Is Bitcoin here to stay? It all depends

In my yearend diatribe on Money we discussed the differences between various types of currency. Everyday I learn a bit more on the issue. Currencies are basically priced based on what value we collectively assign to it.  Even gold is priced on the perceptions of the moment, but we also know that because of its scarcity it tends to keep its own purchasing power over time. Some claim that the underlying value of gold is the all-in costs to mine it, which is currently around U.S. $900.  But really, if no buyer would feel gold is worth $900 then its price could fall far below that and gold miners would stop mining.

In fact, this happens with many commodity prices. Oil is an example and so is uranium. The latter mining costs are around $60 per pound while uranium is trading around $20. What did Cameco, one of the world’s largest mining companies recently do?  It did shut down production in one of its best mines McArthur River. Mining companies in Kazakhstan, its largest competitors, followed up with some production cuts as well and finally the uranium price has gone from bad to less bad. Thus, to claim that the production costs of gold form a base price is not quite true either.

Fiat money prizing is even more of a mug’s game. Each currency is basically an IOU backed by the government that prints it. So how much do you trust the Government of Zimbabwe or Venezuela to back their currencies?  What about the repayment of debt by the U.S.?  The valuation of these currencies may be even less secure than that of gold, because these governments can basically print money out of thin air – there is no scarcity.  Apparently, the Swiss government printed over the last 3 years a trillion Swiss Francs out of thin air. Basically, that currency lost in value compared to currencies that did not print. Thus if the Swiss currency loses value then the Swiss have to work more to buy the same amount of products as in the past from the rest of the World.  Printing of fiat money is basically another way for governments to raise taxes or raise inflation whatever you want to call it. Irony is that the Swiss used close to $250 billion of the money to buy international assets  and made last year a profit on their trades of, yes wait for it… $50 billion.  The Japanese also print money and buy with it securities of Japanese companies – no wonder the Japanese stock market was up last year!  Fiat money is, in all kinds of ways, manipulated by the respective governments that print it. And often that manipulation is not in the favor of its citizens.  Think of this: retirees saved their entire life and try to live of money made on their savings often by investing in government bonds Bonds of which the central banks have driven interest payments down to zero or even into negative territory. On an after tax and after inflation basis those retirees lose money by the bucket full. So, who is really paying for their government's irresponsible spending? To top matters of, to do better than fixed income returns the retirees are forced to buy stocks in a stock market whose prices have been driven up by those same governments not only through buying themselves shares in those markets like the Swiss and Japanese, but also by providing nearly free capital to many corporations that use that capital to buy back shares so that the stock market goes even higher. That is the state of affairs we are currently in; with markets going up nearly everyday, until…. the next crash and who will suffer the losses and pay the taxes to governments so that they bail themselves and over-indebted corporations out?  If that is not a Ponzi scheme, then what is?

No wonder many people have lost confidence in government backed fiat money and now run to the cryptocurrencies and their reserve currency Bitcoin. Bitcoin’s currency system is now valued at close to $250 billion depending of the day of the week. Cryptocurrencies are valued on the same basis as fiat money and gold. It is based on demand as well. ‘What you pay is what its worth”. Because, it is such a young currency its value fluctuates like crazy, but the good news is that nobody (yet) has decided to create more Bitcoins than the originally allocated 21 million. So there is scarcity just like with gold. Fiat money is administered by central banks and their accomplices the big banks and institutions such as Visa and Mastercard. Central banks are together with their respective governments in charge of the printing presses. Banks and the credit card companies are basically the accountants that trace, especially in our increasingly cashless society, the transactions in return for banking fees. The moneys you and I deposit with them and the money they borrow from investors, and the money they get from issuing their shares  are used for trading and investment purposes which is another source of their profits.

Cryptocurrency transactions also are not free of administration costs as many claim.  Yes, they are peer-to-peer transactions just like when you give me some cash in return for some service or goods that I deliver. But the transaction has to be administered on the big ledger in the sky. Rather that the transaction is being recorded or verified by a few banks, they are verified by a large network of computer-owners which makes the ledger nearly hack prove. Will it ever be entirely error and hack-free, in spite of its high level of encryption and multi-verification, someone will find a weak-point that hopefully can be quickly remedied (or not). The members of this decentralized computer network are called miners and for good reason.

Currently, around 16 million Bitcoins are in circulation of the 21 million that have been authorized by Satoshi Nakamoto, the founder or founders of Bitcoin (nobody seems to know). So, the miners, auction style, charge fees for processing or better verifying the Bitcoin transaction which takes typically 10 minutes – way too long in my opinion for purchasing a cup of java. In terms of computing power and electricity this operation is costly and the longer the transaction ledger the more the costs of this verification will be. Also, the miners get compensated in another way for their work: for a certain number of transactions that they process, they are allowed to create a new Bitcoin for themselves up to the maximum of 21 million bitcoins. With 16 million in circulation there are another 5 million to be ‘mined’. Yes that is why they are called bitcoin miners.

Of course, the number of transactions and thus bitcoins created by the miners will increase with the success of the entire system until the maximum has be reached. BUT also, the number of transactions required to create a new bitcoin will go higher and higher (this is build into the system). In the end there will be only a few or better no bitcoins left to be mined while the number of transactions required to earn those last Bitcoins will skyrocket. To create one Bitcoin will require exponentially more transactions processed by the miners. This creates a scarcity of Bitcoin similar to that of gold. It is really a very smart and elegant system.

The underlying costs to ‘mine’ Bitcoin, rises with the decreasing number of Bitcoins left to be mined. Because with this ever-increasing number of required transactions, the computing costs and energy costs of updating the ledger will rise exponentially as well and thus the mining costs of each new Bitcoin.  Recently, JP Morgan has calculated that the costs of mining a new Bitcoin is between U.S. $3000 and $7000. JP Morgan? You may ask. Yes. JP Morgan – really did you expect our sycophant financial businesses to stay away from making money?  They are us and we are them – so it’s a matter of human nature.

The miners will try to decrease the mining costs by doing their computing in jurisdictions that have very low electrical energy costs, such as hydroelectricity-rich Quebec. Probably not in Ontario with its mismanaged high electricity costs! Computing technology will improve as well. Currently mining fees are $28 dollars per Bitcoin transaction. That is one of the weaknesses of this system. For Bitcoin to become accepted as a daily transaction currency the fee has to be fractions of pennies as is the case with the fiat currency transactions. I am sure solutions will be found for that; maybe in the form of cloned or forked currencies such as Bitcash or Ethereum. Yes, the issue of endless money printing seems to be solved.

But the anonymity of Bitcoin transactions is a problem that this planet’s governments not likely will accept because it means loss of their control and power. I am sure that under the guise of national security and the war on terror or drugs this will be ‘rectified’ as well. Initially the internet was a Wild West, to some degree it still is; but if you realize how deep the claws of large corporations and governments reach into our on-line life today, you must admit that our incorruptible government leaders aren’t likely to stay out of the crypto currency business either. It would be naïve to think that. We already have seen China and lately South Korea clamping down on Bitcoin exchanges which are basically the form that our future banking system may take.

Blockchain technology, the technology underlying Bitcoin and other cryptocurrencies, is here to stay. It will likely revolutionize and disrupt our lives in numerous ways. Imagine the title of your real estate property is tracked in a blockchain ledger and you could transfer your property to another person just using a transaction similar to that of a peer to peer Bitcoin transaction.  Whether Bitcoin will survive all the intricacies and troubles that many other currencies also experienced is hard to say. I would think a lot will depend on us humans.  How far will we go and how far will our ‘Über’-institutions (governments, banks, etc.) go to get their claws into it? ‘Über-institutions’ is a term I really like to use for all those governments and big money institutions once designed to serve us and to provide us a better life but now with the roles seemingly reversed. Once we were the people to be served, now we seem to be the servants of those out-of-control Über-institutions.

As pointed out in a previous post, for Bitcoin to become a true currency with a circulation equivalent to a 1 to 3 trillion-dollar fiat currency system, we must accept and bid up the value for a single Bitcoin to between $95,000 and $380,000. Last year Bitcoin peaked at U.S. $20,000 per coin and with the introduction of Bitcoin derivatives to the U.S. official securities markets it may be well on its way to become a real currency. But even with today’s speed of adoption and valuation that is likely to take at least another 5 to 10 years – short when measured on the timescale of human history but still quite slow in terms of daily life perception.