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Bitcoin – Money from Nothing

Imagine a currency that is freely accepted all over the world, can be used to settle any transaction instantaneously over the internet, is beyond the meddling of governments or outside agencies, is free from exchange controls, has zero transaction costs, whose supply is transparent and is as safe as houses…?  Impossible?  Welcome to Bitcoin, the world’s best known virtual currency.1

Andrew from Bitcoin Cape Town calls me.  He says Bitcoin Cape Town is a group of sixty or so people with an interest in digital currencies that meets once a month.  They hold meetings where they get experts to talk on various topics of potential impact on their interests.  I’ve been highly recommended he says.   Could I please address them on fiat currencies and on the effect of the US Federal Reserve’s tapering of quantitative easing on the global economy?2  Or any topic of my choosing that might have an effect on Bitcoin?  It’s very casual he says.  Fine I say, but only in mid-December when I have the time.  Are we going to have to pay you anything? he asks.  Not this time, I’ll load up my fees the second time, if there is one, I joke.

On the designated day I arrive at a parking lot next to a bridge in Claremont and say hi to Andrew who is reclining against a car outside the venue.  He says things are really slacking down in Cape Town for the holidays, it’s very relaxed, people are late and we’ll probably start at 18H30 instead of 18H00.  Oh no.  I’m casually told to help myself to a beer in the fridge, casually.  The Heinekens are theirs but not the others so I should please have one of those.  The true sharing spirit of internet start-ups operates here too, I’m pleased to see.  It’s the first time ever I’ve taken a drink before presenting, but then again it’s v-e-e-e-e-ry laid back and casual and all.  Besides, I’m presenting in the working year’s spare time when Cape Town (Kaapstad) slackens into Slaapstad (Sleeping Town) and spirit of the beach surfs into the work space.  I grab a beer and saunter back to the parking lot to mingle.  Heavens it’s casual.

Andrew and a few souls relax outside the venue with a smoke.  Smoking rates are up again in Cape Town it seems.  The puffing is slow, shallow, casual, effort saving.  People introduce themselves as they arrive.  A funny assortment they are, in their thirties mostly, extremely laid-back, some even in slacker gear (beanies, pants falling off bum etc.) but nearly all carrying I-Pads to track the fortunes of Bitcoin.  Eyes on the IPads, boys.  From what I can surmise, attendees fall into four groups.  There are the curious, there to find out about Bitcoin. There are the confused, those who knew a little but not enough, mostly business people who are considering transacting in Bitcoins but not sure whether they should.  There are a few Bitcoin miners present, people who mined or had mined Bitcoins for money from the electronic blocs in which they are embedded.3  And then there are a few who actually owned Bitcoins, among which was a serious investor/speculator.  He owned 567 Bitcoins, he said.4  He had made enough money to buy a Maserati and was holding out to buy two Maseratis.5  He was attending my talk to find out where the Bitcoin price was headed, he says.  Oh dear.

After fifteen minutes in the car park I realised that I was at an electronic mining/speculators convention and that what I had to say – despite being given the topic – was not quite what the audience had come to hear.  After being introduced I said exactly that.  What I had to say might not be of tremendous relevance to holders of Bitcoins, I said, but might well be of relevance if one held US dollars or Euros or South Africa rand.  At this they perked up, because of course, most people there, Bitcoin obsession notwithstanding, had more conventional money than Bitcoins.  I also said that my presentations were usually delivered in more formal settings, to financial audiences, but they didn’t seem to mind.  So I geared down and devolved my presentation to a talk.

I always aim to inject interest when I speak, taking care to bring relevance to the audience at hand, and by some quirk I somehow managed to hit the jackpot here.  Five minutes into the presentation, languor turned to interest, interest to engagement, engagement to engulfment.  I flatter myself to think it’s my inimitable style, but no, gentle friends, be cynical; it was fear for the South African rand and US dollars in their pockets that pulled them forward.  I got the most questions at a presentation ever – easily fifty – from seriously enquiring minds.  They wouldn’t let me go.  They wanted to know this and that and that and this – mostly about the financial market topics I was discussing.  There were a few misguided notions such as someone setting the value of a Bitcoin at 14000 US dollars based on the relative supply of Bitcoins and US dollars circulating in the world.6  But by-and-large the questions were testing and engaged with the topic.  I loved that audience! – In my next life…

As for the value of Bitcoin:  It was really riding on a high when I presented, trading at around 1200 US dollars each from 10 (ten!) at the beginning of the year.  Bubble?  Bubbles are only obvious in hindsight.  But at the current exchange rate it seemed as though the Maserati guy was on his way to the next one.  Alas, shortly thereafter, the Chinese government shut down the largest Bitcoin trader on the planet, BTC China, and prohibited its financial institutions from trading in Bitcoins.  The Eurozone also issued a warning to Bitcoin users shortly afterwards.7  The price of Bitcoins fell precipitously to 584 USD before rising again (see chart).  So the second Maserati is not quite secured yet.

Bitcoin share Price

Bitcoin share Price

I have yet to make up my mind about Bitcoin.  The cautious part of me tells me to beware of the volatility and security issues.8  But the enterprising part of me says we should have an open mind towards this new phenomenon.  The CEO of major online retailer Overstock recently announced his company would accept Bitcoins for any of their one million-plus products.  He cited business and philosophical reasons for their decision, especially their support of limited (smaller) government and their liking for gold-backed money, the supply of which governments cannot tamper.9  After all, currently around 15m USD of goods get traded in 50000 Bitcoins transactions per day.10  For the moment I’m neither siding with the detractors nor am I climbing into the vanguard with the enthusiasts.  Perhaps Bitcoin’s volatility is one of the many teething problems that could get sorted out in time.  A potential problem also foreseen is the plethora of crypto-currencies being generated today, some of which will be competitors to Bitcoin (e.g. Dogecoin, Litecoin etc.).11

But as they say, you pay your money and you take your chances…  Caveat emptor.

ooooooooooooooooooooooooooo

Notes:

1.       There are many digital currencies circulating around the world today, Bitcoin being by far the best known.  A Bitcoin contains 100 million Satochi, the smallest unit of Bitcoin.  Some websites have converted to the more useful unit of milliBitcoins to be in closer numerical parity to the US Dollar (e.g. https://bitcoinity.org/markets quoted a milliBitcoin at 0.949/USD on 15 Jan 2014).  By design, the supply of Bitcoins is limited to 21 million by 2040.

2.       Fiat currency:  A fiat currency is one backed by the public’s trust in the integrity of the issuers of the currency to uphold its purchasing power, that is all, nothing else.  This contrasts with some sort of backing for a currency like say a stack of gold, where the public can at any time demand gold in exchange for their money at a transparent rate.  Of course, trust does not occur in a vacuum.  The authorities, usually a central bank (i.e. a government agency) have to continually assure and demonstrate to the public that they are doing their utmost to keep the currency strong.  South Africa for example has an inflation target.  The US dollar, the Euro, and the South African rand are all examples of fiat currencies.

3.       The supply of new Bitcoins:  Bitcoins are mined electronically in a process analogous to miners mining for gold.  The designers of the system (Satoshi Nakamoto, a pseudonym) designed a code in which Bitcoins are hidden in digital blocks.  Each block contains a number of Bitcoins which depletes over time by design.  Miners can mine these blocks electronically to find Bitcoins.  To find a Bitcoin electronic miners have to solve a serious mathematical function, which they do with the aid of increasingly powerful computers and commercial software.  Once found, the Bitcoin is transferred to the miner in a process that is open, certified and verifiable to all.  And thus a new Bitcoin comes into circulation.

Mining used to be a fairly simple process early in the history of Bitcoin (2009), but has now become very competitive game where only the most powerful computers can compete.  Other crypto-currencies have different algorithms and rules by which they are generated.  Electonic mining of Bitcoins requires a large capital investment today.  It is not that profitable.  I spoke to a miner who uses his desktop to mine Bitcoins while idle.  He told me that what he had made did not cover his electricity costs (he had been credited with a small fraction of a Bitcoin up to then).

4.       At the exchange rate of 1200 USD per Bitcoin on the day, the man had around 680 000USD in Bitcoins, or just over 7 million in South Africa rand.

5.       On speculation and fast cars:  A young actuary I once worked with told me he wanted to invest in a product run by a currency trader he knew who had posted monthly returns of 5% per month in US Dollars for the past three years.  The trader had made so much money he was driving around in the latest Ferrari.  He wanted to give money to this trader.  What did I think about it?  I told him to be careful – it was a phenomenal return and returns to such high-risk trading sometimes mean revert after a lucky streak.  He was nonetheless adamant to “invest”.  I spoke to my boss and asked him what the young actuary saw in the investment.  “He sees the Ferrari”, said my boss shaking his head, “he sees the Ferrari, that is all…”

6.       The questioner was misguided partially because he was only considering supply functions and not demand, neither was he taking potential (and existing) competing electronic currencies into account.

7.       In December 2013, the Eurozone issued a warning to its public to the effect that it will have no recourse to restitution should their Bitcoins be hacked.  In the case of a commercial bank failing, each account holder in the Eurozone has recourse to a maximum of 100000 Euros as compensation.

8.       Money has three functions in an economy viz. a medium of exchange, a unit of account and a store of value.  Of the three, Bitcoin currently serves best as a medium of exchange, as its virtually costless peer-to-peer, decentralised network allows for efficient and rapid transacting.  However, as a unit of account and a store of value it functions less well.  The problem remains its huge volatility (eight times that of gold, itself volatile) and the fact that hacking remains a problem.  It traded between 10 and 1200 to the US dollar over 2013 (see https://blockchain.info/charts for a good selection of Bitcoin charts).  As for hiding your money from the tax man, forget it.  They have bigger computers that you.  They will find you and jail you.  Remember that the police, the FBI, fellow mobsters etc. could not put Al Capone away.  The tax man did.

9.       See  http://www.businessinsider.com/overstock-accepts-bitcoin-2014-1.

10.   How to buy a Bitcoin.  There are various exchanges that will convert your hard earned dollars into Bitcoin, e.g. Mt. Gox, Bitstamp and even BitX in Cape Town (see http://techsocial.co.za/buy-bitcoin-in-south-africa-with-bitx/).  You wire them your cash and they’ll credit you with a Bitcoin in an electronic wallet.  You would then have entered the Bitcoin world, free to trade in goods and services with willing counterparties.  Follow Bitcoin’s fortunes on https://blockchain.info/charts. Warning:  Keep your electronic wallet safe; hacking is a problem and exchanges have been hacked!  [P.S. On Tuesday the 25th February 2014 Mt Gox, the largest Bitcoin exchange, closed its doors, citing security issues.  Many millions of USD worth of Bitcoins got hacked and stolen.  My worst fears were realised, then…]

11.   Wikipedia has a list of electronic currencies at https://en.bitcoin.it/wiki/List_of_alternative_cryptocurrencies.   Also see MoneyWeb article  – Guide to the odd world of alternative currencies – 14 January 2014 at http://www.moneyweb.co.za/moneyweb-investment-insights/guide-to-the-odd-world-of-alternative-currencies.

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