Bitcoin

Comments on Bitcoin

I don’t claim to know very much at all about Bitcoin or to really understand it. Nevertheless, I do know something about money and something about investing and wanted to put down some thoughts about Bitcoin.

What is Bitcoin?

Dictionary.com defines it as: a type of digital currency that uses state-of-the-art cryptography, can be issued in any fractional denomination,and has a decentralized distribution system. There are other more detailed definitions that can be found by googling the term.

Is Bitcoin money?

Money has long been said to possess three characteristics. I list each below and discuss if Bitcoin possess the characteristic.

1. A Unit of Exchange? Well, there are some online stores that accept Bitcoin for payment. These include Overstock.com, Expedia, some shopify businesses, egifter and the MicroSoft stores for Xbox and Windows. This site lists about 50 places that accept Bitcoin, most quite small or obscure but some are larger businesses.

Presumably, a business that uses dollars as its main currency would quickly re-sell the Bitcoin that it receives in order to eliminate the risk of value fluctuation. Alternatively such a company could allow the Bitcoin to accumulate taking the risk of the value fluctuation and/or using it to make purchases with Bitcoin.

Also it is reputed that certain criminal organization transact partly with Bitcoin.

With very few businesses directly accepting Bitcoin, it is debatable whether it can be considered a unit of exchange. But I will give it the benefit of the doubt and say that it qualifies as a unit of exchange.

2. A Store of Value

Well, Bitcoin holders would likely argue that it has been far better than a mere “store” of value. It has (on most days or weeks) created tremendous value for those who have held it even for a very short time. But the fact that its purchasing power has been rocketing up combined with the risk that the value could fall would seem to disqualify it as a reliable store of value.

Those who have faith in Bitcoin would argue that there is basically no chance that the value will not be higher over time. In the end, it is debatable whether it qualifies as a reasonably reliable store of value.

3. A Unit of Measure

The vast majority Canadians measure their net worth in Canadian dollars. A few may measure their net worth in U.S. dollars. Virtually all Americans would measure their net worth in U.S. dollars. Canadian and American corporations are required by law to measure their financial results and financial position in dollars. In contrast I doubt if there is anyone in this world measuring their net worth or financial results in Bitcoin. No one is saying “Oh no my, $100,000 is now worth only a few Bitcoins”. Rather, Bitcoin holders are bragging about how many dollars their Bitcoin is worth.

I would argue that Bitcoin totally fails the test of being a unit of account.

Overall, since it does not possess all three of the characteristics above, I would argue that Bitcoin is not money, at least not yet.

What is Bitcoin used for?

In addition to the potential to use Bitcoin for purchases it has been used as a way to transfer money to other individuals or to make currency transfers. Presently it is also undeniably being used to speculate on its own future value.

Is Bitcoin just an an object of speculation?

Over and above its nascent use as a medium of exchange and its usefulness in transferring (actual) money to another person or to another currency, it is undeniable that Bitcoin at this time is definitely an object of rampant speculation.

Will Central Banks create their own digital currency to compete with Bitcoin?

I understand that most major currencies are already largely digital in nature. Paper cash is still widely used in transactions. But I think deposits in banks are now essentially entirely digital in nature. When we receive our salary by direct deposit and when we pay bills on line or by pre-authorized debit, and when we use a debit card – that is all done entirely digitally. Many corporations have hundreds of millions of dollars in “cash”. Virtually none of that is held in paper cash.

What Benefits does Bitcoin provide versus dollars?

Inflation Protection

There are more than a few people who believe that the value of the U.S. dollar will or could fall sharply as hyperinflation sets in due to excessive printing of money by the FED or through fractional reserve bank lending. Another large group of people may not fear hyperinflation but would point out that the purchasing power of dollars certainly steadily erodes over longer periods of time even with modest inflation and that the erosion of value is quite substantial over several decades even with inflation that is far short of hyperinflation such as say eight percent annual inflation.

Many of these people would claim that actual inflation over the past decade or two has been far higher than the official inflation figures indicate.

Bitcoin, it is said, will protect against inflation because there is a limit of 21 million Bitcoins that will ever exist. So far, Bitcoin has certainly not eroded in value. Prices of goods in terms of Bitcoin have not inflated but rather have deflated at an enormous rate. What took a full Bitcoin to purchase a few years would take take closer to just one one thousandth of a Bitcoin to purchase today. That’s hyper deflation.

In reality we could get far more than 21 million Bitcoins in circulation. Fractional reserve banking can certainly be done in Bitcoin and this could increase the supply at least ten times. Nevertheless, it is likely true that Bitcoin provides protection against the inflation that the dollar will experience. Well, unless, that is, it simply becomes worthless.

In my view, inflation will remain low and the erosion of the purchasing power of a dollar can be handled by simply investing the dollars. It should not be that hard to find investments, even bank GICs, that will at least keep up with inflation even after paying tax on the interest or other investment gains.

I would argue that in protecting against the risk of hyperinflation, Bitcoin is protecting against a risk that largely does not exist or which can be mitigated in other ways. But, some of those who perceive this inflation risk to be real are attracted to Bitcoin as a solution. Bitcoin provides a cheaper way to transfer between various concurrences.

That may be true. In my experience banks have been charging outrageous fees to transfer money electronically between Canadian and U.S. dollars. Today, I checked and TD Canada Trust / TD Direct would charge me 1.54% over and above the wholesale exchange rate to transfer $10,000 Canadian into U.S. dollars. 

This was actually within the same TD Direct account, just transferring money from the Canadian dollar “side” of the account to the U.S. dollar side. I am not familiar with their costs or risks but I expect that their costs on this all-electronic transaction as well as their exchange rate risks are absolutely minimal. 

I imagine the bank fees to transfer between many other currencies in the world are even higher. Probably far higher and probably involving some intermediate company and probably requiring something like a wire transfer and generally being both costly and inconvenient.

Another outrageous example is that almost every credit card issued by Canadian Banks charges a hefty 2.5% additional exchange rate fee on foreign currency transactions and that is on top of the regular exchange rate charged by the bank. For example, on November 2, my TD visa card charged me an exchange rate of 1.32007 for a U.S. purchase. The Bank of Canada’s official noon exchange rate on November 2 was 1.2822. So, my credit card / bank charged me a stiff conversion fee of 2.95% on this all-electronic transaction. Conveniently, for the bank, the level of this fee is not at all obvious to customers as it is rolled in with the wholesale exchange rate.

In my view, banks have been charging outrageous fees on exchange rates just because they can. Given that, it is no wonder that people look to something like Bitcoin.

But, if Bitcoin takes away significant amounts of currency exchange fee revenue from banks then the banks can simply lower their outrageous fees.

Anonymity

One of the more confusing aspects of Bitcoin is that it is said to be both anonymous and yet to have a verifiable record that all can see. I don’t know to what extent it is normally anonymous but I suspect that if the authorities ever want to trace a transaction, they will be able to.

Is Bitcoin a secure Investment?

Even if Bitcoin maintains its value or continues to rise, there are some security issues. I am not familiar with the details but I understand that someone could take your Bitcoin if they had all the necessary passwords. And, unlike someone transferring money out of your bank account, there might be no way to see who took your Bitcoin or even where it went. I believe that information would be available in theory, but perhaps not in practice. Some people have lost Bitcoin that was stored on a hardrive. In effect, I guess they lost the passwords or other codes needed to access their Bitcoin. I believe one or more corporations that were electronically storing Bitcoin for investors had that Bitcoin stolen (Mt. Gox) and the investors lost that money (err Bitcoin).

Is the value of Bitcoin being manipulated upwards?

I don’t know but that seems like a possibility.

Is there any truth to that story that the Bitcoin operation is consuming more electric power than the entire country of Ireland?

I am extremely skeptical of that claim. I wonder if someone slipped a few decimal places in their calculation?

Should You Invest in Bitcoin?

I think those investing in Bitcoin should treat it as a highly speculative “investment”. It does not seem prudent to risk much money on Bitcoin.

However, it might be worth a few hundred dollars or so to do it just for the education.

Source Shawn Allen - Investors Friend Inc.