The bitcoin bubble has burst – but the real excitement is yet to come

Money Week (UK Best Selling Financial Magazine) ^ | 21/01/2015 | Dominic Frisby

[9thLife]

Today I want to consider the outlook for bitcoin.

2014 was its worst year on record.

It fell by 67%, from $800 to $320 a coin. In doing so, it beat the likes of the Russian rouble and the Ukrainian hryvnia, to the dubious honour of being the world’s worst-performing currency.

You know what the world’s best-performing currency was by the way? Nope, not the US dollar, but the Somali shilling. Yup. It surprised me too.

Anyway, back to bitcoin…

The bursting of the bitcoin bubble

So far, 2015 has not been any better than 2014 for bitcoin. At one stage last week, bitcoin had fallen by another 47% to $170, though the price has since rallied to around $210.

Given that I’ve just written a book on the subject, you might expect me to be uber-bullish. But I’m not. I’m bullish on the tech. The tech is amazing. It’s going to change the way we operate.

But the price of a bitcoin? That’s a different matter.

In November 2013, one bitcoin cost the same as an ounce of gold – $1,240. It had risen by over 1,000% in just a few weeks. Every Tom, Dick and Harry was starting up his own currency. There was talk of bitcoin replacing the US dollar and eradicating poverty.

It bore no resemblance to what was going on in the real world. Few people were actually using bitcoins to buy stuff – which is what money is for. Bitcoin had become a speculative asset.

I do think that bitcoin, or one of its off-shoots, will eventually become the global standard for online transactions. And I think it will have a role to play in bringing unbanked people in developing markets into global commerce.

But we are many years away from that. The bitcoin price at the end of 2013 suggested it was going to happen tomorrow, when the reality was that it had barely a couple of a million users. Read this Money Morning I wrote at the time. It shows how hysterical things had become.

Cast your mind back to the most famous bubble of recent times. I’m not talking about London property – that bubble never burst – but about dotcom stocks in 2000.

Computers were slow. Most of us were still using dial-up modems. The internet had just 361 million users (5% of the world’s population).

Now, almost everybody in the developed world has fast computers and broadband, and the internet has three billion users – around half the world’s adult population. And yet the Nasdaq, where most tech companies are listed, is trading 10% lower than it was then.

That’s because, even although the Nasdaq was ‘right’ – the internet did change the world – by 2000 the prices of stocks listed on the Nasdaq bore no relation to what those companies were actually doing in the real world. It was a bubble.

Something similar, but smaller, has happened with bitcoin. And bubbles take some time to get over.

There’s a long, slow road ahead for bitcoin

But just as internet usage grew in the real world post-2000, so is bitcoin adoption. The number of bitcoin wallets grew from 3.2 million at the start of 2014, to eight million by year-end, according to Coindesk’s latest State of Bitcoin report. By the end of 2015, that’s expected to rise to 12 million.

Of course, given that most users have more than one wallet, you’re still talking about less than five million users.

The number of merchants accepting bitcoin rose from 36,000 to 82,000, with 140,000 forecast for 2015. Even Microsoft is now accepting bitcoin, as well as the likes of Dell and Time. Again, that is a positive development – but what proportion of these merchants’ trade is actually transacted in bitcoin? Pretty small I expect.

At the start of 2014 there were just four bitcoin ATMs. Now there are over 340. Another positive growth story, but compare 340 bitcoin ATMs worldwide to the number of cash ATMs.

Venture capital (VC) is pouring into the sector – and it really is pouring. From $98m invested in 2013 to $335m in 2014.

Silicon Valley alone is responsible for about 30% of this. Along with Hollywood and Wall Street, Silicon Valley is one of America’s three biggest brain pools. These people are not stupid. They can see beyond the falling price, beyond the fact that bitcoin is out of fashion (mainstream mentions are down by over 75%), and beyond the ridicule of last week.

But they’re betting on new companies that will make use of the tech, not necessarily that the price will rise next month. Of course, they’d prefer the price to be rising, but it isn’t essential to their agenda.

Bitcoin 2.0 – how the blockchain could change the world

In short, the initial excitement phase of bitcoin is over. Now it’s on the long, slow climb to mainstream adoption. In terms of price, we’re kind of where the Nasdaq was in 2001-03. It wouldn’t surprise me – as things stand for now, at least – to see $100 a coin before we see $400.

But the tech is amazing, and worth familiarising yourself with. It is known as the ‘blockchain’. I liken it to a supersonic database. The genius behind it is that it eliminates the need for third parties.

We already know that – thanks to bitcoin – you can send money from one person to another without the need for banks. But developers are now taking the tech and seeing what else it can be used for.

They’re finding new ways to communicate and socially network without third-party providers (the likes of Gmail, Apple, Facebook or Twitter). They’re finding ways to draft and enforce contracts without the need for lawyers (these are known as ‘smart contracts’). They’re finding ways to issue and trade shares – without the need for traditional stock exchanges and financiers.

It’s known as Bitcoin 2.0 and, for now, that’s where I think the fireworks will be.

The problem is, as yet, most of the companies operating in the field are still private, so it’s difficult to invest. But that gives you more time to get to grips with how bitcoin works. Here’s a reminder of my handy little guide to getting started with bitcoin.

1. Go to Blockchain or Coinbase and get yourself a wallet. All you need is an email address and password. You will then be told your wallet address. Copy it.

2. You now need to deposit some money. In the UK, you could go to Bittylicious. Paste your wallet address where it says “bitcoin address”. Now deposit £20.

3. Get a friend to do the same.

4. Practise sending each other small amounts of money.

5. Go to a café that accepts bitcoins and buy yourself a coffee.

Well done. You’re now part of the revolution.

[9thLife]

Run in BI under the title: BITCOIN: How It Works, And Why It Could One Day Threaten Legacy Payments Tools Like Credit Cards

[Vermont Lt]

I hate to even get into another discussion about Bitcoin, but I think there will be a bunch of folks putting “some” of their assets in BTC when currencies start to go a little nutty. If Russians could have put a few rubles into Bitcoin last fall, they would be in much better shape today.

[ratzoe]

Silicon Valley alone is responsible for about 30% of this. Along with Hollywood and Wall Street, Silicon Valley is one of America’s three biggest brain pools.

Still don't understand Bitcoin that well, but it makes me wonder when someone includes Hollywood in with Wall St./Silicon Valley as the 3 biggest brain pools. Perhaps I am missing something..

[9thLife]

Power (money and influence) always draws the hotshots.

[Vermont Lt]

As much as everyone likes to hate Wall Street, there are some pretty smart guys there.

And if you discount most of the actors, the folks in Hollywood can sell a product. Even a crappy one like “The Interview” which will go down as one of the best marketing scams since Goebbles pitched Hitler.

And Silicon Valley has been known to generate a few billionaires.

[Zeneta]

The magic of mining

Minting the digital currency has become a big, ruthlessly competitive business

Jan 10th 2015 | BODEN, SWEDEN |

http://www.economist.com/news/business/21638124-minting-digital-currency-has-become-big-ruthlessly-competitive-business-magic

A HUGE aircraft hangar in Boden, in northern Sweden, big enough to hold a dozen helicopters, is now packed with computers—45,000 of them, each with a whirring fan to stop it overheating. The machines (pictured) work ceaselessly, trying to solve fiendishly difficult mathematical puzzles. The solutions are, in themselves, unimportant. Yet by solving the puzzles, the computers earn their owners a reward in bitcoin, a digital “crypto-currency”

snip

What happens in the wake of the bitcoin price collapse is unclear. The long queues for mining rigs have dispersed. Demand for renting cloud-based hashing-power is stagnant. Many equipment-makers have ended up running the machines for their own benefit—and selling some of their stock of bitcoins to cover costs. Some people say this is why the currency has kept falling. People in the industry are already discussing at what price mining becomes unprofitable. But Mr Cole is unfazed. Where others see a weak price, he just sees all the bitcoin yet to be mined, and lots of struggling rivals set to exit the business. He recently raised $14m in venture capital, looking forward to a bigger slice of a less competitive market. If other miners do give up, the difficulty of the puzzles may fall—so winning bitcoins would get easier.

[jaydee770]

I’m still a bit leery and unconvinced that these crypto-currencies are fully beyond govt manipulation & control, so for now (subject to change) my long term expectations for it are pretty low, at least in my lifetime.

[9thLife]

Thx for posting that.

The impact of the technology is already astounding -- it's forced private-sector prototyping of enormously scaled processing like this. I don't think it's going away. It seems to be perfectly fit for the reality of an information-technology-based civilization.

And I don't think it's a wholly good thing. But it's a damned big thing.

[9thLife]

Correction: BI ran this piece under this title: The Incredible Technology Behind Bitcoin Is About To Change The World

I thought it worth including as a subtitle.

[9thLife]

I am too. In fact, I don't think governments will adopt one until it can be hacked.

But I think it will, and they will, and that's going to be the proposed solution to the global debt bubble, sort of as this fellow describes in broad terms over several posts here.

[9thLife]

Still don't understand Bitcoin that well

If you take a few minutes to go through the "block chain" idea, you'll begin to see what all the fuss is about. It's ingnenious. I don't think you need to be too techy to get the gist. Just plow through what you don't understand the first time through it.

[Greysard]

I can say two things:

1. Bitcoin, as we know it, should have no future
2. Bitcoin, as we know it, will have no future

The first comes from the origin of the currency. Imagine that extraterrestrials come to Earth and offer us their currency, called Latinum, in exchange for Earthly goods. Latinum itself has no use on Earth, but we are told that it is very valuable. As aliens assure us that the supply of Latinum is limited in the whole Universe, Earthlings start furiously buying Latinum, spending their own labor and treasure in exchange for it. Once the entire Earth is priced in Latinum, it appears that aliens invented the whole thing, and Latinum is a plentiful waste product of their refineries. But it's too late - aliens own so much Latinum that they can buy the whole Earth - and they proceed to do just that.

You can ask what this story has to do with the Bitcoin. Everything, it appears. Initial mining of bitcoins, done by inventors and earliest developers, was extremely simple. A guy could click a button on his computer, go to sleep, wake up next morning and be 10,000 bitcoins richer, so easy they were to generate back then. So the early developers wasted no time and minted as many BTCs as they could. The exact numbers are huge; they are still recorded in the blockchain. One could say that about 25% to 30% of all BTCs belong to that initial period, when Bitcoin was not known. Now those guys are sitting on millions of BTCs. They want to exchange them for goods, but in order to do that they need to find enough fools who will give them their goods for BTCs. That's why they worked so hard to inflate the bubble. Still they couldn't cash out because the market never became large enough.

The second point comes from technical flaws of Bitcoin. Indeed it does not require a bank or an authority who can vouch for a coin. But the other side of this is that it's YOU who is required to do all the checking. YOU become responsible for the software that runs on your computers, and for the network that delivers data to them. It's YOU who has to watch like a hawk that your computer is not hacked - and that's nearly impossible to do in a business. VISA and other c/c companies have no such problem because the validation of the money is done by them, at their processing centers, not at the retailer. But BTC is verified at the retailer. As you can imagine, a computer can be easily fooled into believing that the transaction is accepted when, in fact, it was never even done. A computer tells you only what it's programmed to do, and it's trivial to change a program.

Security is not the only problem. The distributed nature of the network requires very long times for a confirmation. You pay, and in 15 to 30 minutes the cashier tells you that your payment has cleared and you are free to go. All those willing to wait so much at every store, raise your smartphone!

Yet another issue lies in the fact that BTC payments are not free. Some may be free today - but without any guarantee that they will be accepted by the network. Users are "encouraged" to pay some small fee to cover expenses of miners (who sign transactions.) However that "small fee" is not that small, and in the end it may amount to tens of cents per payment. It's a new tax on all economic activity! This does not compare favorably to a credit card which pays you for the purchase. Payment in cash, or in BTC, only means that you pay 5% extra to the merchant.

Yet another issue relates to the mining companies. They are in business only while there is money to be made. But miners are essential parts of the network; without miners you cannot conduct transactions. Bitcoin fathers believe that miners will be paid with transfer fees after the bitcoins cannot be mined anymore. There is no justification of such a belief. If the fees are small, they won't cover even the power bill. If the fees are large, BTC will die on its own.

There are many other issues with BTC, such as lack of traceability. Each and every payment is final and irrevocable. But it's not productive to enumerate further. The Bitcoin is an interesting technological and social experiment, and perhaps some future digital cash will be based on it. But in order for such money to become accepted, it should be far better designed and introduced. We do not want to adopt new bills if the workers of the printing house printed a few hundred tons of them for themselves.

[9thLife]

If some future currency is based on it, we really can't say that "it will have no future".

However it is refined, the blockchain concept is the Skynet of currency. It WILL not go away, imho.

[Yo-Yo]

Does this mean there won't be a Bitcoin Bowl next year? :(

[Greysard]

If some future currency is based on it, we really can't say that "it will have no future".

That's why I said "as we know it." The current implementation is not viable, and the blockchain itself is a huge problem. Literally a huge problem. It contains all transactions that were ever made with Bitcoin. And you are supposed to carry it on your smartphone! Truth be told, the blockchain can be trimmed; but that was never done. It would break a whole lot of proofs of correctness of early transactions in the remaining segment.

However it is refined, the blockchain concept is the Skynet of currency. It WILL not go away, imho.

It's a curious idea, I don't deny that. However it is an overkill for cash. There is no practical reason to have a formal proof of payment when you pay $1 for a can of soda, but there may be such a reason when you transfer $10M BTC for a pro athlete. In real life we do exactly that - we pay with pieces of paper that are rarely looked at closely because the risk of counterfeit is low. At the same time when a team pays another team no money is even sent; what is sent is orders to the bank - and then banks sort it out amongst themselves.

The problem of the blockchain is serious enough to prevent placing BTC into chips of cards. I think it is safe to say today that nothing larger than a card will be accepted by the people - simply because the cards work great already. Cards with chips are pretty much unhackable. But BTC not only requires some serious computing power at every client, it also requires some serious storage and a network link. In other words, good luck going for 30 miles to the farmer to buy some produce. You won't reach the network there, and you won't be able to pay on the spot. But you can do that with a card because, at least, the card itself is an ID. And certainly you can pay with paper bills.

I cannot say right now how the BTC would have to change to support future transactions. However I think the concept of digital cash will remain low priority for many people, and banks will continue to hold people's money for them. The reason for that is very simple: your savings are safer in the bank. Digital cash in your phone can be easily lost, unless you are paranoid about backups. And there is yet another problem: backups can be attacked by thieves just as well as the primary wallet. BTC has to change to even become usable, that much is obvious.

[Scrambler Bob]

M4 When Broke

[9thLife]

Yeah, a global one.

[NorthMountain]

It seems to be perfectly fit for the reality of an information-technology-based civilization.

"Reality" is what's still there when the power goes down.

Never forget this.

[9thLife]

But you know what? Locale hasn't mattered to processing in a generation.

You'll get your government-assigned piece of that big server in the sky, and you'll be connected through (today) your smartphone and (someday soon) by a tidy little biomechanical interface.

And your kids kids will have their brains doing a lot of that process without being conscious of it and perhaps even without willing it

[9thLife]

"Reality" is what's still there when the power goes down.

I like it. But see below...