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Bitcoin for dummies

Thumbnail image for Bitcoin_Digital_Currency_Logo.pngThe writers of the sitcom The Big Bang Theory probably thought they were on safe ground in early November when (at a guess) they pegged the price of bitcoin at $5,000 for the episode that had its first airing in the US on November 30 (Season 11, episode 9, "The Bitcoin Entanglement"). By then, it had doubled. This week, it neared $17,500, according to Coindesk. In between, it's dropped as much as 25% in a single day.

All of which explains why I've had numerous conversations this week in which I tried to talk people out of feeling bad that they didn't buy bitcoin back when it was cheap. Mortgaging your house or opening up credit card debt in order to buy bitcoin, as CNBC reports some people are doing, is a disastrously bad idea.

Bitcoin is at the stage where a sense of proportion is in short supply. You've got Deutsche Bank claiming that a bitcoin crash would endanger global markets, the Bank of England saying it's no threat, and Andrew Weilbacher at btcmanager.com arguing in return that the euro will be far more destructive. The Bank of England likely has it right: bitcoin is too small - at its $17,000 peak the whole market is $300 billion - to cause a global crash, even at current prices and volatility. It can certainly crash personal economies quite effectively, though.

But why stop Weilbacher when he's having fun? "Bitcoin is poised to overtake current technology for the internet and finance, not considering all of the other blockchain protocols. If and when this technology passes more archaic versions, it will begin to take on the total market valuation of the internet - $19 trillion - and the financial industry as a whole," he writes. Stuff like this always makes me think of this quote from Wall Street giant (and Warren Buffett teacher) Benjamin Graham: "Bright young men have been promising to work miracles with other people's money since time immemorial."

The dot-com bust was a great example. And yet, at its height in 2000 when even the most insistent dot-com boosters were admitting it was a bursting bubble, even the most skeptical believed that ten years later the internet would be much bigger. Many of those early internet companies never recovered, of course - but the internet still hasn't stopped growing.

So is bitcoin like an internet company or like the internet?

Bitcoin was conceived as two things: a cryptocurrency and a payment system. At the beginning people who mined or bought it were mostly curious and wanted to experiment. It was technically challenging, but cheap. A couple of years ago, we were hearing a lot about its potential for cutting costs out of financial transactions.

That dream is in trouble: the rapid rise in prices is killing bitcoin as a cost-cutter because as bitcoin's exchange rate goes up, so do its transaction costs. About 100,000 outlets worldwide accept payment in bitcoin, but there are also many private uses, particularly in areas where trust in government and the financial system is collapsing. The reality, though, is that very few people seriously use bitcoin as a currency and some of them are reconsidering. Steam, for example, announced on December 6 that it was ceasing to accept bitcoin payments partly because of pricing volatility but mostly because the fees are nearing $20 per transaction, 100 times what it cost when Steam started accepting it.

There's another problem, too: recent calculations say that the bitcoin transaction network is hideously energy-intensive, and even if miners derive all their power from renewables, if prices continue to rise it won't be sustainable. Even if it is, Visa is vastly faster and vastly more energy-efficient.

Those involved in fintech have been saying for some time that whatever happens to bitcoin, the blockchain, which records transactions in secure but verifiable blocks, is really significant (although older industry guys call it a "distributed ledger" and wonder why all the fuss over a 30-year-old technology). I see no reason not to believe them. However, you can't invest in the blockchain by buying bitcoin. Instead, the people investing in exploiting this are banks, other financial institutions, and large and small technology companies. That being the case, the idea that the power of the system lies in its decentralized peer-to-peer nature that requires no central authority seems likely to die even faster than the same idea about the internet itself. Get your libertarian rhetoric while you can. And your crypto kittens.

Bitcoin is not scaling. That doesn't mean other cryptocurrencies can't, but it does make Derek Thompson, who, writing for The Atlantic, called bitcoin a digital baseball card, without the faces or stats", even more likely to be right.

So, at present, most bitcoin owners are speculators hoping to cash out by selling to a greater fool. Over the time of bitcoin's existence, mining has moved from ordinary laptops to GPUs, to purpose-built ASICs. Today, most mining is controlled by a relative handful of players with giant clusters. If you are really insistent upon trying to make some money out of the bitcoin bubble, your best bet is the old picks and shovels approach. Needless to say, others have already thought of this.

Bottom line: you may regret missed opportunities but they don't make you feel nearly as stupid as the ones you took but wish you hadn't.

Illustrations: Bitcoin logo.

Wendy M. Grossman is the 2013 winner of the Enigma Award. Her Web site has an extensive archive of her books, articles, and music, and an archive of earlier columns in this series. Stories about the border wars between cyberspace and real life are posted occasionally during the week at the net.wars Pinboard - or follow on Twitter.


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