulda-got-inon-the-ground-floor performance. I first had bitcoin explained to me by a group of Swedish hackers in Malmö in 2011 and let me tell you: I have regrets.
"Bitcoin isn’t supposed to be just some asset. It’s supposed to be a global money. Depending on whom you ask, it will either become the standard medium of exchange for all transactions, or a final medium of settlement for other kinds of money, a bit like the dollars that banks can hold in reserve accounts at the Fed. Which means that it can’t just gain in value. It also has to become more useful, as money, to more people. That’s not a quality you have to ask of your Apple shares."
Ouch!! Anyone paying attention? He goes on:
"Whether bitcoin is a money is an exercise in scholasticism. It is money now, for some people. There are transactions for which it’s appropriate and already being used. ...The value of a bitcoin, however, has continued to rise from just under $2,000 in 2017— volatile but, you know, up. As a money, bitcoin is becoming more valuable, but not more useful.
It’s possible that its usefulness is limited by design. People who argue for bit-coin as the future of money like to say that, unlike the dollar, there is no central bank that can answer for bitcoin or screw it up. But there is a governance structure behind bitcoin, as real and as clear as the one at the Federal Reserve.
The code that generates bitcoins has capped their total number at 21m. That means they are supposed to become more valuable, forever, by design. You can change the code, but just like at the Fed, to change it you have to change the culture — you have to convince a lot of people to use the new code. Here, too, the culture of bitcoin is fixated on the soundness of money, convinced that the best money only becomes more valuable over time. People encourage each other to “hodl” — to hang on to their bit-coins. If you hodl, you have diamond hands. If you sell, you have paper hands. If you hodl nothing, you are encouraged to have fun staying poor. "
Then there is the kicker:
"Both the code and the culture of bit-coin are designed, over the long term, to drive it out of circulation. This leaves hodlers stuck with a collective action problem. Sell, or change the code, and your asset drops in value, becoming more useful as money. Hodl, and keep the code, and your asset appreciates. Monetary culture is monetary policy. Diamond hands are Gresham hands."
The last sentence refers to "Gresham's law", i.e. that "bad money drives out good."
While many of the complaints about Bitcoin over the years have been overhyped (to a degree) one fact remains: The cryptocurrency’s increasing use of real physical resources— energy and computer chips — can no longer be ignored. If Bitcoin wants to avoid government crackdowns, it needs to shift to technologies that don’t require constant massive resource consumption just to maintain the currency’s price.
This spiraling resource consumption indicates a basic weakness in the technology that supports Bitcoin. For most financial assets, like gold, the cost of storage doesn’t go up much as the price goes up; it’s just about as easy to guard the world’s gold at $2,000 an ounce as at $200 an ounce. And for most currencies, transactions are super cheap. Because people already trust banks and the government, these centralized institutions can handle massive amounts of transactions with near-costless efficiency. Bitcoin’s decentralized trust, in contrast, keeps getting more expensive as Bitcoin gets more valuable.
That process can’t go on forever. And as the economist Herbert Stein once astutely observed: “If something cannot go on forever, it will stop.” Eventually, lots of places will follow Inner Mongolia’s lead and ban Bitcoin mining, and the governments of South Korea and Taiwan will intervene to stop computer chips from being sold to miners. This will negatively impact Bitcoin miners, as well as crypto investors and software developers.
Finally, Katie Martin - another Financial Times columnist - offers perhaps the most perspicacious takes on the bitcoin phenomenon and what's driving its enthusiasts:
"Some people have jumped into this asset class, or currency, or whatever you want to call it, just for fun. For others, it is a moonshot to make some money, often successfully. It is a hobby, a side-hustle. But for the true believers, crypto is a way of life.
They deeply love these digital tokens, bitcoin chief among them, in part because of their anarchic nature — their isolation from big government, big banking and big monetary policy. In real life, these people walk among us. Online you can spot them with laser eyes in their Twitter bios."
In other words, bitcoins' miners and investors relish being latter day "anarchists' and rebels and maybe sticking it to the conventional banking-monetary system - like the Game Stop day traders believed they were sticking it to the Street. But in the end it is their very isolation from big government and the banking system that may be their undoing - along with their own brand of chutzpah. Martin again:
"Central banks, the believers say, cannot be trusted. They are debasing fiat currencies like the dollar with their money printing. Regulators want to trap ordinary people inside the existing financial hierarchy. Both they and governments are watching closely, poised to destroy an alternative financial system they cannot control."
But why would any sane person believe bitcoin's anarchic, isolated system can be trusted? I don't. Also, what's to prevent bitcoin miners from ultimately debasing their own "fiat" currency - say in a desperate effort to render bitcoin mining less climate -impacting and energy intensive. (Bitcoin’s demand for computer chips alone has hogged the production lines at Taiwan Semiconductor Manufacturing Co. and Samsung Electronics Co., contributing to a global chip shortage that is costing automakers tens of billions of dollars and threatening the phone industry as well.)
The other aspect comes down to a basic familiarity with the existing financial system which imbues it with more trust. The cold, hard fact is that currently not 1 in 10,000 average blokes has clue one how the bitcoin "alternative' currency system works. Mention "blockchain" and most eyes glaze over. The arcane nature of the whole enterprise, especially mining, is not a recipe for trust equal to what the existing banking system allows (not to say the latter is perfect by any means). But I ain't buying that cryptocurrencies are the answer. What we need for both is more rigorous regulation.
Ms. Martin's final remark ought to be the one most taken to heart by the bitcoin buffs, miners et al:
" Wednesday, while the price of bitcoin was in freefall, The European Central Bank lobbed a grenade at the crypto crowd. In its Financial Stability Review, it compared the massive rally in crypto prices in recent months to “tulip mania” and the South Sea Bubble in the 1600s and 1700s. Bitcoin is “risky and speculative”, it said. It has an “exorbitant carbon footprint” and a possible connection to “illicit” activity."
Is she out to lunch? No. Research has shown that an international currency must meet at least four basic conditions: it must have a longterm stable value; there must be sufficient volume to meet the needs of international trade in goods, services and financial assets; transaction costs must be low, with small differences between bid and ask prices, and high liquidity; and there must be a stable issuer who guarantees the currency.
Bitcoin meets none of these. Zero. Nada. Make of that what you will.
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