May 122014
 

Bitcoin in Your Investment Portfolio

Is Bitcoin in your investment portfolio a good idea? Bitcoin is a technology that enables a public, peer to peer ledger decentralized over an entire network. Huh? Well yes, that’s what Bitcoin is, in a nutshell, even though the main stream media would have you believe it’s some kind of a weird speculative currency with no intrinsic value. If you are evaluating Bitcoin as an addition to your investment portfolio, it is very important to first understand what Bitcoin is and how it might fit into your portfolio.

Warren Buffett, arguably the greatest investor of the last century, has called Bitcoin a ‘mirage’ and has said “…the idea that it has some huge intrinsic value is just a joke in my view” and goes on to compare Bitcoin to check/money order. No, seriously. If you’re interested in the more juicy details, read this Forbes piece on Warren Buffett vs. Marc Andreessen. Mark Andressen likes to compare Bitcoin to the internet in the early 90s – something with the potential to change the world. So who’s right?

Time for disclosures first – I am not an investment adviser and really, you shouldn’t be reading my blog for any investment advice. I run a blog about Bitcoin, so it shouldn’t be surprising that I see a bright future in Bitcoin. Make your own mind up whether Bitcoin is good or bad for you. And yes, I am long Bitcoin.

Also, getting the obvious out of the way, unless you’re really really savvy as an investor or technologist, pay off your debts first before venturing into Bitcoin. And oh for your own sake don’t try to ‘invest’ your rent and food money into this. Also, this guide is for medium to long term investments in Bitcoin, not trading advice (no, I don’t care what triangle is formed on the top of the chart and your prediction for tomorrow’s price movement).

Understanding Bitcoin as a Technology

If you’re going to look at Bitcoin as a medium to long term investment, it is imperative to first understand what Bitcoin is. Is it just a faster money order as Buffett believes, or is it something more?

Well, in short, it is much much more. Calling Bitcoin a faster money order would be like calling the World Wide Web a faster postal service – you’re missing the point entirely. Simply as a technology, Bitcoin has shown it is possible to maintain a completely decentralized database in sync across all the peers without requiring any central trust. This is revolutionary in itself, and solves an old computer science problem of Byzantine Generals Problem. The first and most obvious use of Bitcoin has been as a currency, which makes it possible to transfer money from Nicaragua to Nigeria in a matter of minutes without paying any fees (the optional network fees is less than 5 cents) and without waiting for any clearing houses. This is big because now you don’t require permission from the big payment agencies of the world to get paid, and don’t need to pay their cut to move some digital bytes around (ask Wikileaks if you think all the big payment processors want to go out of their way to serve your interests).

However, Bitcoin as a technology can be used for everything from asset registries to entire stock markets. Markets created in the Bitcoin environment are global and decentralized, and the entire network agrees on whether a transaction took place or not – there’s no case of a fraud (there has never ever been a ‘counterfeit’ Bitcoin) in the protocol (If you think MtGox showed that the Bitcoin protocol is ‘hacked’, you should close this article immediately and go back to reading New York Times). With smart contracts implemented on the blockchain, sky is the limit to where this technology can lead us.

Understanding Bitcoin as an Investment

It’s not always possible to make money even if you correctly predict the next technological revolution. Buffett himself gives a very good example of how there were over a 100 car companies at the turn of the last century and even if you foresaw the car technology taking over, it’s unlikely you would have made a lot of money. Same with the technology industry in the 90s – only a few survived. Even if you believe in Bitcoin’s underlying technology, it might not be the right investment vehicle for you.

If you do plan on putting your money into Bitcoin, ask yourself if you’re willing to experience extreme volatility. In a matter of weeks, Bitcoin fell from $32 to $5, then rose to $266 a few months ago and promptly fell to $60. Then went up to $1000 and now a hovers around the $450 mark. If this is too much to stomach, consider investing in MCD and KO instead (and since you ask, no Bitcoin doesn’t give you dividends).

The investment potential for Bitcoin is purely the possibility of capital gains – how much can one Bitcoin be worth. The worth of a Bitcoin is very tricky to calculate, however. Currently, these are some factors that give Bitcoin its value –

  • Store of Value: Venezuela has a 57% official inflation rate. Capital controls prevent easy conversion of this currency into something that would hold its value over the long term. Bitcoin is one of the alternatives that’s often discussed. Of course, beware of random Wall Street price targets.
  • Medium of Exchange: If you hire a graphic designer from Nigeria for your website, it is almost impossible for you to pay him (there’s no PayPal in Nigeria). Bitcoin solves this problem in an instant. As it spreads across the world, more and more people will start accepting and using Bitcoin for their services. This obviously provides it with value.
  • Transfer Protocol: This is the part Warren Buffet was talking about – as a transfer protocol, Bitcoin can move money from the UK to Kenya in under an hour and at almost no cost. Remittances is a very big international market, exceeding $400 billion. Cost is important because banks now charge an average of more than 12% for African remittances, a ridiculously high amount in today’s day and age.
  • Protocols on the Bitcoin Blockchain: There are several projects that implement a protocol layer on top of the Bitcoin blockchain and can provide additional services, from colored coins to Mastercoin to Counterparty. These allow the creation of secondary markets (such as permacredits for the permaculture industry). All these additional protocol layers provide Bitcoin with a value, as they cannot exist independent of Bitcoin.
  • Speculation: Everything from globalized decentralized stock markets to fully autonomous corporations buying and selling from each other instead of from humans, can be thought of as potential use cases of Bitcoin in the future. This gives it a lot of speculative value as well.

Competition

Bitcoin is an open source technology and as such, anyone can copy the Bitcoin code and create a clone. There are several hundred of these right now. So far, however, none of the Bitcoin copycats (all the altcoins) seem close to dethroning Bitcoin. It has the network effects built in and a great developer support, merchant adoption and community already built-in and it would be hard to replace, even if we see a world with multiple crypto currencies operating simultaneously.

That being said, altcoins can be a potential threat to Bitcoin’s dominance. It’s not true that any new feature that might be created by an altcoin can be incorporated into Bitcoin because of the dynamics of open-source projects and the difficulty in changing the core protocol. Only time will tell if an altcoin can ever be a genuine threat to Bitcoin’s dominance.

It wouldn’t be a bad idea to have Bitcoin in your investment portfolio, provided you understand Bitcoin and believe in the technology. Consider investing x% of your investment portfolio in Bitcoin, for a potential high-risk high-return strategy.

Photo Credit: Thomas

Apr 262014
 

Bitcoin Diversity

The issue of diversity in the Bitcoin space again came to light today, after Kashmir Hill (a journalist I admire for her work related to Bitcoin and cryptocurrencies in general, although I disagree with her on many issues too) wrote a post in Forbes titled “New Bitcoin Movie Introduces You To The Many White Dudes Working On Bitcoin“, a post that critiques the new documentary ‘The Rise and Rise of Bitcoin’ for interviewing almost all white dudes alone and suggesting that the people involved in Bitcoin tend to the demographic of ‘white dudes’. Well, not surprisingly, the Bitcoin Twittersphere didn’t take to this too kindly:

 

 

 

Gender, race and ethnicity are complex issues, at least in the United States. The wrong question to ask is, “Why does the Bitcoin meetup I go to skew towards the white male demographic?” or even “Why do major Bitcoin companies seem to be run by white males?” because the question is loaded with too much existing prejudice and bias in society already. What do you expect when 1 in 3 black males can expect to go to prison? Of course it’s a terrible thing, but the problem isn’t Bitcoin, the problem is the society in which Bitcoin was born, more specifically, the social norms and existing institutions of the most dominant world economy at the time Bitcoin was born.

The real question to ask is, “Is there any prejudice against blacks or women or <insert your marginalized group here> that actively prevents them from contributing to Bitcoin?” I am not a social scientist but I am going to take a guess and answer “Less than almost any other sphere of society”. What, you think when “bitcoingeist” submits a pull request, s/he is asked for age, gender and ethnicity? The whole concept of pseudonymity means that there is less prejudice online in the Bitcoin sphere than in the ‘real’ world outside.

Also important to note is that it isn’t essential for Bitcoin to be represented 50-50 based on gender or follow the demographics of the US population race/ethnicity wise. For instance, there isn’t much outrage about the fact that over 90% of registered nurses in the United States are female. There are many cultural factors at play too. If you would dare to get their world-view challenged, here’s an excerpt from an incredible essay from The Last Psychiatrist about pay-equality between men and women (a hot subject in the US right now):

…The trick is most employable women are at best at the “sales rep” level, not the lawyer level, but because of the juxtaposition you never think: why the hell would a sales rep want to be a manager? “Oh, because it’s a lot more work.” Is it a lot more money? “Well, no, it’s a little more money.” So you want me to work a lot more now for the possibility of eventually getting a job that pays only a little more money? “Yes, stupid, it’s called a promotion.” It sounds like a scam. “No, it’s a stepping stone to Nominal Vice President In Charge of Situations And Scenarios.” Does that pay more? “What are you, a communist? 401k matches 50% of the first 6%.” In other words 3%, ok, am I on a prank show? “Free GPS tracker in your phone and laptop.” Thank you Yaz, my forties are going to be great.

(Read the original piece, it’s better to argue there and show how much you disagree with the author!)

The point of all this is, it’s easy to say there are not enough women/blacks/<insert choice of minority group here> in the Bitcoin ecosystem but the Bitcoin ecosystem doesn’t exist outside the social and cultural norms of its existence. The real question to ask is, therefore, what’s stopping these groups from participating in the Bitcoin economy and more often than not, it’s a result of the society we live in, not the fault of the Bitcoiners actively looking to keep the minorities out.

(p.s. I am not the ‘white-male’ demographic)

Photo Credit: DryHundredFear

Apr 102014
 

Wall Street Not Ready for Bitcoin

It’s a welcome move that the financial industry and Wall Street are looking to get into Bitcoin in a big way. There are several good things that can come out of it – creation of a more transparent and liquid market, derivatives and options on Bitcoin so that the price discovery mechanism can be accelerated and services around Bitcoin that can reach the layman who doesn’t really care about the inner workings of the cryptocurrency world. However, the financial system hasn’t seen something like Bitcoin before and it would be a mistake to treat it as just another commodity or currency.

When I go to the Meetups in New York, they are chalk-full of financial industry professionals who are enthusiastic about Bitcoin without a clue in the world what Bitcoin is about, and how it functions. This isn’t too surprising in a way, considering there is really nothing in the financial system today that is truly decentralized, open-source technology product.

Even though Bitcoin can be bought and sold, at its heart it is still a technology product, not a financial product. This also means that the control of Bitcoin doesn’t lie in the hands of the financial industry or the government (sorry banks, no bailouts).

Has the financial industry considered the implications of 7-10 mining pools controlling 90% of the hashing power to the Bitcoin network? I doubt it. Has it considered a scenario of a fork in the blockchain, deliberate or accidental? Has it considered the possibility of side-chains and how it affects value of each Bitcoin? Does the industry understand the full implications of how the software can and is changed and how the control doesn’t really lie with those with most Bitcoin but instead the real control lies with the developers and miners? In the long term, all these and many more things need to be understood before jumping on the bandwagon.

It’s not surprising that the Wall Street types smell money in Bitcoin and are ready to jump in. But jumping in without understanding the implications of it all and how things work could easily end up in a disaster. It is important for the financial industry to treat Bitcoin as an open-source technology first and educate themselves in the world of cryptocurrency before going full-throttle into this uncharted territory. Meanwhile, Bitcoin will thrive either way, with or without Wall Street.

Photo Credit: arden

 

Mar 292014
 

Bitcoin Insurance

With Bitcoin going more and more mainstream every day (irrespective of the price. Seriously, stop obsessing about the price, up or down!), as a financial instrument (currency/commodity/thing of value/I-have-no-idea-what-it-is-but-I’ll-speculate) it’s only a matter of time before Bitcoin insurance comes along. Well, it sort of already did, and it’s a matter of time before bigger players enter the market. This is an interesting development, considering Bitcoin is still a beta software!

Also, Barry Silbert, the founder and CEO of Second Market had this to say on Twitter recently:

(Interesting. We’re starting to get approached by large, well-known insurance cos looking to offer insurance products on bitcoin exposure)

This is a positive trend for Bitcoin, but just so the Bitcoin insurance companies know, insuring Bitcoin is nothing like insuring your car or insuring your gold supply. It would be very interesting to have an insurance claim on Bitcoin tested out in a court of law. Anyway, here are some things these companies need to think about –

  • Simple thefts: This seems like the primary motivation of the Bitcoin insurance companies. If there was a hacking theft or employee theft, I assume the insurance pays out. It’s trickier though – how do you really prove a hacking theft? The owner might simply transfer them to another wallet and claim he was hacked.
  • Partial key theft: An interesting situation where an insider is able to leak a part of the key (e.g. the one which he has access to) and then sells it on the black market and a powerful computing pool is able to crack the remainder of the key and steal all the Bitcoins. Note that the private key wasn’t ‘stolen’ in this case, but instead brute-forced with the help of some insider information.
  • Key loss: Proving a private key is lost can be tricky. How and when would this insurance pay out if a key is claimed lost?

There are also many unexpected scenarios that the Bitcoin insurance needs to be aware of, which might or might not directly impact the payouts –

  • Hard Fork: It has happened in the past but was quickly resolved. However, with so many interested parties in Bitcoin now that have a considerable investment, it isn’t out of the realm that there’s a hard-fork that cannot be reconciled. For instance, when Mike Hearn pushed for blacklisting of coins, the whole community erupted in opposition. If such a feature was to be implemented, the people close to governments and regulators might welcome the money and many others wouldn’t. There was already talk of forking the Bitcoin blockchain in that case. There’s no ‘main’ chain in that case – there would be two different chains, each one valid and I assume each one very well protected by hashing power. It’s a situation to think about at least.
  • Miner Blacklisted Coins: If the scenario above happens, or even if it doesn’t, the Bitcoin miners have a lot of control over which transactions are added to the blockchain. What if the most powerful players in the very centralized Bitcoin pools decide to block transactions from certain addresses to be processed? It seems unlikely that individual parties can ever conjure up enough hash-power to add to the blockchain themselves. It would be an interesting scenario – the Bitcoins are still present and not stolen, but there is no way to ‘spend’ them.
  • Lost Fungibility: Today, Bitcoins are more or less fungible, in that any Bitcoin is the same as another. However, ideas like Colored Coins would destroy fungibility. Such a situation would mean one Bitcoin is different from another. There are a plethora of issues that need to be thought about in such cases. This also applies to legal frameworks – since the blockchain is public, there could be cases where certain Bitcoins associated with some addresses, for whatever reasons are not considered fungible with the rest of the network due to specific laws in that country.

What other issues could Bitcoin insurance run into or should at least think about?

Photo Credit: Gabriel GM

Mar 272014
 

Bitcoin Tug of War

A quote from Mark Andreessen during the CoinSummit in San Francisco caught my eye – “My prediction is that the Libertarians will turn on bitcoin in two years. It will be part of the mainstreaming.” It is amusing to me, considering Bitcoin has such a rich history already. Also, this comment appears to me to be somewhat naive (I know I am not rich enough to invest tens of millions into Bitcoin companies, but I think I’ve seen and followed this space more than Mark) and lacks nuance.

I am not a fan of Silicon Valley coming along and claiming Bitcoin to be their baby now, and asking ‘those crazy libertarians’ to back-off. Bitcoin needs to grow holistically, which means taking into account all the earlier efforts that have gone into bringing it to its current stage. Remember that it is not Silicon Valley that started Bitcoin or nourished it. They are just here because they see an opportunity to make some money here (you don’t actually think the millions of dollars are being routed to open-source developers do you). Like it or not, Bitcoin has strong cypherpunk roots and those ethos are embedded into the system, whether people realize it or not.

I am not new to this kind of a struggle though. When Bitcoin price peaked near $1200 per Bitcoin a few months ago, there was plenty of trading activity in China and elsewhere, with little consideration to the underlying technology. That cycle is probably going to repeat sometime again. In those cases, the traders and ‘finance-guys’ thought they ran the show and firmly believed in it, without realizing Bitcoin as a technology.

It’s funny how these cycles and bubbles form, but Bitcoin as Bitcoin is survives and thrives nonetheless, without bothering about who is trying to flex their muscles. Even then, there are powerful groups of play here, so I think it’s important to understand and get an overview of the current state of Bitcoin and the players involved –

Crazy Libertarians: The guys who started it all, believed in the idea and philosophy of Bitcoin (including the founder Satoshi Nakamoto), nurtured it in their own way and stuck with it during the ups and downs. They can sometimes seem crazy to the mainstream, mostly because they are, with their anti-government anarchist rhetoric. Bitcoin needs them as they are the strongest supporters of the idea of Bitcoin and contribute to the idea wholeheartedly even when there are no direct financial incentives.

Silicon Valley Geniuses: The guys who believe in making products and services around Bitcoin, making money for themselves in the process, and clash directly with the crazy libertarians over the direction Bitcoin needs to take in terms of government involvement and regulation. Bitcion needs them because they build the technologies and businesses around Bitcoin that will help it gain mainstream adoption, as the founder intended.

Wall Street “Trust us we know what we’re doing” Traders: The guys who have no clue what Bitcoin is, and are only interested in making money off of this new shiny thing they call bit coin or something like that and are trying to figure out whether this new thing is a currency or commodity and how to modify the Black Scholes to create Bitcoin derivatives. Bitcoin needs them because they are the one who can design financial systems around making Bitcoin as a payment system/store of value/store of account and also provide it with the required price stability so ordinary people can start using Bitcoin more and more.

It seems like these groups of people have their ups and downs in terms of what the current narrative in the media is. Make no mistake though – Bitcoin needs all of them and it needs all of them to work together. No one group is going to achieve glory for Bitcoin on its own without the others.

Photo Credit: Janet Lackey

Mar 122014
 

Bitcoin is Much More Than Money

Bitcoin is much more than money, and don’t let the mass-media, or worse, most of the ignorant comments on the mass-media pieces convince you otherwise. About 95% of the “criticism” you read about Bitcoin revolves around how it isn’t a good currency and a plethora of reasons justifying that stance. Don’t get lost in the noise, and let’s be very clear about something – we don’t know what Bitcoin can be yet. No one does. Not the founder, not the core devs, not the miners, not the traders, and certainly not economists and journalists.

Just because Bitcoin has been used as a currency in certain contexts doesn’t make it a currency. Bitcoin is a piece of technology that has potential to decentralize the hell out of everything. With guarded optimism, this is an incredible feat and we don’t know how this going to be used yet.

Not to sound cliched, but the earliest versions of the internet allowed two people on two different continents to communicate. That’s all. Most of the scholars and pundits could never see the emerging web beyond a teenage fad and porn haven. These inventions today have made the old life almost unrecognizable. Bitcoin, I suspect, is on similar footing. It is not possible to really predict what it is and what it will be yet.

Bitcoin isn’t a currency that fluctuates greatly in value, it is a piece of technology that has been used as a currency, and as it develops, it will be used as much more than a currency. In its current state, Bitcoin seems like a hybrid of a currency, payment system, commodity and a financial asset. Don’t think it will remain that way though. With little fan-fare, there are uses beyond this already – time-stamping a piece of document, for instance, without a notary. I don’t think a currency does this, do you?

Don’t get me wrong, Bitcoin can be used as a currency, but it is much more than currency. What the future holds is anyone’s guess. With the implementation of smart contracts in the protocol, sky is the limit, from autonomous corporations to decentralized stock markets. The value of Bitcoin is going to be a sum total of all the utility it provides in the world, not just as a currency.

The reason the main-stream media gets it so wrong most of the time is because they ask the “experts” with a uni-dimensional world-view who cannot think beyond. You know this is the case when world-renowned economists and professors get almost everything wrong about Bitcoin, like Nouriel Roubini or Paul Krugman. As Scott Rose put it eloquently, the current criticisms of Bitcoin are 10 years too early.

 


If you’re trying to value Bitcoin, don’t think of it as one thing and try to model Bitcoin in terms of the familiar, just so you can get away with intellectual laziness. No, Bitcoin isn’t a currency. Bitcoin isn’t a payment system. Bitcoin isn’t a financial asset.

Bitcoin is just Bitcoin, get used to it.

Photo Credit: epsos

Feb 282014
 

Bitcoin only economies

There are so many articles in the media about how ‘Bitcoin is such a poor currency’ that I won’t bother linking to them all. In a one-line summary, they claim Bitcoin is too volatile to be a store of value and not universally accepted. In a one-line refutation, Bitcoin is an emerging technology that will obviously take time to stabilize and catch on. That, however, is just a small part of the story.

For those who are lost in the flurry of media attention about MtGox and Bitcoin’s doom, don’t get lost in the day-to-day details of one business dealing with one aspect (arguably one of the most important, though) of the Bitcoin ecosystem. Yes, Bitcoin can sometimes replace traditional commerce and banking system (tell me again how I send $10 to someone in Nigeria?) but that’s just the beginning. Like I previously mentioned in an older article, the real value of Bitcoin lies in economies that don’t yet exist.

What are Bitcoin-only Economies?

It’s true that Bitcoin can sometimes replace traditional payment systems. If I go to my local bar selling me beer for US Dollar cash, US Dollar credit or Bitcoin, I can choose to pay any way I want, and especially in the new, beginning phase as the ‘early’ adopters of Bitcoin are excited to be able to use Bitcoin to buy ‘real’ things, they’ll be quite inclined to pay with Bitcoin. In the longer term though, there is no reason to think that Bitcoin would replace the existing payment network or structure – it will probably be a strong alternative but not completely replace it. The world of credit cards and cash is too entrenched in our economy to be replaced overnight.

However, the real transformative power of Bitcoin lies in economies where traditional payment systems are either infeasible or impossible. It doesn’t matter whether you like Bitcoin or whether you think it’s the future – if you want to participate in these economies, you will need to get your hands on some Bitcoin. Lets start from the simpler and more obvious cases to the more ambitious ones. Here’s a brief description of the kinds of economies (I’ll write more detailed posts about each one individually in future updates to the blog).

Please note that when I use Bitcoin here, I mean any crypto-currency, not necessarily Bitcoin, although at this current state of things, it seems that Bitcoin would be the dominant chain.

  • Micro-Payments: Tipping, donations to artists, as a general ‘thank-you’ across the internet (Dogecoin seems very dominant in this area too). Chicago Sun Times tried this out, and BitWall, a Silicon Valley startup is actively working on this.
  • Cross-Platform Gaming/Competition Currency: Any game developer can use this as an in-game currency without trying to handle a whole payment system. In addition, it’s easy for in-game competitions and giving the ‘money’ to the winner in a competitive game. This is an evolving field, and there are a few good companies working on this.
  • Provably Fair Gambling: Most reputable Bitcoin gambling sites today have provably-fair gambling. There are other ideas of implementing gambling into the blockchain itself, so there’s absolutely no counterparty risk either from the other side of the bet or from the betting company itself.
  • Payments to Autonomous Corporations: This is another area of the future that only Bitcoin can tackle – autonomous corporations can never take fiat currencies. See Dawn of Autonomous Corporations part-1 and part-2.
  • Smart Property: Again something that should be implemented in the future, but the best way to get this going is through crypto-currencies due to a number of desirable features (weak versions can be created with traditional networks too).
  • Stock/Bond Markets: Within the next 5-10 years, I am sure there will be good implementations of moving securities to the blockchain. There are just so many advantages. Dividends or coupon payments can be made in a very simple and easy to implement manner without having to go through complex brokerage networks. International trading is a piece of cake. Bond-issue voting is easy to implement too.
  • Others: Electronic notarization, cheaper remittances, international payments, etc.

It would be good if Amazon starts accepting Bitcoin. And then Walmart. However, the real strength and value of Bitcoin shine through when these Bitcoin-only economies are developed.

Photo Credit: ViewMinder