Tuesday, February 6, 2018

Bitcoin - The Emperor Has No Clothes by Manny Gonzalez, Guest Blogger



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Bitcoin – The Emperor Has No Clothes
By Manny Gonzalez, Resident Shareholder, Plantation Bay Resort & Spa

My Guest Blogger Manny Gonzalez brings a unique multi-disciplinary perspective to this issue – public policy, financial analysis, and technology. As an officer of the World Bank, Mr. Gonzalez advised governments and financial institutions; as an investment banker he designed financial derivatives and assessed IPOs. He has als been awarded 5 US Patents related to gathering information on the internet. He is now a successful entrepreneur. MBA Columbia University, Robert J. McKim, Jr., Fellow, and Roswell McCrea Award winner.
This article first appeared in the Philippine Star. It is reprinted with the author's permission.

 Thinking of plunging into Bitcoins? Read this first.

Dazzled by the technology, some claim Bitcoins are a new kind of money. No, they aren’t, and I’ll explain why. Unlike some parties who should know better, I was not asleep during my Money & Banking classes.


Money is a measure of value, a medium of exchange, and a store of wealth: “My land is worth $5000; give me cash and it’s yours; I will save the money for my retirement.”

Money has one non-negotiable requirement: scarcity. Something in unlimited supply is worth Nothing. Remember this, because many people, economists included, have forgotten it.

What are Bitcoins anyway? An amorphous “cloud” of computer files which replicate, much like viruses. Is Bitcoin immune to malicious viruses? Is your Bitcoin app immune to hijacking? Time will tell, but rest assured a lot of very smart hackers are working on it. In fact, a major Japanese cryptocurrency exchange just revealed today (January 29) that hackers were able to steal about US$ 660 million.

With backup files and paper records, you could recover from a conventional hack, or even from a solar electromagnetic pulse frying the internet. By its very architecture, any Bitcoin hack or crash would be irremediable, For this reason alone, it would take a very courageous government indeed to allow cryptocurrencies to occupy any role at all in its financial system.

 Leaving imponderables aside, is Bitcoin (we’ll use this word to mean all cryptocurrencies) “money”?

Can you quote prices in it? No, its value is too unpredictable. Even oil prices would never serve as a general measure of value; how could Bitcoin?

A medium of exchange? Yes, for criminals. Computer hackers demand ransoms in Bitcoin. But it will be a long time before you can buy a car with it.
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Is Bitcoin a store of wealth? Maybe, but not a very reliable one: it lacks fundamental protections for investors.

With most contemporary assets that serve as stores of wealth, governments (like them or not) are needed to protect you and maintain order. Land is titled, bank deposits guaranteed, stock manipulators prosecuted. Because of Bitcoin’s very anonymity, there is no one to protect you. Shadowy entities could whipsaw Bitcoin’s price, fleecing the public. This might be happening already.

Bitcoin greases crime, offers unexplored territory for fraudsters, and is harder (but not impossible) to tax. Are governments just going to cuddle up to it? Just how hard would it be to declare Bitcoin, or dealing in it, illegal? The US successfully outlawed gold in 1933. Enforcement? Bitcoins must be bought or sold for “real” currency on an exchange of some sort. This leaves unmistakeable financial footprints, like tracks the Invisible Man leaves in the snow.

All sorts of legal concepts could be invoked: protecting people from their own stupidity, unlicensed gambling, commodities dealing with no underlying “commodity” (aka fraud).

Why has no government done this yet? Simple: everyone is waiting for someone else to say that the Emperor Has No Clothes. No one wants to stick his neck out and possibly look foolish, alarmist, or (the most feared epithet) “incapable of grasping new technology”.  But China is already clearly heading in this direction, and even the tech-fascinated South Koreans are starting to wake up.

In fact, some well-known investment-banking figures already spoke up against Bitcoin, then immediately recanted. Why scare customers when there is still easy money to be made (as with junk bonds, mortgage-backed securities, and dot-com IPOs)? But when enough ordinary people have lost their savings, someone will clamp down on Bitcoin, and every country will follow.

Supporters frequently claim that the limited supply of Bitcoins makes them a better currency than other fiat money such as dollars or Euros. Is this true? Are Bitcoins really “scarce? Any individual cryptocurrency, perhaps. Cryptocurrencies as a group, no. Now that everyone knows all about blockchains, anyone can jump in. Russia and Venezuela have already signalled their intentions. Cost of entry? Software salaries and a clever prospectus.

The potential supply of cryptocurrencies is unlimited. If you disagree, conduct this simple thought experiment: Issue a new cryptocurrency, Electronic Euros, which are structured such that there will always be less of them than the original Bitcoins; how much should each Electronic Euro be worth? Because they are scarcer, more than original Bitcoins, right? Now issue another new cryptocurrency. And another. Each should be worth more than the previous issue, attracting yet more issuers, until the price approaches infinity.

This being unlikely, there must be a flaw somewhere. That flaw is the blithe assumption that each cryptocurrency represents a separate commodity, discrete from any other. No. Whether plain-vanilla or with some supposed link to the real world (that you have no way of enforcing), all cryptocurrencies are part of the same “asset basket”, as substitutable as Tide and Breeze, as Kruggerands and Gold Leafs.

Bitcoins are not money. They are not even an asset. They are computer entries with no underlying reality and no government oversight. With licensed gambling you at least know the odds. With Bitcoin, you are simply casting your conventional money to the winds, while hoping you are smarter than the traders at Goldman Sachs and JP Morgan.

You might make your fortune on Bitcoins, so don’t let me rain on your parade. Just remember these ways their value could approach Zero:

1.      A virus infects Bitcoin, or an electromagnetic pulse fries large numbers of computers. Probability Unknown, but Effect Irremediable.
2.      Governments outlaw it. Probability: High.
3.      So many imitators spring up that cryptocurrencies as a group lose scarcity value. Probability: 100%, unless either 1 or 2 happens first.


Tags: #Business #Finances #Bitcoins #Economy #Economics #MannyGonzalez #Philippines #PlantationBay

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